The hunt for dividend income in 2020

With interest rates at historic lows and likely to stay that way for some time, retirees and other investors who depend on income from their investments are on the lookout for a decent yield.

Income from all the usual sources, such as term deposits and other fixed interest investments, have slowed to trickle. Which is why many investors are turning to Australian shares for their reliable dividend income and relatively high dividend yields.

The average dividend yield on Australian shares was 5 per cent in 2019 and more than that for many popular stocks.

By comparison, returns from traditional income investments are failing to keep pace with Australia’s low inflation rate of 1.7 per cent. Interest rates on term deposit from the big four banks are generally below 1.4 per centi, while the yield on Australian Government 10-year bonds is around 1.2 per centii.

But with shares entailing more risk than term deposits or bonds, is a dividend income strategy safe?

Dividends provide stability

When comparing investments, it’s important to look at total returns. The total return from shares comes from a combination of capital gains (from share price growth) and dividend income. While market commentary tends to focus on short-term price fluctuations driven largely by investor sentiment, dividend income is remarkably stable.

Over the past 20 years, dividend income has added around 4 per cent on average to the total return from Australian shares.

For example, in 2019 the All Ords Index (which measures the share price gains or losses of Australia’s top 500 listed companies) rose 19.1 per cent. When dividends were added, the total return was 24.1 per cent.

So how are dividend yields calculated?

Calculating dividend yields

To work out the dividend yield on a company’s shares you divide the latest annual dividend payments by the current share price.

Take the example of BHP Billiton. Its shares were trading at $37.41 in December after paying annual dividends of $1.9178, providing a dividend yield of 5.13 per cent ($1.9178 divided by $37.41). When you add franking credits, the ‘grossed up’ dividend yield is 7.32 per cent.iii

Franking credits are a type of tax credit compensating shareholders for tax the company has already paid. Companies such as BHP with fully franked shares will have franking credits equal to 30 per cent of the gross dividend value. This is not a recommendation for BHP, simply an illustration of how dividend yields are calculated.

But a big dividend yield is not always better. A high dividend yield may signal a company with limited growth prospects, a falling share price, or both. Sometimes it’s the result of a one-off special dividend.

So how can you spot a quality dividend?

Quality counts

Investors looking for a reliable income stream need to focus on companies with quality assets and strong management teams, good growth prospects and sustainable earnings. This is what will determine the future growth in dividends and/or the share price.

In the current low interest rate, low economic growth and low inflation environment, many companies have taken a cautious approach and rewarded shareholders with higher dividends. As growth picks up, companies may allocate a greater share of profits to growing their business.

Relying too heavily on dividends from Australian shares could also expose you to risk or mean missing out on opportunities elsewhere.

Consider the big picture

When hunting for a good dividend yield, it’s important to follow fundamental investment principles. That means holding shares from a variety of market sectors, with good prospects for growth and income.

Diversification is also important across asset classes. The total return from Australian residential investment property was 6.3 per cent in 2019 (from a combination of price movements and rental yields), but in other years the performance of shares and property could be reversed.iv

And despite their lowly returns, holding term deposits with different maturity dates allows you to manage your cash flow. It also helps avoid having to sell your shares and crystallise losses in a market downturn.

i https://www.canstar.com.au/term-deposits/highest-term-deposit-rates/

ii https://tradingeconomics.com/bonds

iii https://www.marketindex.com.au/analysis/dividend-yield-scan-6-december-2019

iv https://www.corelogic.com.au/news/corelogic-december-2019-home-value-index-strong-finish-housing-values-2019-corelogic-national

Making the most of falling interest rates

The Reserve Bank’s decision to cut official interest rates is good news for anyone with a mortgage or hoping to buy their first home, but presents a challenge for savers. Whatever your personal situation, the question now is how to make the most of falling rates.

On June 4, the Reserve Bank cut the official cash rate by 25 basis points from 1.5 per cent to 1.25 per cent, the lowest on record. Many economists predict further cuts, with some suggesting rates could fall to as little as 0.5 per cent.

