This page has been archived and commenting is disabled.
When Safe Havens Become Bubbles In Disguise
The search for yield in an increasingly yield-less world has become the biggest financial sport in town. The logic is understandable. Thanks to our beloved central bankers, traditional investment portfolios heavily reliant on government bonds and cash are earning little, or worse when inflation is taken into account. Because of this, money is making its way into areas such as corporate bonds, junk bonds, real estate and high dividend yielding stocks. The problem is that many investors are now buying yield with little regard to the price that they're paying. That's the stuff that bubbles are made of and why some perceived safe havens may prove anything but.
Today, Asia Confidential is going to explore the causes of the growing "yield bubble" in more detail and the ways that it may all come unstuck. We'll also look at how some of the current hot asset classes are almost guaranteed to earn poor returns on a long-term timeframe. Lastly, we're going to suggest how investment portfolios may be structured to minimise exposure to the more bubbly assets and still earn respectable (not high), low risk returns.
The great manipulation
For the most part, we don't live in a free market world anymore. Since the financial crisis, there's been unprecedented intervention by central banks in the developed world via quantitative easing (QE) and their zero interest rate policy (ZIRP).
QE involves central banks printing money to buy bonds, largely from banks. The aim is that banks will lend this money out and that the money will make its way into economies through consumption, investment and so on. The problem is that this hasn't happened. Banks have held onto the printed money due to new regulations requiring they hold more capital and their customers have been unwilling to take on more debt as they've been too busy paying off existing debt.
The commercial banks are ok with this because the money that they've been kindly given by central banks is helping them to improve their balance sheets after their enormous risk-taking blew up in 2008. Central bankers aren't as impressed because the printed money isn't flowing through to economies. That's why you're hearing suggestions in the U.S. that banks should be forced to start lending more money.
The other important aim of QE though is for bond yields to remain artificially low. The central banks are saying to people: "We're going to print money to reduce the value of your cash and we're going to make sure you earn little on your bank deposits. We want you to depart with your cash to take on more risk."
The theory behind this is the so-called wealth effect: if people move cash into the likes of stocks and real estate and these assets increase in value, they'll feel wealthier and increase their consumption of goods. A win-win for everybody, it would seem. However, there's no proof that the wealth effect actually works, even though central bankers remain convinced that it does.
Putting this aside, it's clear that cash previously held as bank deposits is starting to make its way into various assets. People are searching for yield. There's been a lot of recent hoopla about a great rotation out of bonds into stocks, but the truth is rather different. It's bank deposits that are making their way into stocks. And money is also pulled from commodities and parked in stocks.
But it's certain types of stocks, namely those with high dividends, that are catching the best bids. High dividend yielding companies in sectors such as utilities and consumer staples have been outperformers and now trade at extensive premiums in most markets. In Asia ex-Japan for instance, utilities trade at 15x 2013 earnings, a 25% premium to the region. That's despite them generally having poor returns on capital and significant regulatory risk.
It's not only high dividend yielding stocks that are attracting money, however. Investors are converging on corporate and junk bonds in their search for better yields over government bonds. Real estate is the other area which is continuing to attract investors who are seeking both yield and security. This is particularly the case in Asia versus other parts of the world, as inflation rather the deflation remains the key problem here.
Possible endgames
If we acknowledge that some of these high-yielding asset classes now appear elevated or even bubbly, then the next question is: what are the potential triggers for these bubbles to eventually pop? Rising inflation is the obvious one. This would lead to hikes in interest rates, or a tightening cycle in economic parlance.
Under this scenario, most bonds, particularly government bonds, would get crushed. So would real estate, where over-leveraged speculators in over-priced areas such as Beijing, Singapore and Hong Kong would suffer most. Rising inflation would actually be positive for stock markets to a certain point. In the developed world for example, history suggests that inflation doesn't start to hurt stocks until it reaches around the 6% level.
The other possible trigger for the current yield bubble to burst is deflation. Under this scenario, investors would scurry back to government bonds and cash. Stocks and real estate would get hammered.
Regular readers will know that I think serious inflation or deflation are the most likely endgames, with the latter being the most probably outcome. But we could muddle through for a while, possibly a long while, before either of these endgames eventuates.
That means the extraordinarily low interest rates currently on offer may be around for some time yet. And the yield bubble could well get bigger before deflating.
The math doesn't add up
But do the potential rewards for chasing some of the higher yielding asset classes outweigh future risks? To determine this, let's crunch some numbers. We'll first take a look at the popular asset of Hong Kong real estate.
Hong Kong residential property is the world's most expensive per square foot. According to The Economist, it's also the second most expensive, behind Canada, in terms of price to rent compared with long-run averages.
