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Posted by Sandy Liang on Sep 3rd, 2020

What Do Gold and Tech Stocks Have in Common? And What’s High Yield Got to Do with It?

It’s all in one-trade right now. Is high-yielding credit next?

There are two asset classes you’re likely hearing about right now – technology and gold. Technology stocks have led the broader market with just a few names dominating the tape. This very narrow market leadership is driven primarily by the most heavily weighted stocks of the S&P 500 Index.

At the same time, gold is also outperforming. The metal itself hit new all-time highs in July and has been making attempted advances back to record-setting territory. It’s a bit confusing, as typically gold operates as a safe haven against market and economic turmoil. They don’t often rally together.

So, what do these two hot asset classes have in common?

Well, both are beneficiaries of the extremely low interest-rate environment that we’re in. As central bankers globally have committed to low short-term interest rates for a long time it’s bolstered both gold and tech stocks to reach higher returns. As the performance has caught media and small investor attention, we’re seeing investors flock to both asset classes in record speed.

While investors are loading up their portfolios, what they aren’t necessarily recognizing is that the correlation between the two assets has increased. For an investor’s portfolio, this means that their diversification may not be what they’re looking to attain. They may inadvertently be moving towards more correlation risk.

Over the coming months and quarters, we expect to see this change and the leadership broaden, which should be good for high-yield credit but also for small cap stocks and value investing in general. One of the keys to successful investing long term is to not have all of one’s eggs in one basket – investors in those high-flying sectors should be thinking about that basket right about now.

Treasury bonds and tech stocks trading together

Since the pandemic-induced sell-off, equity markets have had an uneven recovery. The S&P 500 has been driven in large by a handful of select technology stocks, such as Salesforce, Netflix and Facebook. At the same time, the bond market has rallied from falling interest rates over the last year.

The chart below shows that this narrow leadership in the S&P 500 has become highly correlated with bonds. Given the initial flows into mega-cap stocks, this makes sense. When bonds do well, mega-cap names often also fare well. Liquidity works in both directions. It shouldn’t be surprising that investors would gravitate towards liquid investments given the sense of uncertainty that persists. They’re easier to get out, if necessary.

Chart of iShares 20+ Year Treasury Bond ETF (TLT) versus S&P relative to Equal Weighted S&P 500

The correlation between negative-yielding debt and gold

Globally, the amount of debt with negative yields has skyrocketed since 2014. Simultaneously, gold has also rallied. When bond yields are negative and there is no cost of carry, gold has done well.

In the short term, gold could be considered one way to “own bonds.”

Amount of Negative Yielding Debt Globally versus SPDR Gold Trust GLD

Is the next move inflation and high-yield credit?

Given the increasing correlation between the traditional safe-haven assets such as gold and fixed income, what exactly is the next move and where does the next opportunity lie?

We can safely say that with inflation rates going up, the obvious beneficiary here will be high-yield bonds, specifically junk bonds which are the lowest-rated corporate bonds. This is especially understandable given we are early in the next business cycle. Credit-sensitive fixed income typically performs better early in the business cycle as investors become more comfortable with risk and begin to discount recovery.

Lowest-Rated High-Yield Debt Performance versus TIPs B/E 10 Year Inflation

Over the last six months, everything has been “the same trade,” as asset classes like gold, bonds and a stock market with narrow leadership have moved largely in step with each other.

Is high-yield credit the next move? We think so. Regardless of the next move investors should be thinking about how many of their eggs are in the same basket.

— Sandy Liang, CFA is the Head of Fixed Income at Purpose Investments

All data sourced from Bloomberg unless otherwise noted.

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Sandy Liang, CFA

Sandy has been managing investments on the “buy side” since 2008 following a 17-year career as a credit and equities analyst on the “sell side” working in both Toronto and New York. He was a member of the Institutional Investor Magazine All-America Fixed Income Research Team for his work covering high yielding debt securities at Bear, Stearns & Co. for seven consecutive years from 2001 to 2007. As the portfolio manager of Purpose Credit Opportunities Fund, Sandy has won a Canadian Hedge Fund Award for performance in the Credit Focused category for three straight years in 2018, 2019 and 2020. Sandy is also a Morningstar 5-Star Fund Manager.