Just how low rates go will depend on the broader economy. Growth in the three months to March was up just 0.4 per cent, or 1.8 per cent over the year. The Reserve Bank is also concerned about sluggish wage growth, unemployment stuck at around 5 per cent and inflation of 1.3 per cent well below its target 2-3 per cent range.

Rather than wait to see how low rates will go, there are things you can do now to take advantage of lower rates or minimise their impact, depending on your personal circumstances.

Grab a better home loan deal

Many banks moved quickly to cut home loan interest rates in the days following the Reserve Bank’s move, although not all of them passed on the full amount.

According to rate comparison site Finder, the average standard variable rate offered by the big four banks is now between 5.11 and 5.18 per cent.

.The big four also cut their discount rates to between 3.54 and 3.78 per cent, while some smaller lenders are offering rates as low as 3.19 per cent. The lowest 1-year fixed rate is below 3 per cent.i

While house prices and interest rates continue to fall, the stars could finally be aligning for Australians wanting to buy their first home.

The Australian Regulation Prudential Authority (APRA) plans to relax the minimum 7 per cent interest rate banks are required to use when assessing borrowers’ ability to service a home loan.

Also, the Morrison government proposes low deposit financing for eligible first home buyers who save a deposit of as little as 5 per cent up to 20 per cent to purchase property.

For people with existing home loans, it’s time to check whether you are getting a good deal from your lender. If not, ring them to negotiate a lower rate and be prepared to shop around if they won’t budge.

The outlook for savers

Lower interest rates can be more challenging for savers. That includes anyone with a savings account as well as retirees who depend on the income from term deposits to help with living expenses.

Term deposit rates are likely to head south of 2 per cent. The average interest rate for $10,000 invested in a 1-year term deposit was 2.15 per cent in May and 1.9 per cent across all terms. ii

Banks have also been cutting rates on their online savings accounts. The best rates on offer are currently around 3 per cent for the first four months, before dropping to a base rate around half that, so shop around and read the terms and conditions.

The hunt for yield

If you have a longer time horizon, growth assets such as shares and property can provide regular income. If you can ride out the short-term fluctuations in share and property prices, the income they provide in the form of dividends (shares) and rent (property) tend to be more stable and reliable.

The national average rental yield on Australian residential property is sitting at around 4.1 per cent.iii Coincidentally, Australian shares currently provide an average dividend yield of 4 per cent (7 per cent after franking) but many quality companies pay more.iv

For example, the big four banks currently offer dividend yields of between 5.2 and 6.8 per cent. After franking credits are included, the yields grow to 7.5 and 9.7 per cent respectively.

i Finder, 10 June 2019, https://www.finder.com.au/press-release-savings-loss-following-rate-cut

ii RBA May 2019, https://rba.gov.au/statistics/tables/#interest-rates

iii CoreLogic, 1 June 2019, https://www.corelogic.com.au/sites/default/files/2019-06/CoreLogic%20home%20value%20index%20JUNE%20FINAL.pdf

iv AFR share online market tables, 24 June 2019

How to keep ahead of the yield curve

US Interest rates have been making headlines in recent months, but do they really matter to Australian investors? The short answer is they do, a lot.

Changes in US interest rate settings have made a big impact on investment returns from bonds and shares over the past year, while uncertainty about the future direction of interest rates is also weighing heavily on markets.

Where are rates headed?

The US Federal Reserve has increased its federal funds rate (which controls short-term interest rates) nine times from zero in 2015 to 2.5 per cent, as the US economic recovery gathered steam.

As late as last December the Fed was forecasting two more hikes in 2019. Then in early January it announced a ‘patient’ approach. Respected market observer and former Pimco chief, Mohamed El-Erian now expects the next move will be a cut, but not until 2020.i

Over the same period, the Reserve Bank of Australia cut the official cash rate from 2 per cent to a record low of 1.5 per cent. Until recently, the consensus was that the next move would be up, but many economists now expect a rate cut.ii

This turnaround in sentiment in the US and Australia is due to weaker economic figures, the escalating trade war between China and the US and fears of a China slowdown. Australia also faces slow wages growth and falling property prices.