Right now, you'll get close to a 3% rental yield on residential property in Hong Kong. Mortgage rates at the largest lender there, HSBC, increased from 2.6-2.9% to 3.15% in March.
For those that rent out properties they've purchased, the positive carry (rent exceeding mortgage rate) prior to March has now disappeared. But that's not the half of it. The Hong Kong government has increased stamp duty by 2x to 8.5%. There are also other taxes and maintenance spend that need to be factored in too.
Without capital gains, you're very likely to earn little or no returns on Hong Kong property. But inflation also needs to be taken into account. Current inflation in Hong Kong is 4.4% compared with a 20 year average of 4.6%. Consequently, without significant capital gains, there's also a high probability of negative real returns (returns after inflation).
Given the paltry potential returns on real estate in many parts of Asia, investors are turning to high dividend yielding stocks for alternatives source of income. After all, if you can get a 4% yield on a stock in Hong Kong for instance, it sure beats the 3% yield from real estate there and the close to 0% on offer from bonds and cash.
While yield is nice, paying up for it can be a dangerous game though. Take Hong Kong's largest power utility, CLP, as an example. It has about an 80% share of the electricity market. The company has expanded overseas into markets such as Australia and India due to stagnating electricity usage at home.
Currently, you'll pay 19.7x 2012 earnings for this well-managed stock, compared to 11x for the overall Hong Kong market. CLP also sports an attractive 3.9% dividend yield. And the company has managed to grow earnings per share at a 3.4% compound rate over the past decade.
Let's assume that you're looking to hold this stock for the next five years. If the company manages to grow earnings at historic rates and the dividend payout ratio stays the same, you'll get about a 7.3% annual pre-tax return, assuming the current price-to-earnings ratio (PER) stays the same. That return may not beat the overall market, but it would easily beat the current 4.4% inflation rate, assuming there's no major spike on this front.
However, if the stock's price-to-earnings ratio (PER) declines to its historical average of 16.6x, then any potential capital gains would be wiped out, leaving a pre-tax return close to the current dividend yield of 3.9%. That return would likely trail inflation during the period.
And that's also ignoring any risks around earnings. Profits have actually fallen the past two years due to poor overseas returns, so a 3.4% annual growth assumption on this front may also be optimistic.
Do the potential rewards outweigh the risks for this high yielding stock? I doubt it. But plenty of investors disagree at present due to their willingness to pay up for yield, no matter the price.
Alternative ways to seek low risk returns
This leads to a question that I've been getting a lot of late: in a world where many safe havens are not so safe, where can I invest my money to earn respectable, relatively low risk returns? It will obviously depend a lot on your personal circumstances, location, risk tolerance and so on. But here are a few tips:
-
If you have to own government bonds, stick to short duration ie. less than two years. Short duration bonds are less sensitive to interest rate rises than long-term bonds.
-
Treasury inflation protected securities (TIPS) are also worth investigating. As the name suggests, these bonds protect you from rising inflation. Make sure that you don't pay up for them though.
-
Stocks, particularly ex-high dividend payers, are reasonably priced in many markets, particularly in Asia. Despite long-term risks, they've probably got more to run with low interest rates here to stay. Therefore, they're worth having in your portfolio. To what extent depends on your risk tolerance.
-
Gold is worth owning, even if it's only a small part of your portfolio. It's a hedge against extreme events and is a great diversifier in an asset portfolio, being totally uncorrelated to stocks and bonds.
-
REITs are worth including, albeit only those in less bubbly countries/segments. Research shows that the performance of REITs is also uncorrelated to that of stocks and bonds.
-
Keeping cash on hand makes sense. Despite current meagre returns, cash gives you flexibility and the capacity to move when some of the current elevated asset prices pull back.
One last thing to stress is that it's important to keep a diversified portfolio. The current actions of central banks are unprecedented and no-one can be sure of the end result. A diversified portfolio can help protect your hard-earned money and possibly grow it in a relatively low risk manner.
This post was originally published at Asia Confidential: http://asiaconf.com
»
- advertisements -
you pegged it
The Swiss couldn't take the cross border devaluation heat in their llocal markets. The mantra there in Europe is...
we must be practical.
That's how Adolph rose up, it was a practical thing at the time. With a short term POV, what's practical is right for now. In other words, they are "unprincipled". That's history, plain and simple.
Something BIG is going to happen this week. Tuesday. Say goodnight to the age of pyramid schemes.
MOAR
The bigger risk to the markets is for the global yield curve to steepen because investors begin to realize that they are at risk of having their future currencies diluted significantly. The shift is starting to happen as investors move down the curve to shorter and shorter duration maturities. Would you rather get substantially less dollars back in 30 years or 2 years? This may seem to be an extreme example, but if the Central Banks continue to print and drive longer date yields to unrealistic levels, as now, then it won't be inflation we should be concerned about, but the spike in longer dated maturities. This will become more pronounced when investors realize that the risk of repayment in longer maturities is basically nil in most of the European / Asian economies.
