This was an important week for markets and investors, and I hope everyone takes 5-minutes out of their day to quickly read through my simple thoughts.
The week was important for two simple reasons –
- firstly, real interest rates continue to rise and this week reached their highest level since 2010.
- Second, the Australian financial sector (dominated by the big-4 banks) traded to a 6-year low against the broader ASX200.
‘So what’, you say?
Well, these two observations provide wonderful long-term context for Australian investors and their portfolio composition.
Rising Interest Rates – stealing equity market oxygen
On rising nominal and real interest rates, investors should be aware that since all asset classes trade relative to one another, a rising ‘risk-free’ rate simply makes all other asset classes increasingly less attractive.
In a nutshell, if you can invest profitably with less risk, why would you do anything else?
This week, US 5-year inflation adjusted bond returns jumped up to their highest rate since 2010. US government 5-year bond yields which drive this return jumped through 2.75% and US 10-year bond yields pushed up to 2.91%
Economic strength is one driver of higher rates for sure, but so too is the recent surge in US treasury issuance to pay for Trump’s massive tax plan. On top of that, our primary concern remains the progressive withdrawal of liquidity by the US Federal Reserve, which will only escalate as the year drags on.
In simple supply/demand parlance, the supply of US liquidity is being tightened by the US Federal Reserve whilst at the same time the demand for that liquidity in the very near term is escalating because the US Federal Government are issuing all this debt to pay for the tax cuts.
This remains a primary concern of ours, as it has been for well over 6 months. The constriction of money supply growth is only likely to rise further, and it is precisely this point that is really acting to cap out the otherwise optimistic outlook for corporate earnings, the economy and ultimately the share-market.
Australian Banks, the Royal Commission & the impact of higher rates
This week saw the Australian financial sector plumb a 6-year low relative to the market. Banks and insurers have been sent into a tailspin by the ongoing Hayne Commission revelations, and it seems highly unlikely investors should expect respite anytime soon.
Some context around the significance of this if I may.
Australian banks still comprise far and away the largest part of Australian investment portfolios. By a mile.
The reason I am harping on this again, is put simply, things remain pretty grim if you’re an Australian banker.
There is virtually no loan growth in residential lending at the moment because of the tightening in APRA regulations around investment lending and margins are being squeezed by rising funding costs (see my points above about rising interest rates).
The Bank of Queensland (BOQ) this week demonstrated precisely this in its results reported this week and analysts were forced to downgrade earnings by around 5-6%, and that in spite of reasonably benign credit quality (a good thing).
More worrisome is the future earnings outlook, which has taken a turn for the worse following the recent Royal Commission testimonials from the banks. It seems entirely reasonable to expect that bank lending will FURTHER TIGHTEN in the coming 12 months as regulators and legislators force the industry to adhere more closely to the Responsible Lending laws outlined in the National Credit Act.
It is about to get EVEN HARDER to get a loan folks, and if that’s the case, then Australian house prices are only going further south.
This matters for the future direction of the economy and bank share prices since so much of our recent national wealth accumulation has come from a debt-financed house price boom.
It is starting to get a little gnarly, and yet we already at a 6-year sector low against the market.
There is no time like the present, so once again I would implore everybody to consider these words in the context of their portfolio and to work out a plan with the help of your advisor. Waiting things out hasn’t worked for the last 6 years, and it won’t in the coming six.
Our portfolio & market views in this context remain the same
In light of my remarks above I would stress the following, and all of these thoughts are completely current –
- The share-market upside remains capped by rising global interest rates, and volatility as per the February swoon is an ever increasing prospect
- We have shifted our TACTICAL ASSET ALLOCATIONS MORE CAUTIOUSLY on account of this and other factors
- Australian Banks remain in the dog-house, and investors should consider other forms of income if they are looking to deliver a total portfolio return (capital growth + income) that is competitive – we have made mention of MCP Master Income Trust (MXT), Latrobe Financial – 12mth Australian Credit Fund, IOOF (IFL) and BT Investment Management (BTT) as alternative income generators
- Even after 30% outperformance, MQG remains our preferred bank for the medium to long term, however it is looking rather fully priced in an absolute sense at $105, so we would prefer to be buying again nearer to $90-95
- Small & mid-cap stocks + international equity funds will deliver capital growth well in excess of Australian big-cap stocks, as they already have done so – international equity markets delivered over +10% more in returns in the 12 months to end March
Snippets for next week
The L1 Capital Long/Short (LSF) fund lists next Tuesday. We think this fund is a ripper, and no doubt in the lead up to its listing you will see some good press reported in the weekend papers.
Afterpay (APT) has to be up for consideration for any portfolio seeking capital growth over the coming few years.
Take my remarks about the share-market and banks above, and put the APT remarks in their rightful context. APT I think has the ability to rise 30% or more in the coming 18 months.
Friday 10am values
|S&P / ASX 200||5881||+65||+1.1%|
|Property Trust Index||1313||+6||+0.5%|
Thursday Closing Values
|U.S. S&P 500||2693||+29||+1.1%|
Key Dates: Australian Companies
|Mon 23rd April||N/A
|Tue 24th April||N/A
|Wed 25th April||ANZAC DAY
|Thu 26th April||N/A|
|Fri 27th April||Div Pay-Date – PRIME Financial Group (PFG)|
20th April 2018, 1200pm
For more information on the above please contact Bentleys Wealth Advisors directly or on 02 9220 0700.
This information is general in nature and is provided by Bentleys Wealth Advisors. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.