Late last year nerves got the better of investors and global shares fell sharply. Shares bounced back in January after the US Fed’s about-turn on interest rate policy. But bond markets had been predicting an economic slowdown for some time, due to something called the yield curve.

What is the yield curve?

The yield curve is a graph that plots the yields currently offered on bonds of different maturities, ranging from a few months to 30 years. The yield on a bond is the annual interest paid as a percentage of the bond price.

The ‘typical’, or positive, yield curve is a gently rising line as maturities increase because investors expect a higher return for the added risk of holding an investment for lengthy periods. A flat yield curve occurs when yields on short and long securities are similar.

The relatively rare inverted yield curve, where short-term yields are higher than long-term yields, looks like a downhill slide.

Market watchers use yield curves, especially of US Treasury bonds, to test which way the economic wind is blowing. A positive yield curve is a sign of continuing economic growth, whereas an inverse yield curve implies that investors expect sluggish economic growth, low inflation and hence lower interest rates.

What is it telling us?

At present yield curves are flattening, especially in the US. While the Federal Funds rate has increased to 2.5 per cent over the past year, the yield on 10-year Treasury Bonds has fallen to 2.68 per cent as bond markets priced in an economic slowdown.iii

By suspending further rate hikes, the Fed may have avoided further falls in long term bond yields which would have set off alarm bells in financial markets.

What does this mean for investors?

Interest rates don’t directly affect share prices, but they do affect the cost of borrowing and decisions by businesses and consumers which can flow through to corporate profits and share prices.

As for bonds, as interest rates fall on new bond issues, prices rise for existing bond issues paying higher interest.

This helps explain why Australian fixed interest topped the asset class performance chart in 2018, up 4.5 per cent, while Australian shares fell 2.8 per cent.iv

Past returns are no guide to future performance; what the past does teach us is the importance of diversification. Returns from bonds and cash may not shoot the lights out but they help cushion the impact of falling share prices.

While the yield curve has proved to be a useful indicator of future economic slowdowns, it is simply a prediction based on current market sentiment and can change direction with the economic breeze.

i https://www.cnbc.com/2019/02/05/mohamed-el-erian-fed-next-rate-move-more-likely-a-cut-than-a-hike.html

ii Finder, RBA cash rate survey, 4 February 2019, https://www.finder.com.au/press-release-feb-2019-rba-survey-experts-predict-cash-rate-cut-to-come-not-hike

iii Trading economic as at 28 February 2019, https://tradingeconomics.com/bonds

iv Cuffelinks, edition 291, https://mailchi.mp/cuffelinks/edition-291

Small steps add up

Sometimes, when thinking about your long-term financial goals, they can seem so big as to be insurmountable. But the truth is, those that achieve financial success don’t usually do so by encountering a sudden windfall. Rather, they have in place a set of small habits that allow them to work towards their dreams. And by investing small amounts over the long-term, they see big outcomes.

You see it’s much like climbing a mountain. When you start your journey, the summit can seem intimidatingly far off, but with every little step you get closer to your destination.

Your finances work the same way. The small steps you take today could make a big difference in the future.

Increasing your savings through automation

They say it takes 60 days to establish a new habit. Automating a transfer into a savings account on the other hand takes all of a few minutes. Starting with a small amount that you won’t miss is the best way to go. Frequent regular payments —$50 a week is easier to bear than $200 a month—will mean you don’t feel the pinch.

When choosing an amount to set aside, you want to ensure it’s a sacrifice you can bear so that you can still enjoy the little things, and not so large as that you’ll have to dip in during the month.

As you adjust to these subtle budget tweaks, you can incrementally increase your automated savings contributions over time.

Working down debt by increasing repayments

The same principle applies for your debt repayments. Even committing to a small increase could make a big difference in how quickly you pay off your debts.

Once you’ve decided to commit a little bit more towards paying down your debt, it’s time to consider your repayment strategies. Here a few options you may wish to consider.

• Proportional method: after meeting your minimum repayments split the remaining proportionally between your debts.

