The RBA cited a deteriorating economic outlook in their recent statement, with a decision to hold the official cash rate at 1%. Economists were expecting interest rates to stay constant at current levels and were more interested in the board’s guidance for the future trajectory of interest rates.
This has massively boosted the performance of offshore markets this year. The tech heavy NASDAQ index is up 26% ytd in AUD terms, which is way ahead of the 17% return we have in Australia. The Swiss franc is another safe haven currency, and the Swiss market is up 22% in Aussie dollar terms.
The RBA has a triple mandate, that being maintaining currency stability, maintaining full employment and ensuring continued prosperity. In simple terms, this means trying to make sure the Aussie dollar doesn’t jump around too much, ensuring most people have a job and keeping economic growth up. The central bank will concentrate on different parts of the mandate at different times, as it sees fit.
Over the past few years, it is a focus on reducing unemployment that has caught the attention of the RBA. This is because the central bank believes that unemployment can go lower before inflation even approaches the top end of the RBA’s target band, helping explain why the central bank has kept interest rates at such low levels. The recent economic data, from both Australia and around the world, has however pushed them to be more concerned about addressing weaker economic growth. The RBA is biased towards further cuts and is unlikely to increase interest rates anytime soon.
Aussie interest rates over the past 20 years (Credit: RBA)
Why RBA Rate Cuts and a Falling Aussie makes Investing Overseas a Good idea ?
The RBA has cut interest rates twice to 1.00%, pushing the Aussie dollar down to US67c. The central bank has signalled another two potential interest rate cuts over the next year, which would put further downward pressure on the Aussie dollar. Declines in interest rates make holding money in Aussie dollars less attractive, resulting in international investors selling them for other currencies and pushing the currency’s value down.
One benefit of investing internationally when the Aussie dollar falls is that the AUD value of international investments rise. Assume you invest $100,000 in the United States at an AUD/USD exchange rate of 1.00. Under this scenario you get $100,000 US dollars. Suppose the rate drops to 0.50 and you want to cash your US$100,000 investment in and bring the money home. Your US dollars and now worth 2 Aussie dollars each, meaning you get AU$200,000. That’s an extra $100,000 in an investment that didn’t even go up, just because of a depreciating currency.
Some analysts are projecting the AUD to decline to 60c in the near term, off the back of another two interest rate cuts. Deteriorating commodity prices and further weaknesses in the Australian economy are set to contribute to the depreciation. Australia’s reliance on mineral exports pushed the Aussie dollar down to US45c in the GFC despite us not even going into recession. The advantage of putting your money in another currency if we do have a downturn is clear, because at least you will be able to make sizeable profits off the currency movement. This makes it a perfect time to invest overseas.
The NZ Central Bank has recently announced that they would consider cutting rates to -0.35% in an economic downturn. The RBA, which often moves in lockstep with the NZ Central Bank, has signalled that negative interest rates would be a possibility, but not a preferred option. This puts significant further currency depreciation on the cards.
While we don’t believe the currency depreciation will double your international investments, even a 10-15% tailwind can provide a significant boost to your profitability. The rate cuts constrain any appreciation in the Aussie dollar, at least to some degree. If a depreciation is more likely and you don’t hedge US dollar positions, your investment is set to perform well.
How the Aussie Economy is Tracking ?
The Australian economy is set to grow at the weakest pace since the financial crisis, with the prospect that quarterly growth could inch into negative territory. The main drivers of this move are weak dwelling investment on the back of a housing slowdown, in addition to poor retail sales and inventory numbers. Nevertheless, despite a slowing economy overseas, it is the stronger than expected trade surplus that might actually save the Australian economy from contracting.
Australia recorded a record trade surplus of $19.8bn for the March quarter, which was enough for the Aussie economy to declare its first current account surplus since 1975. This was far ahead of economist expectations of a $1.5bn trade surplus and was an impressive achievement in the face of falling iron ore prices towards the end of the quarter. The trade result will contribute 0.4 percentage points to Wednesday’s GDP numbers, without which the Australian economy would most likely be in contraction.
Australia’s tendency to borrow from overseas and offer attractive domestic investment opportunities has led to a persistent current account deficit for decades. While this does draw attention to a domestic savings problem, a current account deficit is not altogether a bad thing, since it highlights how attractive Aussie investment opportunities are to foreign investors.
Will International Stocks from all Markets do Just as Well from a Falling AUD?
Just as stocks will deliver all sorts of returns, there could be some currencies that decline by more than the Aussie dollar. In the event of a downturn, investors fly to safe investments as the economic outlook sours.
This is no different in currency markets, which sees investors fly to the currencies of stable, prosperous economics. Key targets include the Japanese Yen (JPY), Swiss Franc (CHF) and US Dollar (USD). Currencies like the Euro (EUR) also tend to outperform but are not perceived to have as much safe haven status as the other three currencies. Despite the fact that Europe is a well-developed, politically stable and prosperous region, economic instability and questions over Eurozone stability have held the currency down in recent years.
