Pick Your Reason

  • 04 Sep 2019
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Pick Your Reason

Last month the risk was forgotten as the stampede was on for anything with a yield, as the RBA and most global Central Banks were cutting interest rates again.

We said that it was a difficult environment for investors as the price gains were not driven by improvements in the earnings of the assets, but by desperation for income. When you get this myopic behaviour by investors it is very likely to lead to problems.

Investors push up the price of long term assets (shares and property) based on shorter term considerations (low interest rates). When values go up and earnings (rent or profit) does not, assets are just getting more expensive. If you buy assets when they are more expensive, you reduce the expected return. It can work for a while when everyone is jumping on, but when the dust settles, all you have is the risk of overvaluation.

When this occurs, it does not take much to cause market declines. Trade wars, the inverted yield curve, etc…. may be blamed for the decline, but the reality is that something is eventually going to happen to remind investors that a dividend yield or property rental yield cannot just be compared to the interest rate on guaranteed investments. We just do not know when.

Patience is a crucial element of quality portfolio management, but most people do not have it and there are normally strong pressures not to wait. Investing is more about change than the current state of affairs. If interest rates fall, other assets go up as they are relatively more attractive. However, when interest rates are at record lows, we should have a bias towards higher rates in the future when looking at valuations.

The current mood is that interest rates are low and will never go up again. We agree that there is nothing that can be seen that would lead to higher interest rates, but we think you would have to be nuts to invest in 10 year Australian Government bond locking in a return of less than 1% for 10 years.

The truth is that it is impossible to predict what will occur in the next 10 years and if you value assets based on extreme current conditions, you will be exposed to heavy losses if and when the situation normalises.

How much credence would you give to a weather forecast for 31 October 2029?

For further information or to discuss how we can help you, please speak to your adviser.