• Avalanche method: list your debts in order of the size of the interest and, after meeting your minimums on all of them, pay off the highest one first.

• Snowball method: Direct all excess funds into paying off your smallest debt first. The theory goes that as the smallest one should be an easy victory, it will give you a sense of achievement. As you continue to pay off the debts from smallest to largest, this sense of accomplishment could snowball.

• Debt consolidation: In some case, you may be able to consolidate multiple debts into the one low interest account.

Everyone’s situation is different and therefore the approach to repaying your debt will depend on your unique circumstances. We can help you figure out which method will suit you best.

Building your nest egg

No matter where you are on your journey towards retirement, small incremental additions to your super could make a big difference to the overall size of your nest egg.

A popular way to approach this is through concessional super contributions. Often called salary sacrificing, it works by your employer redirecting a portion of your pre-tax income (above the standard 9.5% contribution they already pay) towards your superannuation. This can have a number of benefits: it’s taxed at a lower rate, and money in your super account continues to generate compound interest over the long term. This can make a big difference to your nest egg when you eventually retire.

Concessional super contributions are capped at $25,000 per financial year and can be tax effective if you’re earning over $37,000.i

Sometimes the smallest financial habits are the ones that bear the most fruit over the long term. So, this year why not make some small changes that will really add up.

i https://www.moneysmart.gov.au/superannuation-and-retirement/how-super-works/super-contributions

2018 year in review

Investors started 2018 full of hope, with the global economy and financial markets in good shape, but by year’s end they were uncertain and a little anxious about what lay ahead. Markets responded with last minute falls across all asset classes.

The issues that weighed heavily were the unresolved trade dispute between the US and China, confusion over Brexit, rising US interest rates, falling commodity prices and the US government shutdown. Australians were also distracted by political instability and falling house prices in Sydney and Melbourne.

With so much uncertainty about, it was easy to lose sight of the solid progress we’ve made.

Positive economic growth

The global economy grew at a steady 3.1 per cent. However, the World Bank estimates global growth will ease slightly to 3 per cent this year and 2.9 per cent in 2020 as central banks remove monetary stimulus in place since the financial crisis.i

The US economy continued its strong recovery, expanding by 3 per cent in the year to September.

China’s growth slowed to 6.5 per cent, its lowest since 2010, as the trade dispute with the US began to bite.ii

Australia enjoyed steady growth of 2.8 per cent in the year to September after 27 years without recession. Corporate profits are at record levels, inflation is a tame 1.9 per cent, unemployment fell to 5.1 per cent.

Consumers remain cautiously upbeat. The Westpac Melbourne Institute rose a percentage point over the year to 104.4 – anything over 100 is regarded as optimistic.iii

Focus on interest rates

The Australian dollar fell 10 per cent in 2018 to finish at US70c, due largely to US dollar strength and a widening of the gap between local and US interest rates.

The US Federal Reserve lifted rates four times to 2.5 per cent but indicated there may be only two more hikes in 2019, not three as previously forecast, due to the slowing economy. By contrast, Australia’s cash rate finished the year where it started at 1.5 per cent.

At the other end of the yield curve, US 10-year government bond yields were barely changed at 2.7 per cent, reflecting market fears of economic slowdown. Yields on Australian 10-year bonds eased to 2.3 per cent.iv

The lower dollar is good news for our exporters and should soften the impact of falling commodity prices, caught in the cross-hairs of trade wars and fears about an economic slowdown.

Iron ore was down 3 per cent while oil, copper, aluminium, zinc and nickel prices dropped between 16 and 19 per cent. The one bright spot for local producers was wheat, up almost 20 per cent.iv

Shares correction

Global shares retreated as the year came to an end, with the MSCI World Index down 10.4 per cent.v

The US market fell 6.5 per cent, its worst performance in a decade. UK shares fell 12 per cent with no Brexit deal in sight while political and economic uncertainty also weighted heavily on share prices across the Eurozone. In Asia, Chinese shares fell 25.5 per cent while the Japanese market fell 12 per cent.iv

Australian shares tapped into the global mood, with the ASX 200 down 6.9 per cent, its worst year since 2011. However, the total return from shares was down just 3.5 per cent when dividends are added.vi

Property loses steam

The heat came out of Australia’s residential property market in 2018, with big falls in Sydney and Melbourne dragging the national market down 4.8 per cent, according to CoreLogic.vii

This is the biggest annual fall in a decade and follows tighter lending practices, rising supply, higher mortgage interest rate and falling investor demand.

