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Tipping Point

We’re long term investors, so we’re not particularly focused on short term market movement – but we may be approaching a tipping point on interest rates.


 

In a rollercoaster week in financial markets, the world’s Central Banks now realise more ‘easy money’ can’t stimulate growth and near negative interest rates really haven’t done enough. Long bond yields are rising – US 10 year treasuries up from 1.66% to 1.73% in two days. EU bonds also rose after a European Central Bank Executive said they should hold off on more monetary easing.

Some reasons for the market sell off are:

  • US stock markets have been around all-time highs.
  • Bond markets now expect yields to rise.
  • The US might raise interest rates next week – regardless, expect a rise before 2017
  • Anxiety about a possible President Trump and also Hillary’s health.

The hunt for yield has been a dominant theme in recent years in the face of weak global economic growth. So, bond yield speculation causes re-pricing thoughts about popular high yielding stocks.

Property and infrastructure stocks rose strongly over the past few years against falling interest rates. Often such stocks benefit from this cheap capital to invest in their businesses or make acquisitions to generate higher long-term returns for shareholders. This can be fine even as interest rates start to rise as long as the rise is slow enough for rising profit to adjust for higher loan costs. But if interest rates rise more quickly than profits, earnings fall and asset prices with them.

The ASX200 dividend payout ratio is now 90%, well above its 75% average. But many capital returns (like share buybacks) have pushed the payout ratio to over 100% of free cash flow. In a low growth climate, high dividend payouts are not sustainable. In a choice between cutting dividends or borrowing themselves into bankruptcy, rational companies will cut dividends.

Investors constantly look about 6 months ahead, so a sell-off may come sooner and faster than many expect – probably well before interest rates start rising. RBA Assistant Governor, Christopher Kent may be correct that the economy is looking better than expected and rates aren’t going lower. Then investing in assets that profit steadily from a growing economy will look best in hindsight. This is the main chance – a ‘global muddle through’ scenario.

If you would like to discuss your investment options further with one of our Wealth Management experts, get in touch today!

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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.