Bonds Vs Real Economy 

Falling bond yields are the new normal in this low-rate environment. So, does it mean that stocks are undervalued relative to bonds? The answer is not clear-cut.

Although this is a clear indication of the income attractions of the equity asset class, it is worth bearing in mind the reasons why bond yields are so low before becoming too enthusiastic, the fund said. The bond market is evidently worried about the health of the global economy.

The bond market also signals that the real economy should look at ways to heal itself without the help of financial markets. A more challenging macroeconomic landscape in the West means that the equity markets are seriously running the risk of a big correction. If so, a target of 6,000 points rather than 7,000 points for the FTSE 100 becomes more likely, the bears argue.

Not so fast.

Ever since the credit crunch in 2008, institutional investors have kept a close eye on trends, while top-down analysis has dictated stock-picking strategies. In this context, companies with strong balance sheets, higher margins, stable cash flows and core free-cash-flow yield above 4% ought to be preferred to more cyclical entities.

Europe, Oh Europe

Indeed, if Europes troubles remain unsolved, bond yields will become even more volatile, particularly at the long end, and will continue to decline, possibly even at a faster pace, depending on the speed at which additional QE measures are implemented by central banks.

The eurozone is now in outright deflation and whilst many economists expect inflation rates to remain negative only temporarily, we are not so convinced,  Mr Woodfords fund added.

In this environment, investors need to be as selective as ever and focused on dividend sustainability, rather than headline yield alone,  the fund also noted. This is a key message for investors, who should not be enticed by yields north of 5% or 6%, unless they have determined how high those yields are achieved and financed.

Indeed, I am surprised Mr Woodfords fund added exposure to Centrica in January, while it may make more sense to hold Imperial Tobacco. British American Tobacco , GlaxoSmithKline and AstraZeneca,  although I would not invest in any of these four companies right now.

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has recommended shares in Centrica and GlaxoSmithKline. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

It looks like Neil Woodford is paying more attention to macroeconomic trends and debt markets these days than ever before and rightly so. Remember: a top-down approach is one key element that may determine the success or failure of your portfolio allocation strategy.