Goodbye to all that

Strong returns: Goodbye to all that

"PORTFOLIO POINT:
The days of 20%-plus returns are over. Now investors are facing lower real returns and higher risks.

Australia's CPI for the June quarter is due out on Wednesday and will probably show that inflation is still around 3% – maybe 2.9, perhaps 3.1. Call it 3.

That means unless you're getting a 5% return before tax for your retirement savings, you're going backwards in real terms.

For a while now it has seemed that one of the benefits of living and investing in Australia is that you can get a pretty good return from relatively safe assets, whereas in other countries – especially the US, Europe and Japan – where the yields from safe cash and bonds are, technically speaking, bugger all.

But things have changed. Real returns are lower here and globally, and risks are higher. The golden days of 20%-plus returns for taking a mild, if not one-way, risk and 10% for safety are over; even the Speculator, David Haselhurst, is struggling.

This has very important implications for your investment portfolio. If you absolutely can't afford to lose money over the next few years, then you need to rethink whether you should be in the stockmarket at all, because the risks of loss are definitely higher than usual; if you have a disciplined long-term approach to investing that involves a good well-diversified portfolio, and you don't need cash in a hurry, then you should stick with it.

Either way, you must expect low real returns for safety and rapidly escalating risk as returns increase.

But I'm not saying the extremists are right: that the market is due for the mother of all crashes, or that the ASX/S&P 200 is going to be 5500 by the end of the year, as most local strategists apparently still believe.

There's a "new normal" you need to be aware of.
Now when I hear people talk about the "new normal" I usually think: ‘Yeah, yeah, sure. Things are always new; change is the only normal.’


And then I speak to someone like NAB's head of business banking, Joseph Healy, who I interviewed on Inside Business yesterday, and I think: ‘Hmm, maybe there is something large and lasting going on.’

Healy has exposed the lack of bank lending to small and medium businesses, and the institutional preference for residential mortgages among the banks. Ten years ago it was dollar for dollar between home mortgages and SMEs; now only $60 gets lent to business for every $100 that goes to housing.

This has not been caused by the global financial crisis (although that didn't help), but the new Basel II capital rules for all global banks, which place a much lower risk weighting on real estate than on businesses.

The result is that the return on risk-weighted capital for a home loan is about 40%, and less than half that for a business loan. No wonder banks prefer bricks and mortar: bank capital is precious and in many countries is simply being used to buy risk-free government bonds.
The bank stress test results released in Europe on Friday showed that most banks have enough capital … as long as they don't take any risks with it.

So the credit starvation of business that Joseph Healy identified in Australia is a global phenomenon: there IS a new normal for the funding of businesses. It's equity or nothing, more or less.

One of the main promoters of "new normal" thinking has been the US bond trading house Pimco, which has been promoting the idea of a world in which deleveraging and regulation will lead to low growth for a long time to come.

Basel II has added to the underlying climate of deleveraging and tightened financial regulation coming out of the GFC and is producing a permanent, regulated, change in the way capitalism works.
Nothing is permanent in business, of course, so let's just call it a long time instead.

The reason company shares perform better than fixed interest over the long term is that you get the effect of economic growth and population growth on sales, plus productivity growth from new technology and leverage from gearing the balance sheet with debt.

As long as the company's equity capital is conserved and not wasted, you should get a double "landlord effect". That effect occurs when a rising income stream is applied to a stable capital base over a long period; eventually annual income outgrows original capital outlay and equals great happiness.


The reason the landlord effect can be leveraged through investing in a company is that the company invests in assets that produce an income stream, using part-debt and part-equity, and you invest in the company for a dividend stream.

Leverage is not dead, but it's in a straitjacket of bank caution. At the same time, economic growth is constrained by sovereign debt and central bank impotence. In some countries, including Australia and the UK, the problem is inflation.

Access Economics today predicts that interest rates in Australia are likely to keep rising for at least 18 months, to 6% in 2012, as the RBA fights inflation. In other words it will ensure that growth here does not get too high.

Productivity growth in Australia has been weak or negative for years, and with both political parties promising no further industrial relations reforms, there is no reason to think that is going to change.

Commodity prices look set to go backwards for the next year or so as well. As discussed, debt levels are low, so there is not much leverage.

In short, there is no reason to expect more than moderate growth in profits or share prices over the next few years. On top of that there remain some big risks – not certainties, just risks. But then again, nothing is ever certain".

 

This echos Shane Olivers comments

http://www.ampcapital.com.au/K2DOCS...Olivers-insights-Back-to-the-1970s.pdf?DIRECT