Returns – Lower for Longer

Well the BREXIT crisis so far really has turned out to be a storm in a teacup. Apart from a couple of down days the market didn’t miss a beat and the sun is shining and the music is playing. Nevertheless, despite outward appearances, the longer outlook is not necessarily as benign as would currently appear.

The answer to how to navigate the current environment is to remain focused on investment fundamentals. For retirees, in particular, this means that the focus has to be first and foremost on managing your money so that investment capital continues to, through retirement, provide the standard of living required. This means paying attention to the preservation of capital as well as generating income. For the defensive components of portfolios, this means factoring current income returns of 2-3% into longer term planning and avoiding higher yielding higher risk defensive investments. See the May 2015 blog “Defensive Investments and the Magic Pudding”. For the growth part of a portfolio, it means restricting investment to businesses that are high quality, have favourable prospects and are not bought at elevated prices. Refer to the November 2015 blog “The Eternal Caravan of Value Reincarnation”.

This month’s blog is an article published by and included here with the permission of Montgomery Investment Management Pty Ltd. It gives a succinct summary of the current state of play in investment markets. For excellent investment insights, Montgomery Investment Management writes a daily blog at



By Roger Montgomery. July 14, 2016.

Around the world five-year government bonds are paying paltry returns to their investors. Indeed, in some countries, rates are negative.
In Germany the rate is -0.6 per cent, in Switzerland, it’s minus 1.1 per cent, in the US it is +1 per cent and in Australia little more than the cash rate. Longer-term bond rates are not much better. In Germany, the 30-year rate is just 0.4 per cent, which means that over 30 years an investor will receive a total return of just 12.7 per cent.

Professionally managed pension and super funds that are investing in these bonds are locking their investors into very low returns for extremely long periods.

Events such as Brexit only add fuel to the fire, causing investors to stampede towards security, driving bond prices even higher and yields lower. In their hunt for security and yield, investors are laying the groundwork for the next collapse in the value of their retirement savings.

Yes, baby boomers chasing high yielding ‘safe’ blue-chip shares and low yielding bonds are likely to suffer another destructive impact to their wealth and purchasing power before their days are up.

But it may be a year, two or three before it occurs. After flip-flopping on talk about interest rate increases in the United States, the US Federal Reserve’s St Louis President James Bullard issued a report anticipating only one rate hike in the US through year end 2018.

Bullard said that the appropriate US Federal Funds rate is around 0.63 per cent, which is only a quarter of a point above where it stands today, and perhaps more importantly, will likely remain there “for the foreseeable future”.

At Montgomery, we believe investors need to accept the argument that returns will be lower for longer. From property, to shares, to private equity transactions – see the purchase of the UFC (Ultimate Fighting Championship) which earned US$600 million in revenue last year and was reportedly sold for US$4B – asset prices are elevated. But earnings growth is flat.
In Australia, aggregate earnings per share growth have been negligible since 2010 and despite this, or perhaps because of it, company payout ratios have increased from 55 per cent to 80 per cent over the same period. What that means is less of each year’s profit is being retained to grow the business and its future earnings.

Other means are available to grow of course. A company can borrow money too. Unfortunately, the appetite for debt is low despite low-interest rates. This is because we are at the end of a very long-term credit cycle not at the beginning. In other words, the world is awash with debt, much of which has been borrowed to fund financial engineering, such as share buybacks and mergers & acquisitions, rather than productive capacity increases.

Neither credit-fuelled growth nor self-funded growth are available options. The only alternative is to issue more shares, but so much debt has been used to fund share repurchases that companies would appear bi-polar if they started selling new shares.

Here in Australia, the stock market appears to be expensive on a number of measures. The S&P/ASX 100 index 12-month forward price to earnings ratio is at 15.4 times, which is as high as it was at the market peak prior to the GFC. And while interest rates are much lower than 2007, the lower rates are not fuelling earnings growth and so should not be used to justify the even higher price to earnings multiples. The S&P/ASX 200’s 12 months forward P/E is also at the highest level seen in the last 15 years and excluding the banks, the ratio is above 18 times – well above the highest level recorded in the last 15 years.

Over in the US the S&P500 is also at historic high P/E ratios of 18 times.

We are staring at an investment world with elevated asset prices supported only by low-interest rates. Growth, and therefore returns, will likely be muted for some time even if interest rates stay low. And if interest rates did start to rise, or if inflation emerged – even amid a recession, expect not only low returns but sharp corrections along the way.

Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564) and may contain general financial advice that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking advice from a financial advisor if necessary.

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