Saving remains a losing strategy

Relying on interest income alone is not a good option in the current low interest rate environment.

PORTFOLIO POINT: Low rates have eroded income returns, but the broader economic fundamentals point to growth.

Our new-found desire to save is going to drive headlong into a deepening problem – that those savings are not going to generate an adequate return.

Over the long term there is only one solution. Equity markets offering grossed-up yields higher than 7% are going to prove a more lucrative home for our spare cash. Remember also that the federal government has scrapped a plan to introduce a 50% discount on interest income, whereas the tax-effective nature of investing in Australia’s equities remains.

Recent data from the prudential regulator shows we are still squirrelling away more in savings than we are borrowing. Total household deposits grew by 8.3% during the 12 months to April 2012. But total mortgage balances grew by 5.7% over the 12 months to April, and by an annualised rate of 5.2% over the three months to April.

At the same time risk-free bond rates have fallen to a record low, and following four cuts over the past eight months the RBA’s official cash rate sits just 50 basis points above a record low.

Term deposit rates have fallen by about 70 basis points over the past three months to an average of about 4.6% compared with a 75 basis point fall in the RBA’s cash rate over the same period.

It’s a terrible time to be living off interest.

The important point to remember is that the repair process in the broader economy post a decade of excess is well and truly under way.

As Sherman Ma, managing director of non-conforming lender Liberty Financial points out, if you combine annual income growth of between 3% and 5% over the past five years with house price reductions of up to 20% in some areas, there has been a 40% adjustment in affordability.

The stockmarket tells a similar story. In simple terms it is back to where it was seven years ago, down 40% since its 2007 peak.

In the fixed interest world there is capacity for interest rates to continue to fall, further eroding our interest income streams.

Westpac chief economist Bill Evans is predicting two further cuts to official interest rates this calendar year, with the low point in the current easing interest rate cycle being 2.75%. It spells bad news for savers.

Figure 1: Net dividend yield of the ASX200 versus yield on 10-year government bonds

The good news is that there are signs that the deleveraging cycle is, at least, slowing.

If one considers the past three months, the differential between deposit and lending growth is narrower than 12 months ago. One of the big margin lenders also reported a pick-up in tax-effective loan prepayments ahead of June 30.

There are other signs of realism amongst the gloom. The two big domestic insurers, Suncorp and IAG, have both been increasing their exposure to equities in recent months.

Westpac CEO Gail Kelly said recently that the $500 million collapse of Hastie Group was not the leading edge of another wave of big corporate collapses.

Federal treasury boss Martin Parkinson has said that the Australian economy remains “quite sound and our prospects are very good”.

Remember, gross domestic product (GDP) rose by 1.3% in the three months to March, for an annual rate of 4.3%, the Australian Bureau of Statistics (ABS) said last month.

The Australian economy is showing signs that it can adjust quickly to external shocks. Despite its recent bounce, the Australian dollar remains below its February high of $1.08.

Those pointing to the implications of a slowing Chinese economy need to remember that at least some of that slowdown is due to the deliberate efforts of the Chinese government.

As the 12th five-year plan is bedded down, some Chinese believe that economic growth will be allowed to accelerate.

All in all, there are reasons to hold one’s nerve as bond markets point to a crisis.

Figure 2: Yield on 10-year government bonds
Hugh Robertson is an executive director of Investorfirst Securities. hrobertson@investorfirst.com.au

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