When Risk Inverts…
One of Charlie Munger favourite sayings is “invert, always invert”. Ben Bernanke has taken this phrase and inverted the worlds markets.
“Safe” assets may now actually be more risky than the “risky” assets.
With the worlds “safe” assets such as bonds and cash now offering yields that would make a pensioner cry and with “Helecopter Ben” throwing fuel on the fire, it looks at this present moment like risk has inverted. The safe assets are no longer safe and the “risky” assets such as shares and property are looking like better vehicles for your capital.
The world is becoming a very difficult place for investors. There are things you could not have dreamed of 5 years ago. I call them Alice in Wonderland style events such as negative bond yields. Government bond yields around the world are at or near their historic lows. In the case of places like the UK we are talking lows over a few hundred years. We are not in normal times.
The great unknown is inflation. Will it come back? Will it be mild? Will it be like the 70’s? No one knows and I am not one to suggest I own a crystal ball.
The key to investing in these very weird times is to attempt to avoid the “return free risk” assets as described by Buffett and look to hold wonderful businesses which have pricing power to counter the effects of potential inflation.
Unfortunately many of these wonderful businesses are fully priced at present and so their inflation protection is becoming more limited.
If interest rates begin to rise in the US over the next few years, I would not want to be holding large amounts of long term bonds. This wont be great for many stocks, but companies with high returns on capital should still perform ok.
In Australia, we are on a bit of a different cycle. We are on the back end of the mining boom and the effect that will have on the rest of the economy is highly contentious at present. I am not convinced that we will sail through the next few years if our national income takes a hit due to a slowing China. Many are far more relaxed with our potential slowdown than I am, and this is being shown in the confidence in investing stocks levered to the economy such as bank stocks.
Interest rates may fall further to cushion the blow of a slowing China, but will this support our economy enough? There is actually a case that a large fall in interest rates in addition to ridiculous policies such as the first home buyers grant could cause a further housing bubble. This could end very horribly if the government allows this. I think this is unlikely, but not a zero chance. If this bubble does occur, the bank stocks will go significantly higher from here. Stranger things have happened. With some of the most expensive houses in the world based on some of the most eye watering mortgages, this would put our economy on the edge of collapse and closer to an Ireland style meltdown at some stage. I sincerely hope the government and reserve bank are not that short sighted to allow this housing bubble to inflate higher. (My guess is that they are more worried about growth rather than sustainable growth and this worries me).
The big question is where will unemployment get to in the next few years? If the Australian dollar holds up then our agriculture, tourism and manufacturing sectors will continue to be under pressure and I think unemployment will rise higher than many are expecting. This could be quite painful for Australia.
The safe assets such as cash and bonds in Australia are not necessarily risky yet. They are still offering moderate yields and if cash rates go down, bonds could provide some moderate capital appreciation. This is a medium term play rather than a long term holding.
In Australia, risk is yet to invert. This risky assets such as shares and property are still (very) risky, however elsewhere in the world, the safe assets are offering virtually no return, but are looking risky if inflation returns or interest rates rise.