How to stay ahead of Trump’s ‘bond rout’
Rising rates open up new opportunities for the smart investor
For investors suddenly tossed on the waves of a major upset in world markets by the election of Donald Trump there is probably little consolation from the torrent of advice on what not to do in the days ahead.
Rather, most active investors — by nature self-directed and stoically optimistic — want to know what they can do now to navigate the changes ahead.
If the immediate signals from the markets are right and we really are facing a “bond rout” — in other words the end of a 30-year bond market bull run — it has enormous consequences. The speed and intensity of those consequences are impossible to predict, but the fundamental directions of key investment indicators are clear.
Interest rates, economic growth rates and ultimately inflation are set to move higher and as they do large swaths of the investment market — bonds, so-called “bond proxies” (shares that are regarded as paying high and steady dividends) hybrid shares and sections of the property market — will come under pressure.
Indeed equity investors will have already noted the impact of rising bond yields on bond-sensitive shares such as the telecommunications, infrastructure, utilities and property sectors of the Australian sharemarket.
These sectors lose their shine as bonds again become a more attractive investment after years of ultra-low rates.
The rise in bond yields from a record low 1.81 per cent at the start of August to this week’s 10-month high of 2.74 per has caused an almost 20 per cent fall in so-called “bond proxies”, including Telstra, Westfield, Scentre Group, Transurban, Sydney Airport and APA Group.
But in this environment other areas are set to shine.
Cash could catch up
There is one major consolation from the ructions unleashed by Trump’s “return to normal” agenda in the US — the potential return of cash as a reasonable investment choice from investors.
The endless bond market bull run of recent years has been nothing but misery for cash investors as lower yields pulled cash rates lower in tandem — term deposit rates have fallen interminably as the RBA cut our official cash rate to 1.5 per cent.
Up until the election of Trump market professionals had expected more interest rate cuts — the chance of a rate cut now as judged by money market prices is 4 per cent ... it’s pretty clear the RBA cuts are over, but when will the RBA start to move rates higher?
When this happens cash comes back into the frame because our cash rates were already reasonably high by world standards.
Moreover, though some wealth and well-diversified investors may hold floating rate bonds — higher cash rates coupled with the government’s explicit guarantee of up to $250,000 per account holder per bank cannot be underestimated.
Shares that stand out
Traders move first and often signal the patterns of the future. Miners BHP, Rio and Fortescue are already moving higher (because a US infrastructure boom will lift demand for bulk commodities), so too are stocks with a distinct US presence — CSL, for example — and outstanding small caps.
The outlook for banks and insurers is more mixed as they don’t automatically benefit from higher bond yields and interest rates but if they are well managed they can benefit strongly. Moreover, though there is every chance the “hunt for yield” will not be instantly replaced by the hunt for growth, instead it will more likely be gradual.
Under this scenario, the sheer altitude of bank dividends should smooth returns in this sector: Top bank stocks such as ANZ and NAB are showing dividend yields of 6 per cent with franking that moves up to beyond 7 per cent — cash rates could double and they would still not match these yields.
As fund manager Geoff Wilson said this week “the big banks look cheap”. From a more strategic perspective, private investors also have to review once more the active versus passive debate in shares.
Plain vanilla index funds or ETFs which simply buy, say, the all ordinaries index, will not be robust enough in this new era.
However, ETFs that can buy directly into the US should be popular — most commentators expect the US sharemarket will lift higher in Trump’s first year (See Stirling Larkin’s piece below). Investors might look afresh at ETFs that can pinpoint areas set to distinctly benefit under a Trump administration. All the major providers — ANZ, Ishares, SPDR, Vanguard — offer a range of ETF products here. Betashares has specialist ETFs which appear to capture global sectors highlighted by traders as winners in a Trump administration such as Betashares Miners and Healthcare. Healthcare stocks are, paradoxically, due to improve under Trump as the prospect of re-regulation recedes. (For more on US ETFs see Elizabeth Redman’s piece on the right.)
There is also an argument — made mostly by fund managers — that active funds management can offer more value in this stock picker’s environment.
Property’s weak spots
Fund manager Roger Montgomery makes the point that overpriced inner-city apartments will face trouble in a rising rates scenario — they were, of course, facing trouble anyway.
But the wider prospects for property are more mixed. Despite a general cloud over the property trust (A-REIT) sector, investors should be careful not to overlook opportunities here: landlord-style property trusts such as Bunnings Trust and many other A-REITS are exposed now, but developers who can actively play into a strengthening economy such as Lend Lease should see better days.
The powerful retail exposure of the US-based Westfield group may also become an attraction.
For direct property investors the outstanding opportunity has to be to fix — or at least partially fix — mortgages as rates make the journey back to “normal”.
There are already signs in the commercial mortgage market that rates are lifting as the leading non-bank lender, Firstmac, has put up fixed rates to beyond 4 per cent.
Ultimately though, the limited attractions of extremely low inner-city rental yields — often below 3 per cent — must fade fast if local interest rates move higher.
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