Performance enhancing drug and the search for yield
In an unprecedented move that will have implications on financial text books around the world, the Swiss Government sold 10 year bonds at a negative yield, meaning you literally have to pay the Government interest to purchase this “investment”. In moves by many central banks to shore up their economy, monetary policies have seen clear distortions from historical averages.
With the Reserve Bank’s recent interest rate cut to a historical low of 2%, it is understandable that ordinary Australians, especially retirees, are struggling to keep up with their income needs. The generous dividend policy of many Australian companies and relatively higher deposit rates have been key drivers of recent investment performance. As a result, the sharemarket has been a major beneficiary of this as investors around the world pull out from cash investments into riskier and more volatile asset classes to offset this income reduction. While markets were cheap, the “yield play” story was recommended and became a major theme for many investors.
Every good story started with great intentions. The “yield play” is no different. Knowing when to slow down or stop is another story and it touches on the very heart of human behaviour especially after it has worked for so long. When effortless money is made and many investors have enjoyed strong gains, the line between investments and speculation becomes blurred. As Warren Buffett has been quoted: “After a heady experience of that kind, normally sensible people drift into behaviour akin to that of Cinderella at the ball. They know that overstaying the festivities, that is, continuing to buy up companies with seemingly higher yield and pushing their valuations beyond the case they are likely to generate in the future, will bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is a helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem though: They are dancing in a room in which the clocks have no hands.”
Taking on this risk due to low interest rates is a common theme we are experiencing at the moment. We, like everyone else, have no clue when the music will stop. Having some cash or cash-equivalents set aside, say ten to fifteen percent, may have a small drag on performance over the shorter term but you will be very thankful when opportunities do come around when markets pull back. As Charlie Munger bluntly puts is – “Cash is like oxygen. When you have it you don’t even notice it. When you don’t have it, you can’t think of anything else.”
For the remainder of your portfolio that is exposed to the sharemarket, we stress that you should be going up the quality curve by owning companies with more earnings stability, industry tailwind and those that have demonstrated a long history of dividend increases. We also highlight that some of these “best of class” companies may also be listed abroad.
At the end of the day, it does not matter what the themes are, markets still move up and down based on valuations. Sometimes, it overshoots and sometimes it undershoots. Whichever way, this is the time to begin being fearful while everyone else seems to be getting greedy.
Disclaimer: This publication has been compiled by Financial Decisions (AFSL/ACL Number 341678). Past performance is not a reliable indicator of future performance. Whilst every effort has been taken to ensure that the assumptions on which the outlooks given in this publication are based on reasonable data, the outlooks may be based on incorrect assumptions or may not take into account known or unknown risk and uncertainties. Material contained in this publication is an overview or summary only and it should not be considered a comprehensive statement on any matter nor relied upon as such. The information and any advice in this publication do not take into account your personal objectives, financial situation or needs. Therefore you should consider its appropriateness having regard to these factors before acting on it. While the information contained in this publication is based on information obtained from sources believed to be reliable, it has not been independently verified. To the maximum extent permitted by law: (a) no guarantee, representation or warranty is given that any information or advice in this publication is complete, accurate, up-to-date or fit for any purpose; and (b) Financial Decisions nor its employees are in any way liable to you (including for negligence) in respect of any reliance upon such information or advice.
Contact: Financial Decisions PO Box 484 Mona Vale NSW 1660, T 02 9997 4647, F 02 9997 7407