Looking ahead

The late market reversals of 2018 were driven by gloomy expectations rather than the reality of solid economic gains. Future performance will depend on US interest rates, the resolution of trade tensions and the negotiation of a workable Brexit.

In Australia, uncertainty will persist until the Federal election is out of the way. Then investors can get back to focusing on our solid economic growth, a strong corporate sector, resilient consumers, low interest rates and more affordable housing.

i World Bank, 5 June 2018, http://www.worldbank.org/en/news/press-release/2018/06/05/global-economy-to-expand-by-3-1-percent-in-2018-slower-growth-seen-ahead

ii Trading economics, as at September 2018, https://tradingeconomics.com/china/gdp-growth-annual

iii Westpac Melbourne Institute, 12 December 2018, https://melbourneinstitute.unimelb.edu.au/__data/assets/pdf_file/0009/2943036/PressReleaseCSI20181212.pdf

iv Trading economics.

v Financial Times, 1 January 2019, https://markets.ft.com/data/indices/tearsheet/summary?s=MS-WX:MSI

vi Year in Review 2018, CommSec Economic Insights, 2 January 2019

vii CoreLogic, 2 January 2019, https://www.corelogic.com.au/news/australian-dwelling-values-fell-48-through-2018-marking-weakest-housing-market-conditions-0

How to prepare for climbing interest rates

Interest rates have been low for so long it’s tempting to think low rates are the new normal. So when the Reserve Bank suggests that a cash rate of 3.5 per cent is the new ‘neutral’, people take notice. Even the Prime Minister warned Australian householders to prepare for higher interest rates ahead.i

The official cash rate has been held at a record low of 1.5 per cent since August 2016, but in recent months the Reserve Bank has begun preparing the ground for higher rates. The Reserve Bank says it now considers the ‘neutral’ cash rate to be 3.5 per cent. Neutral is central bank-speak for the sweet spot where growth is supported without pushing inflation too high.

Then in a speech on July 26, Reserve Bank Governor Philip Lowe made it clear that rates will only rise once there’s a gradual lift in wages growth and inflation.ii As things stand, he’s in no hurry.
 

Wages, inflation keep rates low

Annual wages growth is currently running at below 2 per cent, which means many workers are standing still after inflation is taken into account. The annual rate of inflation eased from 2.1 per cent to 1.9 per cent in the June quarter, below the central bank’s 2-3 per cent target band.

The central bank is also reluctant to put more pressure on borrowers while household debt grows faster than income. The level of household debt to income has increased from about 148 per cent in 2012 to a record 190 per cent in March 2017. For households with a mortgage, the figure is closer to 300 per cent.

So what can you do to make the most of today’s low rates and soften the impact of higher rates in future?
 

Quit the bad debt habit

Make the most of low interest rates to pay down expensive debt such as credit cards and personal loans. Credit card interest rates begin at around 12 per cent and rise to as much as 20 per cent on popular rewards cards.

One strategy is to consolidate personal debts into your mortgage and save up to 15 per cent in interest. You also need to increase repayments on your mortgage, otherwise you could be paying off your credit cards for 20 years or more.
 

Lock in fixed rates

If you have a mortgage and an increase in interest rates would blow a hole in your budget, then think about fixing all or part of your loan.

The best fixed rates for two and three-year terms are currently around 4 per cent, not much more than the best variable rates on offer.

Bear in mind that fixed loans are less flexible than variable loans. You can’t make extra repayments or redraw funds and there are penalties for exiting a fixed loan early, even if it’s to sell your home. One popular solution is to split your loan into fixed and variable amounts for peace of mind with the flexibility to make extra repayments or redraw funds if necessary.
 

