Contrary to suggestions in my last post, yields across the yield curve have moved a bit today…as the above chart shows the curve is up between 5bp and 9bps. This is a result of the Reserve Bank increasing its inflation outlook over the next 2 years. The Reserve Bank believes inflation will be above its target range due to increases in the costs of fruit and vegetables thanks to the Queensland floods as well as wage inflation caused from the mining sector. It also expects unemploymet to fall to 4.25%.
With last week’s high CPI figures coming out there has been increased talk about the Reserve Bank increasing interest rates. The above yield curve chart shows that since 12 April, the yields on government bonds have actually decreased across the board by around 20bps suggesting less long term confidence in our economy than two weeks ago. As has been commented on, the CPI figures were high largely (not totally) because of the high Food and Energy prices…keep in mind the Reserve Bank’s actions will have virtually zero impact on Food and Energy prices as they are high because of a combination of natural disasters, middle east conflict, and a bit of proprietary trading by those nasty US investment banks.
With home prices starting to fall (I did say that residential property would peak when my partner and I purchased a property back in February), the Australian dollar killing our tourism and foreign investment, and underlying inflation (excluding volatile items) actually near 10year lows, whilst our economy is still looking well, as the yield curve movement suggests our economy is not as rosy as the papers and fund managers make us believe and controllable inflation is under control.
Hopefully no interest rate rise today!
I’ve just uploaded a neat little article (if I do say so myself) on the various risks of bonds and what happeneded during the GFC. Its more of an education piece and if you’re interested in a read please click here.
As expected the yield curve is much flatter than the last couple of months but nothing too dramatic. The Japanese tragedies will have an impact on global economy as well as its own but it is more likely to be a short term negative impact that will possibly turn into a growth story later in the year. The Japanese rebuild is bound to be a positive on this resource-rich land of ours (Uranium aside, of course).
With bond yields around current RBA cash rates for the next few years it indicates market support of the RBA staying on hold for the time-being.
My favourite investmnent returns report was released yesterday by Standard and Poors, their SPIVA Report. Its my favourite because unlike other investment return analysis/reports, this report takes into consideration investment fund survivorship. As many of us know, when an investment fund continues to underperform it typically closes never to be seen again and the reports we see on investmnet manager performance end up being a biased report of winners (e.g. Morningstar and Mercers) as these closed funds are ignored.
Anyway, the whole SPIVA report can be found here but the main results are really just the following table…
As the table shows, with the exception of A-REITs, most active managers failed to beat the main broad-based indices over the 2010 calendar year. For the 5 years to the end of 2010, only small cap Australian equity managers appear to be worth spending the additional fees on with 71% of them outperforming the Small Ordinaries index. With the massive focus on the large-cap end of the market, it makes intuitive sense that an active manager has its best chance of outperforming a small cap index in this less efficient part of the market.
With such a high proportion of global and local managers failing to beat the benchmark for both equities and bonds, active management remains a tough sell. Whilst A-REIT managers had a good year last year, when you consider that 70% of that market is made up of just 7 companies (Westfield Group, Stockland, Westfield Retail, GPT, CFS Retail, and Mirvac) and yet there are dozens of analysts looking at these companies, it is very difficult to justify active management for this overly concentrated asset class irrespective of last year’s results.
Active managers will always have a place, as passive managers can’t exist without them, but their job is really cut out for them as they struggle to justify their fees for weak performance in this increasingly difficult investing environment.
First post in a while and the first for the new year, so I thought I’d start with a popular favourite…the Australian Government Bond Yield Curve. The above chart shows the changes in the yield curve over the pas 12 months and it certainly has been an interesting ride. Equities have been largely out of favour thanks to 12 months of European Sovereign concerns putting pressure on the global financial system, but the local economic outlook has shown signs of improvement that has resulted in the shorter term interest rates increasing. Whilst the yield curve is not as steep as it was at the end of 2009 it has certainly steepened over the last 6 months as concerns around a double dip recession in the US subsided and the ECB stepped in to save Ireland.
Moving forward the Euro Sovereign Crisis will continue to place pressure on global financial markets and with Portugal going to the market this week to raise a few dollars I believe this may be a key week in determining global investor psychology in the short term. Portugal’s bond yields are at record highs (~7.1% for a 10 yr bond) and if the auction results in higher yields then I think we’ll be in for a bumpy ride in both equity and bond markets. The newspaper talk has been incredibly bullish with what appears to be every analyst in the land predicting double digit sharemarket returns this year…hopefully they’re right but let’s not forget these Euro issues and the fact that there are many near insolvent US state and municipal governments that will be holding the global recovery in the lower gears. Our economy looks like it will continue to rely on China and whilst the Queensland flood recovery will help some industries (construction) the damage is bigger for others (agriculture and mining).
