calmandquiet wrote: I’m back in RNW after a couple of years out. It feels like having coffee with an old friend.
I’m here to document my thoughts. The writing process forces me to clarify what I’m thinking and why. The bonus is that I can read it later to in order to understand my previous thought process.
RNW is a utility yieldco. The payout ratio is 85-90%. At an average entry price of 9.95 this week, the dividend of 0.94 yields a scrumptious 9.45%. The risk of a dividend cut is minimal.
Last time, I held from 7.5% until my target at 6%, which took less than a year. This time I’m back in at 9.4% and my target is 6% again. The target yield implies a stock price of 15.6 based on the current dividend of 0.94. So 15.6 / 9.95 (+two years of 9.94% yield) = 75% return.
Why might this happen? I think RNW’s stock price is being driven more by external factors (global bond yields) than the reliability of the company’s cash flow. The macro picture today demands that I should be long physical gold, gold miners, and bonds. This stock is a bond proxy.
The US government cannot afford higher rates given its debt load, so higher rates will not be allowed to happen. It doesn’t matter what the bond market thinks. The ability to print money gives them the power to bring rates to zero if they need to. It is a mathematical and political certainty that they will need to, absent a global financial reset. Money printing will return with a vengeance. Financial repression (forcing pensions to buy government bonds) will not provide the required demand for sovereign debt.
The Federal Reserve is two years into a rate hiking campaign. The US ten year is at 2.75%.
The yield curve is flattening. When the rate hike campaign began in Dec. 2015, the 2-10 spread was 1.25%. Now the 2-10 spread is 0.20%. The more the Fed raises short rates, the more the bond market signals “policy error - recession coming!” by buying the long end. The flatness of the curve will prevent more rate hikes. This month’s latest rate hike, to 2.5%, might be the last one. It would be political suicide to forcibly invert the curve.
For reference, the ten year yield bottomed in Jun. 2003 at 3.3%. The 2-10 spread hit zero in Jan. 2006 (roughly where we are now). The ten year topped in Jun. 2006 at 5.1%, and then fell for 2.5 years until bottoming in Dec. 2008 at 2.4% and in 2012 at 1.5%. If the 2-10 spread hits zero in Q1 2019 and it plays out in the same time frame as before, which of course it won’t, that would put the ten year around 1% in Dec. 2021 and 0.6% in 2024.
Some possible outcomes: we get curve flattening/inversion which will cause rates to fall, benefitting bond owners, and/or we get the USD falling vs everything else. So CAD bonds and bond proxies denominated in CAD are the way to go. This particular CAD bond proxy looks like a reasonable way to trade the macro theme.
2019 prediction: the US ten year rate will continue to fall from its recent high at 3.25%.