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Investing in a low yield world

A few months ago I wrote an article talking about how investors were relentlessly searching for yield as interest rates head lower  [ LINK see that article from August 19th edition of Hudson Report here ]}

I highlighted the pitfalls that many were falling into as they bid up higher and higher the share prices of utilities (such as Sydney Airport) and REITs and banks in the search for reliable stable income from their investments

I cautioned investors on paying too high a price for stocks in a bidding war as they were unwittingly adding risk to their portfolios.   Since then some of these individual companies and sectors have seen their share prices reduced dramatically.

Why has this occurred and what do investors do now?

To answer that question we need to review a bit of history first.  Interest rates are low in Australia and they are even lower around the globe as central banks everywhere have resorted to slashing interest rates after the GFC in a vain attempt to stimulate growth and to ward off deflation 

We have seen dramatic interest rate cuts and the liberal use of “quantitative easing” or cash printing by central banks in the USA UK Japan and Euro to keep rates low across the yield curve

Locally the reserve bank has cut the cash rate to 1.5%.

This means home borrowers are enjoying fifty-year low interest rates of under 4%   However the reverse has been true for savers (including retirees) who are seeing term deposits hovering around a little over 2% with at call accounts under 2%

This has forced investors to “search for yield” in unlikely places (as I highlighted in my previous article) Many have gone into the equity markets and bid up the price of high dividend paying shares. They tried to garner higher returns from REITs and or infrastructure stocks like utilities.  

This worked for a time and even the underlying prices of those investments rose giving short-term capital appreciation to their investments. 

But now unfortunately the “chickens are coming home to roost” in the form of movement in the bond market.

The Federal Reserve in the US has raised rates and is likely to continue raising them over the next year or two and has telegraphed this outcome widely. 

This has caused a turning point in the bond market. The 30 year bull market in bonds appears over.  

This bull market saw prices on bonds rise strongly for the past three decades as the yields on offer fell (due to the inverse relationship between price and yield on bonds) to the now unprecedented level of negative interest rates across the yield curve

United States 30 Year Bond Yield

But now rates are rising due to the desire of the Federal Reserve to get back to “normal interest rate settings”. 

The recent unlikely result in the US Presidential election has accelerated this move with a President-elect Trump advocating massive infrastructure spending which will likely lead to a resurgence in inflation and hence higher interest rates (to curb this inflation) in time 

This movement in the bond market has had a dramatic price reversal in yield sensitive investments such as utilities and REITs.

So what to invest in?

Ideally investors need to seek out companies that can grow their profits and hence increase their dividends consistently over time. 

Unfortunately this is a hard thing to find.

In general terms you are looking for quality stocks (or fund managers who can identify such opportunities for you) in various different sectors from healthcare to retail to discretionary consumer stocks 

Investors need to be patient and cautious and invest for the longer term as there are stocks out there like that and there are fund managers out there like that but they are harder to find than simply looking at dividend yield tables  

To discuss more contact your Hudson adviser

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