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“Why are markets rising?”
Hm, interesting question MrsFrugalSamurai posed to me last night, as she clicked on another James Charles video.
James Charles, for the uninitiated, is an American internet sensation/make-up artist/Youtuber. Why women are following men for make-up advice, is beyond the scope of this discussion.
“I mean, why are markets rising when the economy is struggling?”
Pay attention to that video woman, and get rid of these here wrinkles, I thought but did not say as I love my wife.
As I stepped away from the mirror, I began to think.
Why are markets rising?
Everyone knows that COVID-19 has pretty much put the kibosh to any sort of economic growth not only here in Oz, but everywhere around the world.
But how come stock and property markets are still sitting at such lofty levels?
In a word…
Strip away all the BS about earnings, and P/E ratios and growth prospects that is reported in the media.
It all comes down to interest rates.
Or rather, the lowering of the risk-free rate of return due to the decline in interest rates.
Here, let me explain.
In Australia, one of the safest investments you and I can get into is… to keep our money in the bank.
Or rather, staying under the $250,000 government backed deposit guarantee, which guarantees our money should the bank the deposit is in, defaults.
And the rate of return on this money?
You’d do well with an account offering more than 1.5% p.a.
Similarly, another oft-quoted measure of “risk-free” return, is leaving money in your home loan offset account, which offsets the interest that you pay on your home loan.
Which would make a lot of sense, except home loan rates are starting from a ridiculous 1.99% these days.
So the question is, why would you leave money in the bank (literally), when you could put it to use in the stock or property markets, which has historically returned just under 9% p.a?
Case in point, some relatives of ours just received their interest from a term deposit which matured.
They had about $150k in a 3 month term deposit, which earned them… get this, just over $300.
They’re now looking to put that money into the stock market.
In US of A
Similarly, compare this to what’s happening in the US market.
The traditional risk-free rate of return in the US, has been the 3-month US Treasury Bill.
A treasury bill is a government debt obligation backed by the US govt with a maturity under 12 months. This means you hand your money over to Uncle Sam, who then pays you back depending on the term and rate you invested at. They range from T-Bills (<1yr), T-Notes (2-10yrs) and T-Bonds (10yrs+).
And the rate of return on these bills, notes and bonds?
From the US Treasury Dept:
A paltry 0.12% p.a. at BEST for the 3mth.
And heck, even if I wanted to lock up my money with Uncle Sam for 30 YEARS – I would receive a MAXIMUM of 1.67% p.a.
That’s disgusting “spits on ground in disgust”.
So why would I want to do that, when the historical return of the US share market has been just under 10% p.a?
Coming back home, the RBA governor Mr Phillip Lowe has signalled last week, what his plans are for the immediate future… which is to keep rates low for at least the next 2 or 3 years in order to boost asset prices for jobs and economic growth.
Um excuse me, but if that’s not a bullish message for the stock and property markets here in Australia – then I don’t know what is.
It’s not up to this handsome yet humble blogger to determine whether this is monetarily irresponsible policy or if it is the exact thing our economy needs… it’s up to me to make the best financial decisions for my family, and at the same time relay what my thoughts are to you dear reader.
So let me leave you with this.
And these are solely my opinions (disclaimer to follow of course).
My opinion is that in the short-term, there are wayyyy more investing tailwinds than headwinds.
However, there will be a monumental moment of reckoning when rates turn, inflation runs and the economy truly goes up the shitter.
There is nothing good about high asset prices (unless you are or soon-to-be a retiree).
For young ‘uns like us, we want asset prices to be as low as possible.
This is because, the higher an asset price rises, the lower the future expected return is.
Think about it, would you want to buy Amazon stock at $32 or $3,204?
Or a Sydney beachside unit for $500,000 or $1.5m?
The disconnect between economic reality and what’s on paper is too great. The big question is when this will occur.
But in the mean-time to para-phrase “when the music is playing, you gotta get up and dance”.
Proceed with caution, always.
Because throughout history, the market has always moved in cycles – where are we in the market cycle now?
There’s no such thing as easy money.
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