ABX Weekly 7th November 2018 Market update
The safe bet yesterday was on the Reserve Bank of Australia (RBA) keeping interest rates at 1.5%. Citing the “housing markets have continued to ease” and “inflation is expected to pick up over the next couple of years”. Low levels of interest rates are supporting the economy and we expect the RBA to be on hold for some time. The RBA did change some of the wording in their statement after the November Board meeting, including noting that the Australian economy is performing well. Over the past year, GDP increased by 3.4 per cent and the unemployment rate declined to 5 per cent, the lowest in six years. The forecasts for economic growth in 2018 and 2019 have been revised up a little. The central scenario is for GDP growth to average around 3½ per cent over these two years, before slowing in 2020 due to slower growth in exports of resources.
The markets are nervous going into the US mid-term elections, though strong labour demands shows no sign of slowing and we expect to see a continued fall of unemployment in the US. Also the FOMC meets later in the week. Equity markets have often sold-off based on a spike in bond yields, and if the Fed take a hawkish view for rate hikes in 2019, the repricing of US interest rate expectations could spark a sell-off in US Treasuries and global equity markets.
Brewin’ with Nguyen
I’ve gone through a lot of the benefits of bonds, but every good investor knows not to invest in anything you don’t understand how it works and what the risks are. Everything has risk, period. So, I get a lot of clients come through looking for safe stable returns and asking what the risk for bonds are.
The biggest risk with bonds is the credit risk or default risk. That is when the company you are lending to goes broke and can’t pay its debt holders.
At first glance that does look scary, losing your whole investment. But there are many security features of bonds to protect its investors. What must happen before you even lose a cent…The Company makes a loss? They STILL must Pay you…. They make a rights issue to raise capital and dilute all their existing shareholders? They STILL must pay you… They stop paying dividends to their shareholders? They STILL must pay you. The shareholders must lose their whole investment before a bondholder loses a cent.
In Australia, you know that it is not uncommon for a company to go under. But you might not know that it is very rare for a company with bonds to go under. That is because they must grow a certain size before they can even tap into the bond market.
You might hear that bonds have a lot of risks if interest rates go higher as your market value drops. But Bondholders are protected again as you know you will be pay out at $100 at maturity.
Another risk is liquidity risk. But again, you always have a seller at maturity at price $100. And here at the ABX will always provide liquidity on the bonds I offer.
The name of the game here is capital prevention. Because bonds have a maturity date, you always know you’ll get your capital back and is defensive compared to other investments. I may not do well with my Melbourne Cup calls, but I know I am always on the winner with bonds.
Last week the European Banking Authority (EBA) released the results from its latest stress test for Europe’s biggest banks. The good news was that for the Europe wide examination, all the financial institutions have passed the test. The EBA said in its finding that all 48 banks beat the common tire ratio of 5.5 % in the adverse scenario. In addition, the European Central Bank (ECB) added that the test showed that banks in Europe were now “more resilient to financial shocks”. The most surprising point however was that the British banks Barclays and Lloyds ranked at the bottom of this test and one of Europe’s biggest bank, Deutsche Bank, performed better than some forecasters had predicted. A huge surprise was the positive outcome for the Italian banks which managed to record satisfactory scores according to the banking regulators. These recent findings should help to calm the nerves of wary investors and should inject some confidence into the sector which has been under pressure for quite some time.
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