Cramer has been pumping high yield corporates ever since the crisis.
The FED is colluding with their banker masters to try and force more individual investors into equities.
As soon as they get enough sheeple money back in the casino it will be time to crash it all over again; more bonuses, more bailouts, more profits - and more suffering and punishment for regular people who try to save and be responsible.
Fuck the FED, fuck Wall Street, fuck Washington (Sodom and Gomorrah on the Potomac).
i am sick and tired of hearing about this "wealth effect" bullshit, the only thing that makes me feel wealthier is a raise in pay....end of story.
Are UK banks running out of money?
Yesterday an upset person at a cash machine spoke to me on passing..it didn't give me any money... and this isn't the first time I have witnessed this.
I saw later that it was 'out of order', again not for the first time!
Just get yourself some bitcoin. Last price:$127.80000
It is on. That actual fair price for a bitcoin is $796,000 each
Get em while you can. Well you can always buy micro or mini bits.
looking for yield in a yield less world ...is like an addict looking for white stuff in the streets of NY; only the latter has more luck if he is a banksta, not a 99% sheeple.
Prescient sensation of announced asset regression.
"For the most part, we don't live in a free market world anymore."
We didn't to begin with. The FED artificially raised rates to 6.5, then artificially dropped them to 1%, then artificially raised them 1/4 point per meeting. What would the short term rate have been and when, if the market set it instead of the FED?
Didn't to begin with - right. However, the real unfreedom was a choice between gnat's nut regulation and insider market manipulation.
Currently, the genius of the market's been unleashed to allow front-running and pools by hfts, churning by stock brokers, and bubble blowing by the Fed. Hot money raids on PMs, grain, and now real estate are crippling the real economy. The regulatory agencies have been captured for decades, and the libertarian whining about gub'mint is a smokescreen.
Milty conflated 'freedom' with 'ownership' for purely political reasons.
So pipelines at 40x p/e and REITS at 2% cap rate are not a good buys here?
Depends. If the Gnomes of Washington are going to suck up pipeline co. puts with their unlimited cash, and Barry decides his buddies in real estate are next on the stimulus train, you've got a good short-term play. But there's always the question about when the music's going to stop...
There's an incredible risk aversion in the US. Anything with the word "high" in it scares investors away. Read "high" dividend, "high" yield, etc. Further, as mentioned by Disabledvet, no discusssion is worth having without first addressing macro factors such as international trade tensions, political risk at home, and a litany of other things that have yet to be dealt with. I am sure their are 1000 good investments available given this slow money environment, but the problem is, we don't know which one will get nuked and which one will survive. REITs? Might be a great investment, given that the housing bubble has mostly popped. Utilities? Not so much - there has been a lot of grumbling about high energy bills here in the states - and what that usually leads to is fiscal intervention (read subsidies, penalties for charging over a certain price etc). Unfortunately, like most financial advisors, the writer neglects these concerns and leaves the investor wondering
shuckster, good points about utilities and REITs, though I don't believe the RE market is actually improving. Where I live (upstate NY), RE prices were not greatly affected by the bubble bursting, but now they're headed south, with lots of Fannie Mae foreclosures showing up after the courts were clogged with them for years (still are).
Per my post above, cash, silver, land still appear as safe havens, though the recent decline in paper silver has had the opposite effect on physical. Current premiums are now ranging from 25-35%, making the actual price for physical silver closer to $30 per ounce then the post $22 and change.
Land is still a little pricey, especially if it's good farm land, but I'll still take wooded acres because you can cut and use the wood for all kinds of useful things, like buildings, fences, and heat (burns good), and once cleared, viola, farm land. I'm thinking more in terms of small organic garden plots rather than macro-farming, enough to feed a few families. Doesn't take much. The average back yard will feed three-to four families of four.
Cash is your best defense despite the scourge of inflation. If deflation occurs, cash is king, and with a huge crown. That's when you can buy assets on the cheap, which is investing 101 - buy low, sell high - ya know.
I'm still a deflationista, because I look around a lot. You can buy tomatoes at $2.49 a pound at the popular Wegmans' grocery stores, or hit the same thing for $1.59 at Price Rite or even Wally World. Don't get me started on limes, a must for my favorite Bloody Mary, at 3 for $2 at Wegmans, but 4 for a buck at Price Rite.
The Price Rite's and Aldi's are in poor 'hoods, so the sucker middle class gets raped at the "safe" stores. The dimwits in the inner cities, though, are buying mostly Cheetos and crap rather than good food with the SNAP cards, so, they'd just die off, albeit at lower prices.
