February 21, 2020
MARKET INSIGHTS
MARKETPLACE DYNAMICS: WHEN LOW SUPPLY MEETS HIGH DEMAND.
Intelligent investment requires a clear focus on the core market dynamics.
Whether the market is for exotic stamps, downtown real estate, funky sports shoes or public equities, a universal concept is that price depends on the balance of supply and demand.
If there is a lot of demand for a product, but not a lot of supply, the price will increase. It’s that basic.
This week, we discuss two public markets where the mismatch of high demand and low supply is creating ever-higher prices.
1. The Search for “Safe” Yield
Bond yields are historically low and continuing to fall further.
A 30-year US Treasury now yields a paltry 1.91%. Canada’s 30-year rate is an even smaller 1.38%. And, these are among the highest yields among the developed economies.
Bond yields are actually negative when compared to the inflation rate.
Even so, they still attract demand from eager buyers in record numbers. Last week set an all-time record for bond inflows (below).
Pension funds, which have to manage continuing cash inflows from worker-contributors, add to the buying pressure. They continue buying regardless of the low yields.
As a result of the high demand, yields continue on their long-term (since 1982) downtrend (below chart).
In Europe, where economic growth is even slower (and where the European Central Bank is adding to demand by actively buying government and corporate bonds) most countries have negative rates.
In fact, about $14 trillion of all global bonds pay a negative rate.
This week, some of the bonds sold by the Louis Vuitton parent company to buy Tiffany’s, were issued at a negative yield.
The investor demand for high-quality bonds was so great that they agreed to forego interest payments from Louis Vuitton and also agreed to allow the company permanently to keep a (small) amount of their invested capital.
The high demand for sovereign (government) debt creates apparently ludicrous results.
Some may remember the infamous Greek debt crisis of 2011 where government bond yields reached nearly 35%, and, European and global markets were worried about the global impact of a credit default.
Today, demand for positive yield (i.e. the right to receive any interest at all) is so high that, even though Greek bonds retain their “junk” status, demand is so high that their current 10-year rate is now only 0.98% (i.e. even lower than the US and Canada).
These very low yields:
- Increase the comparative value of all equities;
- Specifically increase the comparative price of dividend paying equities in particular.
2. Search for ESG investments
Demand for ESG investments (Environmental, Social, Governance) is growing sharply due to accelerating interest in people wanting to make environmental and socially responsible investments (below chart).
Looking specifically at one major ESG subsector, green power generation, the supply of investable assets is actually shrinking.
- Pattern Energy, one of our portfolio companies, is being removed from the market since the Canadian Pension Plan is buying the entire company.
- Terraform Power, is being removed from the market since it is being bought by Brookfield Renewable Partners, another of one our portfolio companies.
Increasing demand and shrinking supply are creating large price gains in this sector.
This 1-year chart of one of our clean energy investments is typical for this sector. This position is up 24% already year-to-date.
Final Thoughts
1. Targeted investment in industries and companies with favourable supply-demand characteristics is key to investment performance.
2. Toronto real estate (and other urban Canadian real estate) is another example of a significant mismatch of demand with undersupply. We will discuss this in a subsequent blog.