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Archive for February, 2009
Fixed versus Inflation Linked Government Bonds – Sep 2010
The above chart shows the yields of 2 different types of government issued bonds…Fixed Rate and Inflation Linked. Given they both have the same maturity, September 2010, the difference in the yields must therefore represent the market’s expectations of inflation.
As the chart demonstrates, the yields on both bond types has converged since the start of 2008. The difference in the yields have gone from around 3% to 4% down to its current difference of only1%. So whilst inflation was running at around 3.7% over the last 12 months, the expectations over the next 18 months is only1%…so whilst many regard ter deposit rates of 4% to 5% as low, on an after-inflation basis maybe they’re not so low after all.
Source: UBS
I normally wouldn’t rely on a single statistic or chart to influence an investment decision but the above chart almost changes that. What we see is that for the first time in almost 40 years (maybe longer if I had the data) the trailing dividend yield for Australian shares is sbove that of 10 year bond yields. In fact its not just above by a small margin but quite a large one, 7.2% for the S&P/ASX200 versus 4.3% for the 10year bond yield.
I did say ‘almost changes’ because there is an expectation of a signficant decline in dividends whilst companies’ profits decline and occasionally struggle to access capital. So whilst the trailing yield is 7.2% now, expectations are that it will be lower in the future…but lower than the 10 year bond yield??? Within the next year or two, I’d be very surprised.
Chart 1
When you see on the news that Oil is at or below $40US per barrel after peaking at $147US in the middle of 2008, its very frustrating when to see petrol prices around $1.10 to $1.20 per litre at the pump.
Chart 1 shows that between January 14 and January 21 the price of Unleaded Petrol increased significantly whilst Diesel and Crude Oil declined. Previous to January 14, Unleaded Petrol closely tracked the Crude Oil price but magically, it has increased by 20c per litre to be now tracking the more expensive Diesel.
Chart 2
Chart 2, shows that currency is not the reason for the Unleaded Petrol price hike as the Australian dollar barely moved so the question is…are we being ripped of at the pump due to an unexplained 20c jump?
I’ve had enquiries from numerous advisers wanting to invest their client’s money into mortgage funds. Thanks to the Rudd Government’s deposit guarantee many mortgage fund investors decided to redeem their funds and shift to the more secure bank deposits. Unfortunately for the funds and their remaining investors the level of redemptions were so great, the funds had to suspend all redemptions. Now we are left with the funds drip feeding redemptions to investors and one of the last redemption reports I heard was that investors only received 30% of their requested redemption and will have to wait for the remaining funds when the next window opens.
With the global credit crisis and resulting decline in interest rates, mortgage fund’s income return now looks quite attractive as many funds have a large book of fixed rate mortgages. Whilst they look good, credit spreads are still enormous and whilst these funds aren’t taking on any new borrowers (the redemptions took care of that) they are still rolling their good borrowers at fixed interest rates of at least 9%! Very nice in this environment if you can get it.
What I would like to know is…how can a mortgage fund still price itself at a fixed $1 per unit? The clear lack of liquidity of these unerlying investmetns combined with the massive movement in credit spreads over the last 18 months does not suggest that mortgages price is static. Certainly mortgage backed securities on the over-the-counter market have had a shocking run since the credit crunch began in mid-2007 so to still suggest a $1 price is ludicous.
Clearly the funds do not know how to price these securities with any accuracy, but given the lack of demand for these securities and credit blow-out, if you want to invest at $1 per unit then I suggest you are paying way too much. The interest rate is not anywhere as attractive as it needs to be given the increased liquidity risks and current economic environment.
In recent weeks I’ve spoken with a few people who were waiting for the Reserve Bank to drop cash rates before looking to fix their mortgages for the long term. The chart above shows the change in government bond yields from last Thursday (29 January) to today (3 February) after the Reserve Bank dropped interest rates from 4.25% to 3.25%. Despite the massive drop in the RBA Cash rate to the lowest level since 1964, there is very little change in the longer term government bond yields. In fact, if anything the yields have increased slightly.
Given fixed rate loans are related to the longer dated part of the yield curve (really up to the 5 year mark), those looking for lower interest rates on longer term loans like car leases, fixed rate mortgages, personal loans etc. may have to wait a little longer before there is significant change.
The above chart shows the yields of 2 different types of government issued bonds…Fixed Rate and Inflation Linked. Given they both have the same maturity, September 2010, the difference in the yields must therefore represent the market’s expectations of inflation.
