We better get used to ‘lower for longer’
Around the world five-year government bonds are paying paltry returns to their investors. Indeed, in some countries, rates are negative.
In Germany the rate is -0.6 per cent, in Switzerland it’s minus 1.1 per cent, in the US it is +1 per cent and in Australia little more than the cash rate. Longer term bond rates are not much better. In Germany, the 30-year rate is just 0.4 per cent, which means that over 30 years an investor will receive a total return of just 12.7 per cent.
Professionally managed pension and super funds that are investing in these bonds are locking their investors into very low returns for extremely long periods.
Events such as Brexit only add fuel to the fire, causing investors to stampede towards security, driving bond prices even higher and yields lower. In their hunt for security and yield, investors are laying the groundwork for the next collapse in the value of their retirement savings.
Yes, baby boomers chasing high yielding ‘safe’ blue-chip shares and low yielding bonds are likely to suffer another destructive impact to their wealth and purchasing power before their days are up.
But it may be a year, two or three before it occurs. After flip-flopping on talk about interest rate increases in the United States, the US Federal Reserve’s St Louis President James Bullard issued a report anticipating only one rate hike in the US through year end 2018.
Bullard said that the appropriate US Federal Funds rate is around 0.63 per cent, which is only a quarter of a point above where it stands today, and perhaps more importantly, will likely remain there “for the foreseeable future”.
At Montgomery, we believe investors need to accept the argument that returns will be lower for longer. From property, to shares, to private equity transactions – see the purchase of the UFC (Ultimate Fighting Championship) which earned US$600 million in revenue last year and was reportedly sold for US$4B – asset prices are elevated. But earnings growth is flat.
In Australia, aggregate earnings per share growth has been negligible since 2010 and despite this, or perhaps because of it, company payout ratios have increased from 55 per cent to 80 per cent over the same period. What that means is less of each year’s profit is being retained to grow the business and its future earnings.
Other means are available to grow of course. A company can borrow money too. Unfortunately, the appetite for debt is low despite low interest rates. This is because we are at the end of a very long-term credit cycle not at the beginning. In other words, the world is awash with debt, much of which has been borrowed to fund financial engineering, such as share buybacks and mergers & acquisitions, rather than productive capacity increases.
Neither credit-fuelled growth nor self-funded growth are available options. The only alternative is to issue more shares, but so much debt has been used to fund share repurchases that companies would appear bi-polar if they started selling new shares.
Here in Australia the stock market appears to be expensive on a number of measures. The S&P/ASX 100 index 12-month forward price to earning ratio is at 15.4 times, which is as high as it was at the market peak prior to the GFC. And while interest rates are much lower than 2007, the lower rates are not fuelling earnings growth and so should not be used to justify even higher price to earnings multiples. The S&P/ASX 200’s 12 month forward P/E is also at the highest level seen in the last 15 years and excluding the banks, the ratio is above 18 times – well above the highest level recorded in the last 15 years.
Over in the US the S&P500 is also at historic high P/E ratios of 18 times.
We are staring at an investment world with elevated asset prices supported only by low interest rates. Growth, and therefore returns, will likely be muted for some time even if interest rates stay low. And if interest rates did start to rise, or if inflation emerged – even amid a recession, expect not only low returns, but sharp corrections along the way.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
garry howlett
:
And surely all the share buy backs and M&A activity on assets at such high valuations, only decreases the value of the company’s (already expensive) doing them.
Unless of course, surprisingly, we are at the start of a major bull market of economic growth and increasing company (stock market) valuations?
Roger Montgomery
:
Spot on Garry.
Kelvin Ng
:
Hi Roger, this is a contrary view as to what the equity markets will do (and with which I agree):
“In brief, the world’s central banks are running out of ideas and options.
We are therefore rapidly approaching a day of reckoning when such a perception becomes consensus in the financial markets.
This is very dangerous.
And also means that governments need to be ready to get the fiscal pumps in action, for when this day of reckoning dawns.
Governments will respond, but probably only after, and in response to, a financial crisis.
We have now had that crisis, it was, and is BREXIT.
BREXIT was, for policymakers in 2016, the 2008 Lehman moment.
BREXIT signified a populist uprising and it terrified the living daylights out of policymakers from Washington to Wellington.
It came at a time European and Japanese bank shares were plummeting.
It came at a time of serious concerns about excessive corporate debt in China.
At a time when a protectionist and anti-globalisation Donald Trump loomed large on the global political landscape.
It came at a time when there was a growing perception in the markets as to the potency of monetary policy.
And to cut a long story short, BREXIT confirmed that a populist, anti-elite, anti-establishment uprising was sweeping the globe.
It was an absolute imperative that the elites and the establishment took back control.
In short policymakers needed to act and they needed to bring a monetary and fiscal bazooka to the party.
Policymakers needed to show that they were in charge.
Japan is about to launch that fiscal and monetary bazooka.
In the meantime the S&P 500 breaks free of its chains of consolidation and makes a new high.
This is very significant.
The markets now believe that the central banks will in fact do whatever it takes to keep equity markets moving inexorably higher.
BREXIT ensures a very friendly FED for the balance of 2016.
It also perhaps ensures that we’ll get some typically ‘fudged’ European resolution to the non-performing loan problem in Italy.
And it looks like it will usher in a new dawn in the history of modern monetary policy and the arrival of HELICOPTER MONEY.”
Kind regards,
Kelvin