As the dust settles after the savage bond market movements earlier this month, Morgan Stanley sees its selection of companies combining growth and reasonable yield (GARY) as the shares to back in times of rising bond yields.
Subscribe now for unlimited access.
$0/
(min cost $0)
or signup to continue reading
The bank's analysts have taken a look at how the various segments of the "yield trade" have fared during the bond market snap-back and found that blue chips and "bond proxies" have been hardest hit, while the broker's cohort of GARY stocks has outperformed.
Morgan Stanley embarked on its GARY strategy at the beginning of the year when it decided the three-year hunt for yield had stretched valuations to uncomfortable levels.
Anticipating rising bond yields, Morgan Stanley analysts began preparing their equity strategy for a correction by looking for stocks that were generating above market earnings per share growth but also delivering a yield of 3.5 per cent or more.
"We anticipated a shift in market leadership away from bond proxy and blue chip cohorts and focused instead on the GARY stocks," managing director Chris Nicol said in a note this week on the performance of the strategy.
Morgan Stanley's picks included AMP, Macquarie Group, Perpetual, Tabcorp, JB Hi-Fi, Nine Entertainment Group and even BHP Billiton.
"BHP screened fairly well if you believe they will pay their dividend, but whether it is truly and utterly a GARY will come down to commodity prices in the long term," Mr Nicol said.
Since bond yields bottomed on January 30, the GARY stocks have grown by 1271 basis points, compared with the blue chip stocks that rose by 218 basis points, Morgan Stanley said. Meanwhile, bond yields rose by 286 basis points in the last five months.
Since January, AMP stocks have risen 25.3 per cent to $5.50 on Tuesday morning, Tabcorp Holdings is up 14.3 per cent to $3.86 and BHP Billiton is on $27.45, down by 22.7 per cent.
In the same period, high-yield stocks such as Cromwell Property Group paid a dividend of 7.06 per cent as the share price climbed 5.64 per cent, while Westfield Corporation returned a dividend of 6.91 per cent while the share price dropped 10.6 per cent.
Morgan Stanley will be continuing with an equity strategy that favours GARY stocks and companies that have significant exposure of foreign capital.
The recent weakness in the US dollar has hit foreign currency earners, but the Morgan Stanley team expect greenback weakness is transitory and the US dollar will resume its upward trend.
The analysts see the Australian dollar falling to new cycle lows of around US62¢ by the end of 2016, after another predicted rate cut by the Reserve Bank, favouring companies that will benefit from ongoing foreign exchange rate benefits.
Therefore, foreign earners remain a key theme for Morgan Stanley, and the analysts back Macquarie Group, James Hardie, Goodman Group, Ansell, and ResMed.
Other key market trends Morgan Stanley is positioning to accommodate are ongoing negative earnings momentum (-1.5 per cent), and a growing gap for companies that have cyclical earnings but slowing growth momentum.
They are also expecting increased merger and acquisition activity.
"With the Australian dollar below US80¢, we look for M&A activity when the value of market incumbency and asset footprint falls below what the market is willing to pay for the near-term earnings outlook."