My point is, get off the investment grid. Buy local (farmers markets are awesome), horde cash, and, when and if the silver mania subsides, more shiney.
aldi is awesome-been holding prices through all of this bernanke bullshit-plus aldi is german- happy b-day Adolf!
Even better; grow your own food.
Let me introduce you to a word, a concept.
Synergy, where 1+1+1 can equal 7.
See, gardening reduces your stress so you live longer.
You get organic vegetables at next to zero cost so you save money.
I've never yet had a garden that didn't massively over produce; tomatoes, zucchini, and cucumbers especially grow at horror film rates. You can sell or distribute these for free or trade. See? You are building community and expanding your contact sphere.
Get those kids in the dirt. Doing so leads to less bullshit like deadly peanut allergies, asthma and immune disorders. Yea, you can look it up.
Teach those kids a direct relationship between work and reward. FarmVille is for bored women who are to fat or undersexed to initiate an affair.
Synergy! It's what's for dinner
+1 even though I'm jealous.
You never had a garden that didn't massively over produce??? Damn it , I want you to come here and tell me what the fuck I'm doing wrong. Regardless, I love your passion and that's what its about. My soil is high acidic so..blueberries and rasberries grow quite well, beside that, I'm lost. In my experience it's best to stick what you're good at and pay a local trade farmer that knows what they're doing for the small amount of produce you would expect to take out of your garden after the expenses of fertilizer..weeding etc.
Our topsoil is about 18 inches deep, good drainage. Back in the day we'd feed bushels of excess tomatoes and peppers to the cows; they'd slobber like they were rabid on the peppers, but they ate every one.
See, for our blueberries, we have to work the PH in the soil so they do well...
I'll take IBM for 200, Alex... er, make that 175.
I've always been skeptical of yields on dividend stocks, because, in a market-clearing event like 2001 or 2008, these stocks all lose on a per share basis. Yes, your yield rises, but at the expense of share price. At best, you break even; at worst, you lose and the dividend gets cut, a la 2008.
BTW, when I first saw the author of this piece, I thought it might be Bernie Lo, who used to do Asia Confidential with Bernie Lo on Bloomberg TV.
Bernie's on CNBC Asia now, doing Asia Squawk and First Call. As much as I dislike CNBC and Bloomberg overall, Bernie usually gives it straight with no spin and a good dose of humor and satirical wit. He's a pretty sharp guy, overall.
He airs 7:00 pm - 10:00 pm ET, and usually is better than watching the shitty Yankee games on YES.
And, no, Bernie didn't pay me to say this. I just think he's ahead of the usual CNBC curve and spin.
Deflation combined with present debt levels will lead to outright default. I don't know what the value of the currency of a bankrupt issuer is, but it can't be higher than before such event.
Great point, Agent Default (excellent moniker). That's why I favor deflation, cash, silver and land.
So I yet again find myself frustrated by a financial missive written without regard to economics or business cycle. Not an expert in investing directly in East Asia of course...but given their export led economies (is there domestic demand outside real estate?) seems to me they are very much tied at least to North American demand. (especially given the ferociously protectionist policies they have with one another.) my personal view is that understanding the cyclical nature of recoveries and recessions makes understanding interest rates, inflation and "p/e" expansions/contractions a lot easier. Obviously growth and inflation are high over there...that strikes me as a big deal and I find it hard to imagine that will change anytime soon.
i really tend to lose interest, when one recommends tips.....how can you when inflation is so rigged....tips are a gauranteed loser...
The only investment that actually makes sense in our current post-petroleum world is conservation. It actually provides a capital return on money-capital.
It is never considered because conservation has little- or no sex appeal. Instead, the world gets conservation 'up the ass' whether it likes it or not. The outcome of enforced conservation is deflation: there are no hedges against deflation only less losses in one asset category relative to others.
Meanwhile, economies fall into ruin and there is hunger, disease and violence.
how do you become a gublagazillionaire selling conservation, the spiritual zeitgeist of the Various States of Detroitification is the exact antithesis of conservation, hence we are witness to peak humanity. From here it's dark ages 2.0
I'm into consersvation-of ammo- for now;)
Yea, maybe a good idea. Seems like you can expend about 1 billion rounds quite easily why else would it be stockpiled like that.
Unless they eventually release as gov't surplus.
Even more importantly, thanks to its currency peg, Hong Kong imports its policy interest rate from the U.S. Federal Reserve.
Bernanke's ZIRP regime for the troubled U.S. economy is totally inappropriate for Hong Kong, and has created a monster property bubble.
When the Fed fools finally and belatedly tighten, Hong Kong will hit the wall hard.
pegs are so fucking stupid- I lost what little respect I had left for the swiss when they pegged CHF to the POS euro-which they will someday regret.