Low rates not all good
Investors in the Montgomery [Private] Fund recently received the latest monthly investment report.
We will not normally publish our thoughts from our monthly reports as these are reserved exclusively for investors, however the impact of the RBA’s interest rate decisions affects all investors and savers and the government should be on notice…
On Tuesday October 2, 2012 the Reserve Bank of Australia cut its target for the cash rate. This is the rate at which banks borrow from and lend to each other on an overnight, unsecured basis. The rate was reduced to 3.25%. Another cut by 25 basis points would take the rate to the 3.00% we saw at the low point of the GFC. This is astounding because Canberra has long had us believing the economy was on a dream run. As you know we have not held that view and these cuts along with the latest rounds of quantitative easing in the US and unlimited bond buying in Europe only serve to remind us that all is not well and there is no pickup in sight.
More concerning for investors and retirees is the fact that Australia’s ten year Government Bonds now yield 2.93%. While this rate compares favourably with ten year Government bond yields in Japan, Germany, the US and the UK of 0.8%, 1.5%, 1.6% and 1.7%, respectively, there is nothing favourable about working one’s whole life to accumulate $1 million (and be labeled a millionaire) only to have it earn $29,300 per year for a decade. Government bonds are supposed to be low risk but there is nothing riskier than being guaranteed to lose purchasing power.
The unintended consequence of low rates of course is to punish those who have been prudent with their finances and reward those who are profligate. But low rates are a necessary evil if economic activity is sought to be activated. The only problem in our view is that rates are inelastic in their effect on spending and investing intentions as they go lower. If a 3.25% doesn’t spur you into action and borrow money – assuming of course the banks are willing to lend it – then a 3.00% rate isn’t going to make much difference.
What is needed is confidence. Only confidence will end the great deleveraging we are witness to and which we have described previously. And only when the deleveraging ends will investors, who are less selective than us about which stocks they buy, see returns better than the guaranteed losses they currently prefer by investing in cash, bonds and annuities.
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.
Duncan Lenton
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I seem to have very little sympathy for retirees. They have had decades of being able to be both prudent and profligate at the same time. an abundance of cash made them greedy. They have had houses that sold for $71k now sell for $400k. Investment of $10k that turn into $1m. I know its not everyone but those that wanted to work had the opportunity to work hard a make a very good life.
$29K annual interest on $1m, although not massive, without a mortgage you can have nice holidays on that!! We have a $300k mortgage, 2 kids under 10, $85k income, two holidays this year, paid an extra $5k off the mortgage, bought a new car and house furniture. every 0.25% drop gives me $600 a year roughly to SPEND. 2.75% sounds good to me!!
Perspective or confidence?
Roger Montgomery
:
Great perspective from s one one with impressive financial discipline.
Roger Montgomery
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Great perspective from s one one with impressive financial discipline.
portfolio14
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I have a different view. What is needed is improvement in productivity.
If you view the entire economy as a single company, deleveraging means repaying its outsize debt. Having confidence in the company doesn’t help. The debt is still outstanding. The only way to restore its financial health is to improve its profitability, its ROE.
Roger Montgomery
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Sadly, if you ask the RBA or the Fed Reserve, its all about confidence.
Andrew Legget
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Hi Roger,
I agree with your thoughts. Especially the one about interest rate drop benefits being inelastic at low rates. It is not as if a drop from 3.25% to 3% will result in a meaningful increase in free cash and if 3.25% doesn’t make you unlock your wallets or purses than why would 3%.
I am really not sure at the moment when the catalyst will appear that will make people go “time to spend again”. I read an article in the weekend AFR discussing how some retailers were thinking of discounting during the christmas period which would seem like blasphemy in the retailing world. On a trip to the local shopping center i see that Myer has continued its “year long” sale (my title not theirs) and David Jones is very similar with signs saying 30,40,50% off etc. The retailers that seem to be doing wells till match my and my wifes observations of the past that they are either on the low price end or the really high price end, the problem is those stuck in the middle.
It is still very sluggish out there i think, being conservative is the flavour of the day. The overall sentiment is not all that happy and that is leaking into all areas from politics, spending etc. We wait on the RBA decision like we are watching our lotto numbers hoping they come up the way we want them too.
There is a model i have seen come up in many different industries from entertainment, fashion and even politics. We tend to be very inward looking and conservative in times where we think is tough and then be very optimistic, “progressive” and outward looking when we think times are good.
For example, Disney fantasy cartoons were really popular during war time and Disney’s “tomorrowland” space themed entertainment was really popular after the war was over etc.
i think all would have a few examples that fit into the above but it is a way of gauging the public sentiment.
Roger Montgomery
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Hi ANdrew,
Myer and DJ’s have unique issues. We are seeing massive growth elsewhere. Friends with 60 foot boats and farms for sale for the last year are now receiving several enquires if not sales and agents are receiving more enquiry and sales pre-auction.