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Bulls ride high after Lowe-down on rates

3 min read
http://www.afr.com/wealth/personal-finance/bulls-ride-high-after-lowe-down-on-rates-20191129-p53fai

The reaction? Stocks rallied to a record high on Wednesday, assisted by comments from US President Donald Trump that a trade deal with China was in its “final throes”.

Meanwhile 10-year bond yields dipped back below 1 per cent by Thursday. This marks a significant rally in bond prices, with an earlier sell-off in bonds pushing yields to around 1.3 per cent on November 11. Bond prices and yields move in opposite directions.

The prospect of an ongoing low-yield world has consequences for investors.

As acknowledged by this week’s bull run, it makes stocks – which offer growth and dividend yield – an attractive option compared to bonds.

The benchmark S&P/ASX200 Index enjoyed the biggest weekly advance since early February.

But stocks aren’t cheap: they trade at around 17 times prospective earnings. While fund managers debate the extent to which low rates can support a higher multiple, current valuations look full compared to the lacklustre outlook for broader market earnings.

Record highs for biopharmaceutical giant CSL (which has a prospective price-earnings multiple of 41 times) and supermarket operator Woolworths (which trades at 27 times forecast earnings) highlight how solid blue chips remain a magnet for capital even as their multiples are pushed skyward.

The concern is the hunt for yield could push stocks that have hefty valuations even higher.

Big-four blues

Low yields are yet another issue for the embattled bedrock of the local market: banks. The big four banks have a 20 per cent weighting in the S&P/ASX200 Index.

While banks’ earnings are set to suffer self-inflicted wounds from fines and higher compliance costs related to multiple regulatory failures, this week’s drop in yields is a reminder of the ongoing pressure on their net interest margins.

Banks who use a ‘replicating portfolio’ to hedge against falling rates would not have been pleased to see the yield on the three-year bond, which is used as a hedge, heading back towards record lows this week.

That could get worse if – and that’s a big if, given Lowe’s comments – the RBA implements quantitative easing. The buying of government bonds would put added downward pressure on yields.

While the RBA is hoping this year’s three rate cuts will boost the broader economy, it’s house prices that have been a winner from lower rates.

“There is clear evidence that the cuts are pumping up the housing market, but few signs of the boost spreading beyond this as yet,” says HSBC chief economist Paul Bloxham.

And that’s the problem for Lowe and Treasurer Josh Frydenberg. Lower rates have been a boon for asset prices, but not so much for the real economy.

The worse-than-expected 0.2 per cent fall in third-quarter capex underscores the wariness among non-mining companies to commit capital to new investments when there is uncertainty about the global and Australian economies.

Domestically, the focus is on the health of the consumer. Comments from RBA deputy governor Guy Debelle this week that low wages growth had “become the new norm” also highlights the challenge for policymakers to get the economy moving again.

It’s why everyone is looking to Canberra to deliver a fiscal boost (fast-tracked tax cuts perhaps?) to ensure any rate-cut-inspired recovery can gain traction and the faith of the bulls is vindicated.

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