Article30 May 2013

The Global Search for Yield

It should be fairly simple. Management of public companies run their businesses well and are subsequently rewarded as investors take note of their good performance and buy the stock. This draws in more capital as markets chase positive returns, which in turn drives the share price even higher. Conversely, if management run their business poorly, the mood turns bearish and more sellers emerge. The share price starts to fall, eroding sentiment even further as investors look to shift their capital elsewhere.

But is it really that straightforward? How does this process reverse? What if investor requirements shift? And what if shareholders try to change how management run their business? To answer these questions, Citi’s global equity strategists explore the connections (and dis-connections) between investor desires and corporate behaviour.

First, they highlight an obsessive investor search for yield. A multi-year asset shift, compounded by quantitative easing (QE) policies, has pushed bond yields to all-time lows. For the first time since the 1950s, global equities now trade on higher yields than government bonds. For income-hungry investors, equities are becoming the asset class of choice.

Second, Citi strategists find that this has the potential to reshape corporate behaviour. Recovering profits, rising cash on balance sheets and the search for yield are intensifying pressure on CEOs to return capital to investors. As part of the process, global equity markets are now awarding higher valuations to markets and sectors that weight dividends or share buybacks over capital investment. Many companies are shifting their behaviour in response. CEOs who do not listen to these market signals may find themselves replaced by ones who do. Activist shareholders are often the catalyst for change.

Third, while this market thirst for yield is global, the strategy team finds the corporate response to be more local. Yes, shareholders can force change in markets where management are more accountable. But this mechanism does not apply in all parts of the world. Elsewhere, other stakeholders can have a bigger influence – cross-holding structures, governments, families, management or employees. These can limit the equity market’s influence over corporate resource allocation. Shareholder activism is less effective.

Finally, our strategists look for triggers that might reverse equity investors’ current obsession with yield. Perhaps the end of quantitative easing and a normalisation of interest rates could push income-seekers back to the bond markets. Or maybe a sharp acceleration in the global economy could drive investors towards corporates that have been spending on capex instead. Both scenarios would relieve the pressure on CEOs to pay out cashflow. The preference for dividends and buybacks might subside and tolerance of corporate expansion would rise again.

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Global Growth

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