As you can see from the chart below, the Australian Share market (as measured by the ASX200 Index) peaked back on the 13th of August. Since that time, the market has shown increased volatility (ie more extreme day to day movements) and more or less tracked sideways but with a bit of a downward trend. So, what’s going on? Is this just a temporary pause in an otherwise upward trend or a signal of something more concerning?
S&P/ASX200 Index 1-Year Movement to 30 November 2021
Source: Bloomberg Markets
Regular readers will recall our recurring thesis that asset prices are underpinned by interest rates. The lower the interest rate, the higher the asset price and vice versa. So, the most likely cause of what we see here is that all the recent commentary regarding the increased likelihood for central banks to raise interest rates is just making investors a little cautious.
So the question becomes is the prospect of an interest rate rise real? Only a few days ago, Phil Lowe, the Governor of the Reserve Bank, reiterated the banks stance that interest rates would not be rising any time soon and certainly not in 2022. The RBA will be looking for sustained wage inflation before they pull the interest rate trigger and there’s no sign of that happening, particularly given the recent rise in the unemployment figures.
But the RBA is only part of the equation. Whilst Australia is geographically an island in financial terms it’s not. What happens in the rest of the developed world, particularly the US, impacts on us. And the US does appear to be experiencing wage inflation (as is the UK but that’s a self-inflicted Brexit wound). No one is sure yet whether this is just a temporary spike or more systemic. But if it does prove to be sustained, in which case the US Federal Reserve (their version of the RBA) may be forced to raise interest rates. If that happens then US stock prices will fall, and the Australian market will do likewise (even if our interest rates haven’t moved.
The other factor when consider interest rates is that the RBA’s cash rate isn’t the only determinant of the interest rate you’ll pay in the real world (on your mortgage for example). During the pandemic, household savings increased dramatically as we had no where to spend our money. This gave banks a source of cheap funds. Furthermore, the RBA set up the Term Funding Facility, where the banks could borrow money at 0.1% to 0.25% and then lend it out to you at 2%. This was further supported by the RBA’s program of buying 2-3 year bonds in order to keep the yield at the 0.1% target. Both RBA initiatives have now finished and we’re now back spending our money. So banks are now forced to borrow money elsewhere (mainly offshore) which is more expensive. We are therefore seeing an increase in mortgage rates and a reversion to the norm of fixed rates being higher than variable rates.
This should start to cool the current overheated housing market. There is some evidence of this happening with Corelogic reporting that house prices rose 1.49% in October compared to 2.8% back in March.
On the positive front dividend payments from Australian companies increased by 126% over the same time last year. A positive sign that, with some obvious exceptions, the economy is rebounding strongly. This is great news for our self-funded retiree clients who rely on that dividend income to fund their pension payments.
The choice of heading for this month’s newsletter was quite deliberate. Whilst it’s interesting to analyse the data to explain what’s happened in the past, predicting the future, especially in the short term is fraught with danger. So, as always, our advice is to stick with the investment strategy agreed with your adviser, because that’s what will create success over the long term.
