Cast your mind back to 2012…the RBA cash rate started the year at 4.25%.
Within the space of two years, our central bank (following the lead of its overseas counterparts) had reduced rates on six occasions (there was a 0.5% reduction in May 2012 and the rest were 0.25% reductions).
At the end of 2013, tour cash rate was down to 2.50%.
Borrowers — encouraged by the RBA’s ‘accommodative’ interest rate setting — formed long queues at their local bank.
With nothing more than a pay slip and a heartbeat to prove their creditworthiness, they were given whatever (and sometimes, more than what) they asked for.
The RBA-sponsored credit boom was a boon for banks.
The lower rates went, the higher share prices.
The biggest of the Big Four — CBA — saw its share price rise from $50 in early 2012 to around $95 in March 2015.
Source: Trading Economics
The RBA’s low-calorie interest rate diet forced yield hungry investors to look elsewhere for a ‘meal rich in income’.
Those big, juicy, fully franked dividends from the banks had them salivating…especially self-managed super funds in pension mode.
From 2012 to 2015, ravenous investors entered into a bidding war.
As usual in a booming market, investors lose peripheral vision.
The focus is solely on one thing and one thing only…the offer of higher returns.
Little, if any, heed is given to potential downside.
The common refrain in a market feeding frenzy is…‘you can’t go wrong buying…’ and in this case, the final two words in the sentence were ‘bank shares’.
When it came to investing in bank shares, the combination of rising value PLUS higher dividends was (way) too tempting to ignore…especially when compared with the lousy 2%–3% being paid for depositing money in those very same banks.
In November 2013 — in the midst of this boom in banking shares –– I was asked to recommend five stocks I would recommend selling.
Those five stocks were…the big four banks and BHP.
The rationale behind the recommendation was that these five companies constituted a large part of the All Ordinaries Index. In the event the US market tanked, then our market would follow…taking the five largest stocks with it.
As it’s turned out, the US market did not tank…that fate still awaits the financial world.
However, the call on selling the top five shares — in the context of the medium term — was reasonably accurate.
|10 October 2018
Over the past five years the capital value of the five shares has fallen 16.5 percent.
Offsetting the shrinkage in capital has been the fully franked dividends…approximately 7% per annum (grossed up).
Investors have lost 16.5% in exchange for (on average) 35% in dividends…a net return of 18.5%.
Over the same five-year period, money in the bank (if you shopped around) would have returned ‘more or less’ the same figure.
But what about those who bought in at the peak…in March/April 2015?
How have they fared?
|10 October 2018
Without BHP’s positive number, the result would have been ‘ugly’.
The Big Four have dropped around 30% in value.
Again, dividend payments — over the three-and-a-half-year period — of (say) 25% have pushed the overall return into the positive…at +6.6%.
Whereas, those with money in the bank have averaged around 10–11% over the same period…with no risk to capital.
But that was then, what about now?
What do investors with bank shares do in the face of…
- Looming legal battles
- Provisioning for customer refunds and compensation
- Tighter lending restrictions
- Rising cost of accessing offshore funding
- The downturn in the property market impairing balance sheets
- The need to provision for an increase in bad debts
And, last, but by no means the least…the recent downturn in the US market is the forerunner of what’s to come…the cratering of an over-over-valued market.
The danger of seeking yield
Investors seeking yield are caught between ‘the devil and the deep blue sea’.
Do you stay around for the income?
Maybe. But what happens to corporate profits (and dividend payouts) if things do go ‘to mud’?
That big, juicy dividend income — the one you’ve paid a heavy price (as in capital losses incurred) to receive — could be slashed…like we’ve seen with Telstra shares.
It’s ironic that it takes hindsight to restore peripheral sight.
Investors start looking anxiously to the left and right, up and down, wondering what lies ahead.
Whereas in the boom, eyes are fixed firmly on the golden path in front of them…never wavering, never doubting, never glancing sideways.
What would I do if I owned bank shares? For the record, I don’t own any.
The Dow’s 800-point loss on Wednesday was another faltering step towards a long overdue correction.
And, if history is any guide, the coming correction is going to be one for the history books.
The following chart — compiled by Hussman Strategic Advisors — tracks the movement of five different market valuation measures since 1947.
The 0% line is the long-term average — when the US market is fairly valued.
Source: Hussman Strategic Advisors
As you’d expect, valuations ‘ebb and flow’ with market mood.
Going from under to over-valued and back again.
Since the late 1980s — when Greenspan started tinkering with markets — the rolling ‘under and over’ pattern of previous decades has been replaced with sharper series of ‘peaks and troughs’.
The Fed’s relentless interference has stopped the market from fully expressing itself on the downside.
In restricting the market’s journey into under-valued territory, the Fed has created a pressure cooker.
Pushing markets higher and higher has taken a tremendous amount of resources…ultra-low interest rates for an extended period of time and at least US$14 trillion in freshly minted currencies.
Reaching those post-1987 valuation peaks has required more and more energy.
My guess is the Fed has all-but-exhausted itself.
When the market rout begins in earnest, what’s the Fed got left?
Even lower rates for longer? Perhaps.
Print even more money? Perhaps.
But who (in the numbers required) is going to be willing and able to stand in the way of a market force that’s intent on purging the system of nearly three decades of excess?
Should the US market valuation measurements fall to the level of the early 1980s, it means the US share market has lost 80% of its value.
Only if you have a blinkered view of history…one that’s only ever seen Fed intervention.
But what if the Fed’s best efforts are no longer effective in fighting the will of the market?
The last good cleanse of excess debt in the system was in the 1930s.
Back then the Dow lost over 80% in value.
Should history — even somewhat — repeat itself, then yield hungry investors are going to find themselves starved of capital.
In this scenario, I’ll take 100% of my capital earning 2% every day of the week and twice on Sundays.
Editor, The Gowdie Letter
PS: Interest rates could hover at these super-low levels for the next 100 years…but this four-pronged strategy could help you avoid the fallout. Click here to learn more.