Strategies for a falling interest rate environment
Finally the NZ Reserve Bank is lowering interest rates, just as it seems the US is about to start raising rates. How does this affect a Kiwi investor?
Lower rates typically have these sorts of affects: weaker exchange rate, borrowing for property is more attractive, shares in heavily indebted or high dividend companies are more attractive, exporters do better (from weaker currency).
The other important sector is fixed interest/bonds. This is a little trickier because these markets look ahead to expected interest rates between now and when the bond/fixed interest contract is to mature. For a maturity date say 5 years away, prevailing expected rates for years 3-5 might be more influential than the interest rate outlook for the next 24 months. Hence bond prices can fall in a falling rate environment (normally a bond-friendly factor) if it is expected that later in the bond’s life the environment will be adverse.
Thinking particularly of the NZ sharemarket, the average dividend is around 6% ie for each $100 dollars invested there are six dollars being paid out each year. This compares with around 4.5% for a tying you money up in a term deposit at the bank for 3 years. Electricity companies on the NZ market are averaging an 8% dividend yield! Lower (Reserve Bank) interest rates tend to stretch this gap between term deposits and dividend yields even further , a share-friendly situation.
In the US we may already be seeing markets adjust to an expected rise in the Federal Reserve rate, with the benchmark US Govt bond rates up from 1.7% at the beginning of Feb to 2.4% now. For that market, that is a big rise over that time frame. To be fair, this merely recovers the rate to where it was last November. Still, the last 3 month trend is clearly up and, if that continues much more, the affects noted in paragraph 2, above, can be reversed for the US.
In Europe and Japan they are printing money about as fast as it can be done, taking up where the US has left off. They have super low interest rates and not a hint of a rise in rates any time soon.
. . . need to keep some wealth liquid, why not US cash?
For Kiwis, a typical middle of the road investor might therefore see high dividend local shares, and perhaps commercial property funds, as offering (relatively) very attractive income streams, in the 5-8% range. Even without any capital gains, that is not too bad with inflation barely at 1% and fixed interest at near historic lows.
Off-shore, the US sharemarket is a bit expensive by historic standards but not so when super low inflation and interest rates are taken into account. What does add the shine is that traditionally, when the US starts raising its interest rates, the US Dollar strengthens relentlessly. That on its own could make US cash, and shares, a happy place for Kiwi investors. But US fixed interest might produce negative returns in an environment of interest rate hikes.
Lastly, the surprise of 2015 is that Europe and Japan are both doing much better than it would seem almost anyone picked last year. Their economies and sharemarkets are responding to container loads of printed cash like dry grass in a drought responds to rain. Life springs forth! It looks somewhat like the scene in the US several years ago when the cash printing presses started in earnest there – cash poured into the US sharemarkets.
For strong cash flows, New Zealand looks like a happy place to be but for gains from growth, Europe and Japan hold promise. And if there is a need to keep some wealth liquid, why not US cash?
These are big issues which we should see impacting investment strategy. Do let us know at Alliotts if you would like to review your own investments. 09 5290 9200.
David Burt is licensed by the Financial Markets Authority (FMA) as an Authorised Financial Adviser (AFA) and his Disclosure Statement is available on request, free of charge.
The above note is not personalised for any individual or entity. It does not take into account your particular financial situation or goals (or any 1 or more of them). If you act on information contained in this note the outcomes may not be what you expected nor suit your particular circumstances. Neither David Burt nor Global Portfolios Ltd will be responsible for any loss or non-payment as a result of actions taken upon information or recommendations provided in this note. Readers should seek investment/tax advice prior to action in relation to any of the matters discussed above.