Make extra repayments

If you have a variable rate mortgage, then it’s a good strategy to use any extra savings or lump sums to reduce your loan while rates are at historic lows.

You can tip this money into an offset account where it will reduce the interest you pay, but this only works if you’re disciplined and avoid the temptation to dip into your offset account for everyday spending. You may be better off making additional ongoing or one-off loan repayments; they will still be available for a rainy day if you choose a loan with a redraw facility.
 

Catch the rising tide

Higher interest rates are not all bad news. If you’re a saver or depend on income from investments, higher rates can’t come quick enough.

If you would like to discuss ways to reduce debt or grow your savings and investments, don’t hesitate to call.
 

i ‘Prepare for interest rates to climb, Malcolm Turnbull warns’, by David Ross, The New Daily 20 July 2017, http://thenewdaily.com.au/money/finance-news/2017/07/20/malcolm-turnbull-warning-interest-rates/

ii “The labour market and monetary policy’, speech by RBA Governor Philip Lowe, 26 July 2017, http://www.rba.gov.au/speeches/2017/sp-gov-2017-07-26.html

Fast track your home loan

With interest rates on the rise, now is the time to look at ways to fast track your mortgage. After all, the sooner you pay off your mortgage, the less you will pay in interest.

That’s probably why nine out of ten Australian mortgage holders told a recent finder.com.au survey that they try to pay back their mortgage ahead of time.i

So what are the ways you can fast track your mortgage and minimise your interest payments?
 

Increase your repayments

The most popular strategy is to make extra payments. Rather than paying your designated monthly repayment, why not pay more? Not only does this reduce your interest charges but if rates should rise you will be able to absorb the increase.

You can also make extra payments if you get a windfall or a bonus at work. But if you have chosen a fixed home loan, you may find you can’t make extra payments, so check with your lender.

More frequent payments are also a good strategy. Instead of paying your mortgage off monthly, pay half the monthly amount each fortnight. After all, there are only 12 months in a year, but 26 fortnights, so you effectively end up paying an extra month each year.

Most home loans are structured so you pay mostly interest in the first five to eight years without making any inroads into the principal. If you can manage to pay some principal off too during that period, then you can cut the interest you’ll pay on an average 25-year loan.

Consider an offset account

An offset account can also prove useful. With your salary going into your mortgage account, the principal will drop and that means you will pay less interest. For instance, if you had a 100 per cent offset account with $30,000, on a home loan of $400,000, you would see interest only calculated on a balance of $370,000 instead of $400,000.

If you’re looking at a honeymoon rate on a new home loan, do your homework and make sure that the rate you pay at the end of the honeymoon period is not substantially higher. If that is the case, it could eliminate any gains you may have made in that first year of lower rates. But be aware that switching to a cheaper loan might incur a high exit fee.

It’s always a good idea to review your home loan annually to make sure it’s still working for you. For instance, do you really need all the bells and whistles that are on offer? Often, you’ll be paying for these extras through higher interest rates.

Negotiate a better deal

If you are unhappy with your current rates, then talk with your existing lender to see if you can negotiate a better deal. But make sure you do your homework first and check out what other lenders are offering so that you are in a better negotiating position with your current lender. Most lenders would rather hold on to existing clients than lose them to a competitor.

When negotiating your home loan, you might be able to access a package from the lender giving you some beneficial extras such as discounted home insurance, fee-free credit cards or fee-free transaction accounts. Or you might be able to waive the fees associated with the loan.

When you initially take out a loan, consider making your payment before the due date. That way you are always ahead of the game.

With interest rates expected to rise in 2017, this may be a good time to consider fixing part of your loan to cushion yourself against future rises.

If you want to make sure that you are doing all you can to minimise interest payments on your loan and fast-track your mortgage, call us to discuss the financial strategies that might work best for you.


