The future of our economic growth
The Australian economy is going through a transition from a high-growth, resource-rich, big-construction phase to a future that is altogether less certain.
So ask yourself quickly: without mining, where do you see our economic growth coming from? If you don't have an answer, you don't have an investment strategy.
And if you don't have an investment strategy, you're relying on - to use the Motley Fool motto - a greater fool than you to buy your assets at a higher price than you paid.
Around the world there is change.
Interest rates are heading north in the US. In Europe, German government bonds have jumped above 1% for the first time in eight months - they have been negative in recent months.
Just think about that! Investors in Europe were so defensive they would pay for the privilege of having the German government borrow money from them. In Australia, 10-year government bonds have popped above 3% - a sign of more changes in the economy.
One of the things you can surmise from these bond yield increases is that investors are losing some faith in bonds, mainly because so many have been issued through government quantitative easing policies.
But, oddly, it's also a sign of confidence: when investors are so disillusioned by the poor returns from bonds, they start chasing higher returns elsewhere. Maybe that will stimulate traditional businesses that employ people and generate growth.
But you have to be careful how and where you invest. As bank investors have clearly noticed in the past two months - the 17% fall in Commonwealth Bank shares should have grabbed your attention - as long-term bond yields rise, the yields on other income-based assets also increase.
Yields increase for two reasons:
- The organisation increases the payout. For listed companies, this is an increase in dividends. In the case of investment properties, you increase the rent.
- The income remains the same but the price of the asset falls.
Think about a share trading at $1 with an annual dividend of 4c a share. The yield is 4%. If the shares fall to 50c but the income remains the same, the yield rises to 8%.
The higher yield implies a cheaper price. This is what is happening with bank shares as long-term government bond yields rise.
Just a tip, though. If you are chasing yield but the economy is crook, keep a watching brief on the profitability of companies you buy.
If you buy high yields as the share price falls, the market might be telling you the next profit report will be poor and there's a chance management will cut the dividend (your income).
Nothing is more certain to bring down a share price than a dividend cut: an especially high dividend yield can be an investor's fool's gold. Let's go back to the suggestion that higher long-term interest rates are a good sign. For this you need just a touch of economics.
A traditional yield curve has short-term interest the lowest with a smooth curve up as you invest in longer-term bonds. It makes sense that the longer you invest, the more interest you get.
In that scenario, you would expect the economy to be relatively strong. Without an incentive to keep money very short term, capital will seek longer-term investments to pay better rates of return.
But for much of the past decade, we have witnessed either neutral yield curves, where short- and long-term rates are pretty much the same, or inverse yield curves, where short-term rates are higher than long-term (again, note those negative bond yields in Germany and Switzerland, and local one-year bond rates below 2%). So if the yield curve is to turn upwards, where to invest?
The answer traditionally should be in the cyclical stocks - media, transport and housing are foremost among those. But go back to the opening question: do you have a strategy? Do you have a view as to where growth will come from in the future?
The key themes are pretty obvious.
Free-trade agreements will present enormous opportunities to those companies that exploit them well. So do research on the healthcare companies, the food and agriculture businesses and the services-based businesses that are keen to expand into China, Japan and Korea.
The ageing population will similarly present opportunities for long-term investors prepared to find the right companies and stay the course. Growth will come in healthcare, pension asset managers and aged care service providers. These are the easy pickings.
The question of timing is always more difficult but the better your read on the future - and the more time you are prepared to wait - the more the short-term inconveniences will seem inconsequential.