28 July 2020
Australian Government bonds are AAA rated and the Investment Grade is BBB- and better. Global financial markets view Australia as having sound political and legal systems with a well-run economy (regardless of whether Labor/Liberal are in Government) and therefore the AUD is a safe haven currency, albeit commodity based.
The objective is to protect capital. We foresaw 3 problem areas as follows:
Uncertainty in corporate earnings, high unemployment (in Australia its around 10%) and globally GDP is forecast to fall in 2020/2021 and this could lead to falls in equity markets. Please click here to see diagram that shows the gap between S&P 500 price and earnings. It is recognised that the US Fed is doing what it can do to support financial markets by printing money and buying corporate debt. This is unprecedent and it has indicated it will continue these activities to support the markets.
Negative yielding international bonds means you are paying to invest. This does not make sense.
Falling (devaluing) USD produces currency losses on international investments depending on when and what the rate was when you purchased. We have seen a rise in the AUD against the USD from 0.55 cents to around 0.71cents over the last 4 months. So we determined it was best to realise any currency gain now before it is washed away. With all the money printing (Quantitative Easing by the US Fed) the AUD could easily go higher against the USD.
They will provide new opportunities in the future, e.g. if the AUD keeps rising in value and the US equity market corrects, then US equities will be cheap and many do represent a stored value.
State of the Economy
We are in a global “income” recession that has been triggered by Covid-19. Normally, recessions are triggered by a “credit crunch” as a result of an asset price bubble as part of a business cycle and central banks increase interest rates to “pop” the bubble. Once asset prices fall, interest rates are reduced and lending starts again as does the business cycle. This time interest rates were already near zero so the RBA could not reduce them any further. So the Government has stepped in to cover the loss in income by introducing Job Keeper and Job Seeker and along with action by the RBA this is also supporting the share market. Job Keeper now ends in March 2021, while the qualifying criteria has been tightened from October, which means the tap is slowly being turned off.
Investment Returns Impact
With low interest rates (cash rate is 0.25%) and corporates having cut or reduced dividends investment income is down, so adopting a capital protection strategy in a low interest environment where bonds are positively yielding makes sense.
Australian Government 30 Year Bond
The Australian Office of Financial Management (AOFM) has announced it is going to the market with 30 year bonds. The AOFM has not issued debt longer than 12 years since February 2020, and it is expected there will be strong demand for this paper. This is something we anticipated so hearing the announcement is pleasing as we see it as a positive for investments in those bond funds, even though yields will be low they will likely be higher than 30 year US treasuries and other international bonds without the currency risk or hedge cost.
If you wish to discuss please feel free to contact us.
Warning: Any advice or information provided is general advice only, and has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any General Advice provided, you should consider the appropriateness of the advice, having regard to your own objectives, financial situation and needs. If you wish to discuss the contents on this newsletter, please do not hesitate to contact us.