Goldman Sachs says "bond proxies" best bet amid trade war, growth fears

Investors have flooded into supposed safe havens in a bid to avoid trade war related volatility.

Fixed income markets have become a tricky place to go with negative yields increasingly the norm while stock prices are near record highs.

Goldman Sachs has a better idea for those seeking refuge: move into “bond proxies” a relatively new term for a similar class of ostensibly low-risk equities.

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Investors spooked that the trade war and a slowdown in global growth will hammer equities are running out of places to go.

Stock prices are already sky high, and in similar scenarios protection seekers have typically fled to bonds. But fixed income has struggled in 2019 as an increasing number of securities have negative yields in a low interest-rate environment.

They've instead been piling into havens like hedged ETFs, gold, and even bitcoin. A worrying sign that investors are expecting a big jolt in stock markets — traders this week flooded into 570,000 call options on the Cboe Vix, or “the fear gauge,” said Bloomberg, meaning they're betting on a surge in volatility.

Goldman Sachs has a better idea for those seeking refuge:

Investors should move into “bond proxies” a relatively new term for a similar class of ostensibly low-risk equities.

Bond proxies are equities which are characteristically steady dividend payers rather than high growth options. Because many fixed income markets have negative yields because of global low interest rates, investors are looking for bond-like qualities in the equity market with hopefully limited risk.

This asset class has actually underperformed in 2019 so far, as the chart below shows. But Goldman anticipates that it will perform better than other groups at this stage of the cycle. It could be a welcome addition to the basket of assets investors are looking to as a hedge against volatility.

The flight from volatility is a sign that slowing US, and global, growth alongside continued trade war uncertainty is causing investors to worry. The Federal Reserve looks set to cut rates again, hastened by continued political pressure.

Goldman says investors should consider buying bond proxy stocks and selling US Treasuries. In particular, they recommend real estate and telecom services stocks and beyond that suggests investors go for stocks “that have lagged their typical macro relationships the most relative to other bond proxies,” the bank said in research led by Ben Snider.

There has been plenty of skepticism in the past about the effectiveness of a “bond proxy” with claims that focusing on the yield element of a stock is the wrong fundamental analysis given the underlying economic uncertainties. But, in this low interest rate environment the indication is that fixed income investors may have made the move into seemingly defensive picks to find yield with limited risk.

Goldman's positioning is built on the back of its economist's expectations for US growth to rebound. If US Treasuries decline as economic date improves then Goldman anticipates bond proxies will in fact outperform relatively.

“Alternatively, if the macroeconomic environment continues to weaken, these stocks should outperform the S&P 500 by more than the appreciation of Treasuries, which have already experienced a large decline in yields,” Goldman said. “In this scenario we would also expect bond proxies to outperform” even hedged ETF stocks that have rallied in recent months.