Not surprisingly since August 31 interest rates have increased across the board on the back of stronger local economic data (good unemployment, strong China etc) and now the yield curve has rates above those back at the end of May 2010.
It will be interesting to see what happend to interest rates over the coming days/weeks given the latest round of Euro-Sovereign crisis issues have started impacting the risk trade. My guess is that equities markets will be taking a break for a little while and there will be movement back to cash and bonds which should see the yield curve flatten a touch.
It certainly is a very tough investment environment at the moment…shares are loaded with all sorts of risk from the current Euro Sovereign crisis, to the sluggish global economy, to the potential over-reliance on China to perform. Bond prices are high (or yields are low) and property markets still appear fragile. As for commodities…there are good arguments for downside just as much as the upside story so a high risk story with limited expected return. If we’re looking for some decent returns I guess its time to get a little creative as the market (whatever market that may be) has a low return expectation accompanied by some higher than usual risk.
Normally I try and produce the chart before the RBA’s decision but was a little slow this time but it is a little intersting to see the market’s reaction to the RBA’s decision to increase the cash rate to 4.75% and its shown in the chart above…an increase in yields across the all maturities although not too much for the 3 month T-Note.
Anyway, I can imagine Steve Kean will be smiling as one of the likely impacts of this rate rise will be further declines in residential property prices across Australia. Personally, I am currently waiting on my mortgage lender to get back to me with an indication of my borrowing capacity….I guess with this rate rise he might come back with a pretty low number…oh well, no hurry for me as I partilaly agree that property prices will go lower or at best sideways for a long time yet.
Not surprisingly, the Australian sharemarket dropped a little bit as soon as the RBA’s announcement was made (as valuations reduce with higher interest rate) but then increased around 15points to the end of the day…not much of a movement but I guess the RBA’s concerns are about higher inflation resulting from stronger private spending which should be a positive for the sharemarket. Employment is strong and likely to be looking stronger in the short term so this move makes sense if that’s the case.
Not surprisingly the rate rise has seen the Aussie dollar incerase sharply and is again flirting with USD parity. It immediately jumped 1cent after the announcement and has been sitting on 0.998USD since.
Whilst the RBA is concerned about local inflation, with this strong dollar I tend to think a lot of our dollars will be spent overseas and/or reducing our personal debt and irrespective of our spending patterns, with deflationary concerns continuing in the US, Japan, and Europe my gut feel is that this move may be a tad premature.
As mentioned around a month ago after the month of August a rate rise from the Reserve Bank appeared a long way away but September has certainly been a month for the risk takers. Aussie Dollar near record highs and the sharemarkets are up so of course that means government bonds are down. The above chart shows that 1 month and 3 month Australian Government Treasury Notes are trading around 4.85% and with cash rates at 4.5% that can only suggest the market believes a rate increase to 4.75% is odds on.
This will obviously have consequences that will hit home loans the most. Personally I cannot remember a time when there has been so much talk about how expensive house prices are in Australia. We’ve had Jeremy Grantham (the G in GMO) saying if our housing bubble doesn’t burst it would be the only asset bubble in history not to do so; Steve Kean walk to Mt Kosciusko because he expected property prices to decline massively by now; the Commonwealth Bank is spruiking around the world with dodgy figures suggesting our house prices are ok; and Goldman Sachs economist, Tim Toohey, has said our prices are overvalued by something like up to 35%.
I don’t believe this rate rise will send our home prices off the cliff, but there is no doubt to me they are likely to be going nowhere over the next few years. There does appear to be an Australian psychology that we are different and our house prices won’t fall but the warning in that is that is always the psychology before a massive fall…we obviously have many very recent examples to call upon to support that statement.
All this talk about Australian Dollar and US Dollar parity got me thinking about the behaviour of the Aussie relative to other assets, namely the sharemarket. The above chart shows that, with the exception of the first half of 2008 when the the sharemarket was a little more forward thinking than the RBA, there has been a fairly strong correlation between the sharemarket performance and the Aussie dollar. Basically both of these ‘plays’ are risk trades and the correlation over the last two and a half years has been very high.
So whilst the RBA and the bond market is currently talking up a rate rise which will most likely bring sufficient AUD strength to bring parity with the US Dollar, it is the global willingness to accept risk that will ultimately determine whether parity holds or not. For example, if global sharemarkets start to plummet because the Greek Crisis has turned into a Greek and Irish Crisis so too will the Aussie dollar decline…irrespective of the RBA’s talk of inflation and interest rate rises.
