Canary in the coal mine
Bond rates are rising. In the US 30-year Treasury Bonds rates have risen in the last week, and just as they did in 1994 (the year of the bond market crash), they are dragging long bond rates elsewhere in the world with them. In just four days Australian ten-year Treasury Bond rates have risen from 2.23 per cent to 2.85 per cent. If ten-year bond rates continue to rise, the argument for seeking higher yields in stocks weakens.
And consider what a small rise in US rates could mean elsewhere. Historically low and even negative rates in Europe, as well as historically low spreads, for example between Italian, Spanish and German bonds, act like a spring when sentiment and/or fundamentals shift. A widening could be a signal that the migration up the risk spectrum is unwinding.
In 1994 when the US Fed first hiked rates, ten-year US bond yields rose, more than 200bp in just ten months. That translated to a 3.5 per cent increase in Aussie bonds and a 21 per cent capital loss in less than a year. The same thing happened in Spain, Italy and Germany. Rates went up and the spreads between them widened as well. In Italy it translated to a near 30 per cent capital loss for bond holders.
This situation would be a negative for equities and raises the risk of a material correction. After seven years of US economic expansion (albeit anaemic), it might make sense to have more cash and reduce debt.
And don’t forget this is all amid a wave of IPO and M&A (mergers and acquisitions) activity, record property, wine and art prices as well as 80 per cent of all Nasdaq IPO’s being unprofitable, suggesting markets are jubilant.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.
Sam Goh
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I see it as Hockey carefully choosing his words. Obviously by ‘invest’ he wants people to ‘spend’ BUT if he say ‘spend’ then Im sure the public will see it as a negative & keep their money. Using ‘invest’ instead brings a much positive thinking to the minds.
Roger Montgomery
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I wish we all had your ‘optimism’ Sam.
Sam Goh
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Hahaha!! Someone got to be brave in these uncertain times. But I certainly won’t be wildly ‘investing’ as requested.
Chris
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Roger, surely those of us who are also invested overseas (e.g. ETFs) will benefit if international bond rates increase, because this translates through to an appreciation of their currencies ?
It is interesting that there has been no catalyst per se to make bond rates climb so steep and so fast, it is almost as if “this has just happened”.
Roger Montgomery
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Not if they all rise at the same time…
We’ve long argued that you don’t need a catalyst to start a crash. You can have a crash that everyone argues afterwards about what started it…
Duncan Lenton
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Has your opinion changed changed on Kathmandu recently?
Just wondering why Challenger would invest. On the sunshine coast Kathmandu wasn’t looking good. Importing staff from Brisbane. Very limited shoe range ( i wanted to buy there and couldn’t) and massive discounts.
Dunc
Roger Montgomery
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Our opinion on KMD hasn’t recently changed.Back on March our KMD analyst Scott Shuttleworth wrote: “Kathmandu is in a very difficult position. The company deploys a heavy promotional strategy during 3 sales periods throughout the year, where discounts above 60% are common. The strategy relies on a strong brand name. However, recent results have demonstrated that consumer behaviour has changed to take advantage of the heavy discounting at the end of promotions, and are shunning premium products. Amid this changing market dynamic, management has pursued an aggressive rollout strategy in Australia. Poor inventory management and heavy clearance sales has resulted in poor profitability. At the first half 2015 result, management stated that the store rollout will slow as the strategy is revised. It was deeply troubling to hear management acknowledge that these issues may be structural.”
Duncan Lenton
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Thanks Roger
Therefore, I question challengers investment capabilities and ability to grow profits. Maybe you could get onto their board!!
Dunc
Roger Montgomery
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If you had questioned it over the last few years, you may have erred…
Patrick Poke
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I’m curious, are you basing your comment that Challenger had invested in KMD on a notice of substantial shareholding? If so, you should keep in mind that CGF has a significant funds management business, so it’s quite possible, likely even, that the holding is made up of investments made by individual fund managers at one of their funds (e.g. Fidante Partners), rather than out of their annuities float. This is important because if the investment was made by fund managers that means it does not reflect the views of CGF management. Also, because it would be other people’s money (i.e. clients of the funds management businesses), rather than shareholder’s money, the only negative effect that poor performance by KMD would have on CGF would be any potential lost performance fees that the funds may have earned.
danny Stojovski
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Thanks for the article Roger.
With all this ‘doom and gloom’ is it even worth being invested at all if you are expecting a material correction in the share market? Would be interested to hear your thoughts.
Cheers
Roger Montgomery
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Yes, because most of the time the market does not crash. And most of the time, the value of high quality businesses rises, by definition. Over the longer run, prices will follow the values of those businesses.
Andrew Legget
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Whilst not entirely on topic, i felt a bit of unease when Joe Hockey after the rate cut yesterday came out and proclaimed “now is the time to invest”. Although i understand why he said it, with what i regard as a relatively expensive stock market and property prices (at least in Sydney) that seem to defy gravity then i think this is a particularly dangerous statement, especially if people use leverage to invest.
I just think we are getting closer and closer to the tipping point, and for a lot of people the other side is going to be a scary one if they are overleveraged due to expectations of continuing low interest rates.
Roger Montgomery
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And don’t forget in 2007 Mr Hockey’s mentor, John Howard told all Australian’s to buy Telstra at $7.40. It’s not yet seen that price again.
Random Ash
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The amount of mum and dad “investors” that do own TLS (whether because of that statement or not) and genuinely think they picked a winner due to dividend payments is astounding.
Roger Montgomery
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Just remember, the market transfers wealth from those that have no patience to those that do.
Dario Petkovic
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Do the opposite to what the government is calling you to do, so Joe couldn’t have made it clearer as to what not to do at this stage of the cycle.
Roger Montgomery
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Thanks for sharing Dario.