Go ahead and try your luck on premium market stocks

A drop in Treasury yields in the month of February consistently followed the slump in stocks as investors have fled risky assets for the shelter of government paper, even as the interest earned from holding treasuries shrinks.

The 91-day, 182-day and 364-day Treasury bills, which recorded an overall subscription rate above 200 per cent in the period, currently yield 7.3 per cent (trading below its five-year average of 8.6), 8.3 and 9.8 per cent, respectively.

Likewise, the 10-year and 12-year Eurobonds (issued in 2014 and 2019 respectively), all climbed down from their January closes to end February at 4.6 and 6.8 per cent.

On the other hand, equities have extended their year-to-date losses right into correction zone—a correction is defined as a 10 per cent drop from a recent peak.

Moreover, the “equity risk premium” (the supposed amount of excess return that stocks are supposed to deliver over bonds) seems to have vanished. Seems stock is the new word for fear in 2020.

With a price to earnings ratio (P/E) of 10x and a dividend yield of 6.3 per cent, one may think the market would be appealing to all the bullish interest, but all there is wishy-washy interest.

But it’s understandable, when many false starts are involved (especially in the past four years), a lack of confidence follows even though historically, declines of 10 per cent magnitude are known to serve as a buying opportunity.

As investors have become accustomed to losing after buying the dip or picking up the undervalued name, demand has slowly faded around correction events. If this weak interest continues to take hold of the market, equities may wallow in underperformance for a considerable time.

Consequently, havens (treasuries) will continue as market favourites—a scenario partly causing further declines in short-end yields.

But there is more than weak buying interest at play in this. Most notable sentiment indicator (PMI Index) came in at 49.7 end of February, down from the 53.3 seen in December 2019, pointing towards a decline in business conditions—a reading above 50 indicates improvements in the business environment, while a reading below 50 indicates a worsening outlook.

Inflation rate poked above six per cent last month. Private sector credit growth is still in single digits; interest rate cap law was removed in October 2019. With all that said, is it right to buy what the herd is selling?

Just remember, markets are about psychology as much as anything else. If investors stay panicked, markets are likely to stay depressed.

This means that for short termers, this environment might be a toxic one. Nonetheless, for long-termers, go ahead and bet on any strong name (steady cash flows, low operational costs, etc) that has fallen about 50 per cent from its peak.

So long as you can ride out some volatility, you’ll almost always find it’s worth your while over the next couple of years.

Such assets usually produce strong above-market returns. Probably, the best description of the market right now is the UB40 song, “Homely girl.” - Now shunned, but not so long. She eventually grows to be the prettiest girl in the neighbourhood that every Johnny wants to date.