Interest rates have never been this low. If you’re an investor, you’re now getting paid less for your savings, so what do you do?
Do you accept more risk and put more of your savings into growth assets (shares and property), despite recent market jitters? Is it better to invest some of your defensive (debt) assets for higher interest and more risk? Markets have grown strongly since the GFC, pushed up by comparison with lower interest rates. Is the end of the cycle nigh, making it a dangerous time for investors?
Specific steps to cover market risk are covered later but let’s look at the growth markets first. Global stock markets have run up and the US stock market in particular now looks expensive even after its pull-back. Australia looks fairly priced, as do the rest of the world’s markets – yet a little spare cash would be prudent. The interest rate sensitive listed property sector has also run up and is now getting fully priced.
Money supply and its falling cost has driven growth markets up since 2012. Is this like the ‘Roaring 1920s’, or should you now ‘keep your powder dry’? Will the bull-run continue, is recession ahead or will growth markets muddle on? Overall, world market prices vs earnings are around the long term average. So if we can avoid recession, stock market prices should just reflect profit growth.
Continuing Bull Run?
Cheap money, higher government spending to allay any slowdown and dividends well above interest rates could push markets ever higher. Some describe this as a ‘melt-up’ – fast rise in market prices driven by sentiment (optimism, ignoring fundamental value). Higher income from growth assets than deposit/bond interest encourages this somewhat – but it will still probably end in tears.
Recent market jitters suggest bond market expectations may more truly reflect prospects than previous stock market optimism. It’s a desperately low interest environment that encourages speculation rather than productive investment… unless governments use low rates to fulfil future community infrastructure needs. Trump’s brinksmanship adds another hindering factor.
There’s heightened geo-political risks as China’s growing power confronts a capriciously narcissistic US leadership with a frail grasp of economics. Trump risks ending US expansion with his impulsive use of tools untested since the 1930s. His ego-driven tweets are unlikely to cause China to lose face – it has leverage in the 27% of excessive US Government debt it owns. The Trade war won’t improve economic growth or revive US manufacturing but there’s about a 1 in 3 chance it may trigger global recession.
Trade confrontation raises market risks above the normal… amplified by excessive debt. If this circumstance triggers recession, corporate profits (stock markets) will fall – particularly in Australia, caught between both China and the US. It may be slight comfort that global governance is more crisis-ready since the GFC experience.
Such a recession would differ from others as it doesn’t arise from the typical causes. We’d simply have been ‘Trumped’. It should be short-lived with consequent bargains if you’ve cash and patience. An uncomplicated, diversified portfolio with liquidity should let you sail through just fine, sticking to your long-term plan without selling out – despite any recession.
Our currency often falls during distress, so unhedged international assets might mitigate losses. Also if prices become more attractive the defensive part of your diverse mix can be used to buy-in while low. Meanwhile it’s unwise to sell your equities, hoping to pick when best to buy back in as it’s difficult to pick the top of the market and just as difficult to pick the bottom.
Faced with never lower interest rates, muddling through seems more likely… with mild earnings and low growth around the world, largely due to the above geopolitics. Australia can expect amplified volatility due to our high debts and also because our corporate profits will probably feel more of the ‘Trump backwash’. His 2020 election imperative might either soften or prolong our volatility – if so, investors could use such periods for selective buying opportunities.
Regardless, prudently optimising your defensive assets and cautiously reviewing growth assets should prove worthwhile. On the defensive side, bank hybrid prices have run up since interest rates dropped again. But consider a balanced blend of cash, bank deposits, corporate credit, private lending and limited bank hybrids.
Specific steps to mitigate risk
Market downturns and recession are always possible and negative news does sell. But it’s unwise to sell all your shares and property assets just in case. Why? Because these assets produce the highest long term returns and you’re unlikely to reliably time when to sell and when to buy back in. In the hunt for income, it’s best to avoid exotic, financially engineered assets, lest they prove illiquid when you need flexibility most.
A robust portfolio has a diverse range of simple, liquid assets here and overseas, including some safe assets like deposits and bonds. Those assets can be matched to your investment time frame no matter how events unfold. Overall, having sufficient safe assets can allow you to exercise whatever patience is needed. With this, you should be able to relax and eventually buy up any bargains.
If you would like to discuss your investment options with one of our wealth management professionals, get in touch with Wotherspoon today!
Disclaimer: All information in this article is intended to be general in nature for discussion purposes only. So you should not rely on it and seek personalised professional advice before making any decision.