Yield and Risk

By Alan Kohler | More Articles by Alan Kohler

The XFJ accumulation index, which includes ASX 200 banks and REITs, along with their dividends, and which might be described as Australia’s retail bond market, underperformed the broader market last year – 5% vs 12% for ASX 200 Accumulation – and has the sector started the new year in the same vein: -1% vs flat.

It’s because bond prices are falling (yields are rising), so that Australia’s “bonds” (100% franked dividend stocks), are falling in sympathy.

What’s more, the future remains clouded. As Jim Grant of Grant’s Interest Rate Observer remarked this week: “the combination of an elevated stockmarket and a wobbly bond market puts a premium on caution”.

Caution should always trade at a premium; more so when most people have thrown it to the wind.

Dave Rosenberg, chief economist and strategist at Canadian broker Gluskin Sheff, wrote this week: “The US economy has never been so dependent on asset inflation for its success… (The) surge in paper wealth has enabled the savings rate to fall to a decade low of sub-3%, a move that has made the difference between 3% and 1% growth in the real economy”.

To which he added: “This is not to say anything more than the elastic band looks extremely stretched and … that we hit similar peaks in the past just ahead of a turning point, and right at a time when investor complacency and bullish sentiment were around where those metrics are today”.

But as we have been discussing here in The Constant Investor Overview, the key question is around the definition of “just ahead” – that is, when will the turning point occur?

The problem for bears like Rosenberg is that these things often take a longer than Godot, and certainly longer than they expect – indeed, it already has taken longer this time.

Meanwhile, the US 10-year Treasury yield – the benchmark-of-benchmarks – popped up to 2.67% this week, breaking above the 2.6% is reached just after the November 2016 election.

Might this be time for yield investors to strike, and take advantage of high yields – say, NAB’s 6.8%, fully franked, not to mention Telstra’s 8.7%, also 100% franked?

Well yes, as long as you don’t mind a capital loss and, in the case of Telstra, the prospect of a dividend cut.

Underpinning the 35-year bond bull market that has so helped Australian yield investors to take advantage of the 30-year-old dividend imputation system has been demographics, which are now shifting.

After the early 1980s, thanks to the post-war baby boom, the global population became skewed towards 35-64 year-olds – that is, people in their peak productivity and earning years.

As a result, goods and services were more plentiful and cheaper, and at the same time the people in that age bracket were saving more and spending less, to save for retirement. That directly affected relative prices.

In a big picture sense, demographics have put downward pressure on “current prices” and upward pressure on “future prices” – that is, claims on future goods, otherwise known as long term investments.

This is often referred to as a “savings glut”, and the pure expression of it is that long bonds have done better than short-term Treasury bills. On the sharemarket, up until recently, defensive yield stocks have done better than cyclical growth stocks.

At the same time, in the broader economy, the prices of “current goods” (CPI inflation) have risen more slowly than future goods (asset prices).

Those trends are now reversing, as baby boomers like me pass 65; the relative number of 35-64 is in decline. It means the structural influences on all prices are changing and in particular the demographic pillars supporting long-term bonds (and Aussie yield stocks) are crumbling.

There will always be exceptions to this, and periods when the opposite happens, as there have been over the past 35 years, but demographics is the tide; the other things are the waves.

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About Alan Kohler

As well as being the founder of The Constant Investor, Alan is currently business editor at large of The Australian, finance presenter on ABC news, presenter of the Talking Business channel on Qantas inflight radio and adjunct professor in the business faculty of Victoria University.

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