Checklist

• Make extra repayments
• Pay more frequently
• Use an offset account
• Review your mortgage annually

i ‘Aussies go above and beyond to pay down home loan sooner’, Nov 2016, finder.com.au

2016 Year in Review: A global sea change

If 2016 taught us anything, it was to expect the unexpected. Britain’s vote to exit the European Union and Donald Trump’s election as the next US President surprised the pundits and markets alike. Markets generally hate surprises, yet in the closing weeks of the year so-called ‘Trump trades’ pushed shares, bond yields and the US dollar.

Then, in a not-so-surprising move, the US Federal Reserve lifted rates for only the second time since 2006. At its December meeting, the US Fed lifted rates to a range of 0.5 to 0.75 per cent and forecast three more rises in 2017. This was viewed as a vote of confidence in the US economic recovery and a signal that the global economic tide may be turning.
 

Economy poised for growth

The Federal Reserve board forecasts US economic growth of 2.1 per cent in 2017 and unemployment of 4.6 per cent. In Australia, the medium-term outlook is also positive but there were hiccups along the way in 2016.

Uncertainty surrounding the US election, Brexit and our own mid-year federal election weighed heavily on the local economy, which shrank 0.5 per cent in the September quarter. This was the first negative quarter since March 2011 and lowered the annual growth rate from 3.1 per cent to 1.8 per cent.

The Reserve Bank has warned that the economy could slow further before picking up in 2017.i Our trade performance is moving in the right direction though, thanks to higher commodity prices and the lower dollar. Australia’s trade balance moved back to surplus in November for the first time in 33 months; the rolling 12-month deficit of $23.8 billion was the lowest in 18 months. What’s more, the unemployment rate, at 5.7 per cent, remains near three year lows.
 

Commodities rebound

One of the big turnarounds of 2016 was the surge in commodity prices. Iron ore almost doubled in price to $80 a tonne. Other metals were also up strongly, along with agricultural commodities and oil. Crude oil rose 45 per cent to US$53.72 a barrel as OPEC and non-OPEC nations agreed to cut oil production.

While more expensive fuel is bad news for motorists, higher commodity prices are a boon for Australia’s mining and agricultural sectors. As these higher prices flow through to inflation they should help pave the way for central banks to lift interest rates to more normal settings. Inflation in Australia is running at an annual rate of 1.3 per cent, well below the Reserve Bank’s target band of 2-3 per cent.
 

Interest rates on the rise

Australia’s cash rate remains at 1.5 per cent but there are signs that we may have reached the bottom of the rate cycle. The major banks have already begun lifting home loan rates and this trend looks set to continue as mortgage funding sourced from overseas becomes more expensive.

Donald Trump’s election victory also marked a turning point in bond yields on the expectation that his policies will be stimulatory. US 10-year bond yields rose slightly to 2.45 per cent in 2016, while Australian 10-year government bond yields lifted to 2.79 per cent after reaching an all-time low of 1.83 per cent in August.

The US dollar has also strengthened against the Aussie dollar, which finished the year at US72.36c after hitting a high of US78c in November.
 

Shares finish strongly

Global sharemarkets reacted positively to Trump’s promised tax cuts and infrastructure spending. After negative returns in 2015, the US market finished the year up 13.4 per cent and Australian shares rose 7 per cent led by the resources sector.

Despite the solid gains in shares and residential property, Aussie consumers finished the year in a sober mood. The Westpac-Melbourne Institute Index of Consumer Sentiment eased to 97.3 in December, down 3.5 per cent over 12 months. By comparison, business confidence is improving. The NAB Business Confidence Index rose from 4.3 points to 5.0 points in November.
 

Patchwork property market

The residential property market continues to grow, but it was a tale of many markets. Home prices grew 10.9 across all capital cities, but a modest 2.8 per cent outside the metropolitan areas. Sydney prices rose 15.5 per cent, followed by Melbourne (13.7), Hobart (11.2), Canberra (9.3), Adelaide (4.2), Brisbane (3.6) and Darwin (0.9). Perth prices fell 4.3 per cent.ii

Although housing affordability remains a national issue, the property market shows no signs of a hard landing.
 

