Red Alert

Red Alert

We warned you about the Chinese stock market before it’s correction and we have been warning you, for many years, about the price of iron ore falling back to $40/tonne. There have also been many other alerts and insights here on the blog. Today’s is a less tangible, but it is no less important. Indeed, its impact on your portfolio could be much more significant and longer-lasting.

Let me begin with a quote from the Bank of International Settlements:

“Interest rates have never been so low for so long. They are low in nominal and real (inflation-adjusted) terms and low against any benchmark. Between December 2014 and end-May 2015, on average around $2 trillion in global long-term sovereign debt, much of it issued by euro area sovereigns, was trading at negative yields. At their trough, French, German and Swiss sovereign yields were negative out to a respective five, nine and 15 years. Such yields are unprecedented. Policy rates are even lower than at the peak of the Great Financial Crisis in both nominal and real terms. And in real terms they have now been negative for even longer than during the Great Inflation of the 1970s. Yet, exceptional as this situation may be, many expect it to continue.” You can read more here.

Having returned from a trip to London, France, Austria and Italy, what troubles me as much as the IMF is that what was previously unthinkable and certainly not considered sustainable is now being considered normal. People everywhere are going about their business without any apparent concern for the levels of debt that have mounted (despite relatively depressed output and incomes) in an attempt to avoid what previously where unpleasant but nevertheless reasonably regular, and survivable, recessions.

Broad and blunt monetary policy is being employed by policy makers, much like the man with a hammer, for whom every problem is a nail. The absence of unpopular and politically unpalatable macro-prudential polices that would sharpen the tip of monetary policy means that too much responsibility sits on the shoulders of low interest rates.

When low interest rates give way – either way – the impact on inflated asset prices may not be pleasant.

The combination of central bank-controlled monetary policy and dovish fiscal policy failed to avoid the situation the world now finds itself in and yet it seems more and more of the same medicine is expected to get us all out of it.

One cannot help but believe that the man with the hammer is simply striking more nails without realizing the long-term solution is structural reform – the replacement of the hammer with something more modern and job-specific.

The stupidity of Australia’s reliance on China, it’s leaders’ kowtowing to the vested interests of prehistoric industries and the failure to embrace or encourage those policies that would structurally improve our debt and balance of payments predicament, while simultaneously staving off the brain drain and solving the pressures of urban consolidation, is only exceeded by the belief that building more houses and encouraging consumers to buy more stuff will comprehensively and permanently fill the hole left by the hitherto reliance on another failed mining boom.

For investors in broad and indiscriminate stock market index funds to enjoy solid long-term returns governments must move away from a reliance on policies designed to encourage consumption and business demand, and towards structural reform of a lasting and permanent kind.

That is unlikely to happen anytime soon, and if it did there would be legacy industries that would emerge as winners and losers. Either way Montgomery will continue to focus on specific business opportunities locally and globally and hold funds in the safety of cash when those opportunities are unobservable. We believe this will continue to produce outperformance as it has done for our investors since inception.

Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.

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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.