Japan program a winner for yields

This week it was my intention to review the nine months (financial year to date) performance of my income portfolio, to see if it was meeting my targeted return of 8% p.a. However, the dramatic economic policy upheaval in Japan certainly requires some analysis as it is likely to have a material effect on the income portfolio that I have constructed. I will outline the reasons for this a little later.

At the outset I must admit that the return from the income portfolio has dramatically exceeded my expectations. My aim was to achieve a solid income flow that would be enhanced by capital gains across the portfolio. I constructed the portfolio to ensure capital maintenance as much as possible.

During the nine months I made only one portfolio change. Readers will recall that ANZHA was rotated out and replaced by NAB ordinary shares on 31 December. NAB entered the portfolio at $25 and has surged to $31. The rationale for the rotation was based on a projected higher yield from listed bank shares (NAB stood out) than was on offer from listed bank debt securities. Today that price and yield arbitrage has substantially disappeared.

Certainly the portfolio has benefitted from a strong rally in high-yielding equities over the last six months. The standouts are the bank shares and Telstra. These shares were placed in the portfolio at a significant discount to their MyClime valuation and with most attractive projected yields. Westpac has returned the portfolio over 50% in the last nine months. The much maligned Telstra has paid two dividends (28 cents fully franked) and its price has lifted by over 18%, giving a total pre-tax return of over 30%.

Now before I outline my current views on the hybrid securities in the portfolio, I would like to comment briefly on the Japanese economic policy settings and its ramifications for Australian equities and yield securities.

Japanese Quantitative Easing

The announcement by the Japanese administration of a $1.4 trillion quantitative easing (QE) program is already having a dramatic effect on bond, equity and foreign exchange markets. The ultimate effect on Japanese economic activity, and therefore commodity prices, will be months away.

The immediate effect has been seen in bond markets around the world. In my view there will be a massive unloading of Japanese bonds by Japanese institutions and pension funds. Indeed, the intervention by the Japanese central bank has averted a bond market calamity in Japan. Japanese bonds are rallying (yield down) and the institutions are buying Japanese equities and property. They will also divert their bond holdings into “quality” foreign bonds. The likely targets are US, German and Australian bonds. To offset this liquidity flow, the European and US central banks will maintain or increase QE programs. Unless they do so the euro and $US will spiral up against the yen. The Australian Reserve Bank has a propensity to do nothing, and so the $A will froth upwards. It has already reached ¥105, which is 30% above its level just six months ago. 

So Australian bonds will continue to rally (now yielding 3.3%) and this will lead to support for yielding securities, property assets and yielding equities. So our income portfolio is in a very sweet spot at present.

In passing, let’s not forget that there are other consequences of the collapsing yen. Already we are seeing distress in the automotive markets. Australian suppliers are in for a very tough period and consumers who are thinking of buying cars in the next few months should be patient. Auto retailers and wholesalers will be clearing stock that is depreciating in their hands. A similar problem is emerging for electrical and white goods retailers. Not only will we see price deflation from Japan but the competitive response from China and Korea will be swift.

The winners will be importers of fast moving consumer goods. I suspect that the retail subsidiaries of Woolworths and Coles (e.g. Big W and Bunnings) will have a good time. The Reject Shop is another winner.

Finally, what will Japanese outbound tourists do? Common sense suggests they may now stay home as Australia becomes an expensive place to visit.

Income Portfolio outlook

The likely rally in bond yields suggests that we should maintain our positions across our hybrid securities. Further, the actions of the Japanese central bank will demand a response from the Reserve Bank and our government. The Australian manufacturing base will literally fry under the currency pressure and the potential trade war in Asia. A logical response will be to cut cash rates further and for our government to have a significant long-dated bond issuance to tap into the massive international capital flows.

Based on the above outlook, here are the prices at which I am keen to add to my hybrid positions – except for WOWHC:

• AAZPB can be accumulated at a 8.25% running yield (floating), which is just below $96;
• MBLHB target 6.75% (floating) accumulation at $71;
• MXUPA target 8.25% (floating) accumulation at $85;
• NABHA target 6.25% (floating) accumulation at $70;
• RHCPA target 7.8% (floating pre-tax) accumulation at $102;
• SVWPA target 8.8% (floating pre-tax) accumulation at $89; and
• WOWHC at a current price of $105.70 is under review. Readers should be aware that the redemption yield is falling rapidly.

John Abernethy is the Chief investment officer at Clime Investment Management.

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Purchases Quarter to 28 March 2012: N/A

Sales in Quarter to 31 December 2012: N/A

Free cash at end of period:$2,466.56 *Dividends not yet redeployed