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Revisiting the oldest investment question of all

2 May 2022 1 month(s) ago

The first requirement in investing is to decide on the balance between shares and fixed interest.

For years, the most basic question of investing, how much to have in shares and how much to have in debt, has been easy to resolve. With interest rates near to zero and shares producing decent yields, the latter has obviously been the one to prefer. The only other question is whether to invest heavily in property instead to take advantage of the biggest asset bubble of our lifetimes, which is also consequence of low interest rates.

With inflation rising around the world, and interest rates set to rise in line with that, the fundamental question is back. Which to prefer, fixed interest or shares?

FirstLinks says that with core inflation above the Reserve Bank’s target rate, interest rate rises are inevitable, probably starting in May. The markets are shifting, something being obscured by the election:

“The list of negatives for the market continues to lengthen ... global growth forecasts downgraded this week by the IMF, a 20-year high inflation result, the end of easy monetary policies, the rise of autocratic powers, geopolitical risks in the Pacific, reduced globalisation amid supply blockages, surging energy prices ... and both sides of Australian politics handing out stimulatory spending to contradict the aims of tighter monetary policy.”

For investors, it means the risk reward calculation is changing. Cash investments may actually deliver some half way reasonable returns:

"With interest rates likely to rise in the next month, and the bank bill rate already above 0.7%, there is a prospect of savers actually generating some income from cash soon. Take a look at the rate on your savings and you can see why bank share prices have been rising. The table below is the rate schedule on my SMSF's main transaction account.

“Thank goodness the rates have a tiering to reward higher balances. The rates will not rise at the same speed as cash rates while increases are passed on in loans. It's good for margins. I have sat on the Pricing Committees of three banks over many years and across the tens of billions in these accounts, the Reserve Bank actions will feed into commercial bank profits.”

Australia’s markets are different, in part because they are propped up by the huge pool of super money. But we are still affected by overseas developments, just not as much as before.

It is no longer the case that if the “US sneezes, Australia catches a cold”:

“Regardless of how much we focus on Australia for our own investments, it is the US market which sets the tone for all others (it comprises 56% of the market cap of global stock markets). Even if you do not invest directly in the US, it's worth knowing how US investors view the market. A long-term data source is the American Association of Individual Investors (AAII) Sentiment Survey, which provides a spreadsheet of sentiment data since 1987. The 'percent bullish' was the lowest last week that it had been since 1992.

Although investors are sitting on mountains of cash, inflation, recession, war and rates are playing on their minds.”

 

Reader note: This is general reporting only and should not be considered in any way to be investment or tax advice. It does not take into consideration the investment objectives, financial situation or particular needs of any particular investor. For more information please read our disclosure statement.

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