Looking ahead

The prospect of higher interest rates and inflation, after almost a decade of abnormally low rates, marks a turning point for global financial markets. There are bound to be setbacks along the way, as the world weans itself off cheap credit, but the gradual recovery in global economic growth is just what the central bank doctors ordered.

If you would like to discuss the contents of this article in the context of your overall investment strategy, don’t hesitate to call.
 

i Statement by Philip Lowe, Governor: Monetary Policy Decision, RBA, 6 December 2016, https://www.rba.gov.au/media-releases/2016/mr-16-30.html

ii Core Logic Home Value Index, http://www.corelogic.com.au/news/capital-city-dwelling-values-surge-10-9-higher-over-the-2016-calendar-year/

How to play the Trump card

To say that Donald Trump’s election as President of the United States took the world by surprise is an understatement. Markets hate surprises and uncertainty, so a short-term period of volatility is to be expected. But as investors begin to digest the new policy direction, buying opportunities could arise.

So, what do we know of President-elect Trump’s policies and what will they mean for us?

Mining shares rally

Global share markets responded positively to Trump’s promise to increase spending on infrastructure and defence and to cut taxes. These policies would provide a shot of fiscal stimulus to the US economy and Australian companies that do business there.

Coal and iron ore prices were already rising but iron ore surged ahead by almost 15 per cent in the week of the election.i Australian resource stocks are up about 35 per cent this year.ii

Trump has also pledged to reduce industry regulation and allow the importation of foreign drugs, which is viewed as positive for Australian financial and healthcare stocks.

The fly in the ointment for the Australian economy and local exporters is Trump’s protectionist trade policy. He has promised to renegotiate free trade agreements and impose high tariffs on Chinese goods. As China is Australia’s top trading partner, what is bad for Chinese trade is bad for us.

The end of the bond bubble?

The economic stimulus of tax cuts and increased spending are expected to increase inflation, which is not a bad thing after years of sluggish growth. With inflation and economic growth on the rise, the US will not need to rely so heavily on monetary stimulus so demand for US government bonds is likely to fall. This would mean lower bond prices and rising yields.

Bond yields were already on the rise, but Trump’s victory has accelerated the trend. US 10-year bond yields have climbed from a low of 1.36 per cent before Brexit to 2.2 per cent. Bond yields are also rising in the UK, Europe and here in Australia.iii

AMP Capital chief economist, Shane Oliver, says the stimulatory effects of a Trump presidency add to evidence that the 35-year rally in bonds is over. However, he expects yields will rise gradually until global growth gains momentum.iii

Interest rates at the crossroads

US Federal Reserve chairwoman Janet Yellen recently confirmed that a December rate rise is still on track on the back of slowly improving economic data. And there are signs that Australian rates may also have bottomed. In a speechiv on November 15, Reserve Bank Governor Phillip Lowe all but ruled out the need for further rate cuts.

The prospect of gently rising inflation and interest rates are good news for long-suffering investors who depend on income from their investments. Borrowers, on the other hand, may choose to lock in fixed rates at their current low levels.

A softer Aussie dollar

After falling from US77c before the election to as low as US73c, the Australian dollar has been holding firm at around US74 cents on the back of higher commodity prices. Longer term though, the market expects the Aussie dollar to fall further against the greenback.

If America does become more protectionist under President Trump the US dollar is likely to rise too as American companies shift business back home. The flow of funds into the US, together with any softening of global trade would put downward pressure on our dollar. While this is bad news for travellers, a weaker Aussie dollar will help make our exports more competitive.

While uncertainty persists about the policy outcomes of a Trump administration, investors should expect ongoing market volatility. What is certain though, is that Donald Trump’s victory will present challenges and possible buying opportunities for Australian investors. And that’s always been the case whoever sits in the Oval Office.

If you would like to discuss your portfolio in the light of the US election result, don’t hesitate to call.

i Bassanese bites: A Focus on Trump Trades, 14 November 2016

ii http://www.asx.com.au

iii Oliver’s Insights, AMP, 14 November 2016

iv http://www.rba.gov.au/speeches/2016/sp-gov-2016-11-15.html