Yesterday afternoon the Reserve Bank cut the cash rate from 1.75% to 1.5%. Not long after, Commonwealth Bank (ASX:CBA) announced it would reduce its standard variable rate by just 0.13%. Curiously enough, though, alongside the decision, CBA decided to increase its term deposit rates and NAB (ASX:NAB) followed suit. This will surely confuse the bank bashers looking for a story for today’s newspapers.
The focus, presumably, will be on the mortgage rate, and the bank’ refusal to pass on the entire cut. But why blame them for exercising their market power, for wanting to make more money for shareholders?
The outrage and attempts to embarrass the banks into ‘doing the right thing’ aren’t just a naïve view of recent history – the banks’ conduct in recent scandals is too lengthy to list and has been shameless and self-interested – but a denial of how capitalism works. The Corporations Act says much about a company’s legal obligations to its owners but nothing about corporate social responsibility and moral obligation.
If a company achieves market dominance, especially a position obtained with the assistance of regulators and politicians that supposedly represent the public interest, can we realistically expect them to not wield it when they get the chance? If this is a problem, it is not one for the banks but for us.
Since their recent peak, interest rates have fallen by 3%. Callam Pickering, sister company Eureka Report's resident economist, believes that without those cuts Australia would have already entered recession. This points to the big issue. The RBA pumped up house prices to offset a fall in mining investment. Now that the property market has come off the boil people aren’t feeling as rich anymore, especially as wages growth has been very weak. Those historically low interest rates are there for a reason.
As a result, supposedly safe, unexciting investments like AREITs (or listed property trusts), bonds, and utility-like stocks have boomed. The ASX AREIT Index, for example, rose 24.59% last financial year, a figure that must send term deposit holders into a seething rage.
Herein lies the first lesson. Please do not use low rates as an excuse to chase already-expensive yield producing investments. Popular usually means expensive. This is a time to seek out the unheralded, which is why we’ve recently increased the size of our small cap research team. We’re finding opportunities. This week alone we’ve had two Dragon’s Dens on stocks that might surprise you.
Second, if you’re still fixated on double-digit returns you may want to lower your expectations. Investing in a world where the cash rate is 1.5% rather than 5.5% requires a readjustment. If you don’t make that mental transition you may end up further up the risk curve than you should be.
Third, and acknowledging that investors relying on regular dividends to cover expenses have less flexibility here, try and be agnostic about where your returns come from. If you can live with a little less yield and slightly higher capital growth then prices favour you right now.
Where to look?
So, where to look?
If you want to avoid the legwork of individual stock picking, our Equity Income Portfolio, currently yielding 3.8% (and most of which is fully franked), offers a good alternative. There are 25 stocks in this portfolio and 18 of them reappear in our Growth Portfolio, which goes to show how dependable yield has become expensive relative to growth.
In the middle sit a host of companies that deliver acceptable yield and attractive growth prospects, which was the basis for our Okay yield and growth’ mini-portfolio published on 27 May 16. These stocks offer a combined total yield of 4.5% plus some attractive capital growth potential. Reporting season should produce a few more.
There are opportunities and we’re finding plenty of them. Our long-term track record is proof of our success and ability to deal with challenging environments. What we recommend is that you channel any rage you feel about the banks and focus on staying calm, buying cheaply and sensibly, and hanging on.