AUD Performance over the past three decades (Credit: RBA)
Most of the international investments we have are concentrated in the United states. The US has been a bright spot in the global economy, with the country’s economic data and low interest rates underpinning markets, thus helping to offset the poor performance of the EU. US reporting season was supportive of the markets, with a strong bias towards upgrades.
America is also a great place to invest for investors chasing dividends. There are numerous US companies that have not missed a dividend payment in a hundred years, have sustainable payout ratios and quality management. Given this includes two world wars, the Great Depression and the GFC, it is quite an accomplishment.
Our international high dividend Vue, a selected list of international stocks with attracts no management or performance fees, pays an 8-9% dividend yield. For investors who also want to not tie all their assets to the health of the Aussie economy, an 8-9% dividend yield beats 1% in local banks. This is one of the many options that investors have, if they want to boost their income and get out of the trap of declining interest rates that has defined term deposits over the past few years.
We also have some investments in Europe, but we selectively choose companies that are positioned to outperform in an economic slowdown as well as a bull market. While EU investments may not benefit as much from a depreciation in the AUD as US investments will, the EU has less room to cut interest rates since they already sit at 0% and the EU has already done quantitative easing. While we are more open to US investment opportunities, we do like to hold a couple of portfolios with more exposure to great businesses in Europe that will also have a currency tailwind.
Where is the Aussie Dollar Heading?
AMP Capital Chief Economist, Shane Oliver, believes that the AUD will hit US$60c within the next couple of years, because of a deteriorating domestic economy and falling interest rates. This would cause an 11% appreciation in the value of international investments in the US, when measured in Aussie dollar terms. The US China trade war, or sky-high levels of debt in China, could lead to a sharp slowdown in the country’s economic growth rate, which has not yet been priced into the Aussie dollar. In a recessionary scenario, which we are not expecting but want to be prepared for, the Aussie dollar could easily re-test the US45c level. This would result in a 50% appreciation in US dollar investments. Given the US market declines by an average of 20-25% in recessions, you could actually make money by investing offshore just before a recession.
Commodity exports are more dependent on China’s growth level than the underlying level of economic activity, which means they could be particularly badly hit from the downturn. With half of the ASX 200 in highly cyclical financial and mining stocks that are going nowhere, like the Commonwealth Bank (ASX: CBA), ANZ (ASX: ANZ), Westpac (ASX: WBC), NAB (ASX: NAB), BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO), we have a bias towards offshore investment opportunities.
Will we go into Recession?
2s10s inversion has been a timely recession indicator (Credit: St Louis Fed)
When investing both in Australia and overseas, it is important to have a view on the economic outlook. While Aussie dollar depreciation will save the international investor a lot of money, the shares themselves could still go down in a recession.
The Australian economy is also heavily exposed to global economic cycle due to our reliance on mineral exports. The only reason why we didn’t go into recession in the GFC is an unprecedented stimulus package from China that pushed investment to 50% of the country’s GDP, the highest level on record for any major economy in peacetime. This boosted Aussie mineral exports and was the sole reason we didn’t follow the rest of the world into recession.
It would be imprudent to base investment decisions on the hope that such extraordinary circumstances will repeat themselves. Equities are a cyclical asset class in all corners of the globe and will almost always move downwards to some extent in a recession. Nevertheless, given the long-term growth potential of both asset classes, it makes sense to still have some exposure and benefit from long term returns. Cash has always been a terrible long-term investment, so the main question is what percentage of your portfolio should be in growth assets.
One indicator that is used to see whether the economy will go into recession is the 2s10s spread. When investors worry about the economic cycle, they prefer to buy long term bonds since they go up more than short term bonds. To illustrate why, suppose you held a $1,000 bond paying a $50 a year in interest for the next 10 years. Imagine interest rates suddenly fell by 5%, and new bonds that sold for $1000 now paid a 0% interest rate. Investors will clearly pay a lot more for the first one since it makes more money, pushing the price of the initial bond up. This effect is more muted over shorter time horizons.
This is why investors like longer term bonds as much as shorter term ones when they think the economy will contract. Bond markets have, in the last four market cycles, predicted contractions far earlier than the stock market. The difficulty is that the stock market generally rallies 13% over a few quarters after the first yield curve inversion. If history is any guide, now is not the time to exit the markets completely, but it is the time to invest more defensively.
Global GDP growth is slowing, but not as fast as Aussie growth in the last quarter (Credit: RBA)
One of the main reasons why investors keep holding the big four Aussie banks is their attractive fully franked dividend payments. BHP’s dividend cut in 2016 did however show us that most of the income from attractive, fully franked dividends can be lost very quickly. Financials are a highly cyclical industry, it’s just that they don’t look it in Australia since we haven’t seen a recession for three decades. Investors who are after dividends that are sustainable over long periods of time may do better to look elsewhere.
This explains the importance of quality yield and highlights why we still recommend stocks paying a 4-5% dividend locally, despite being able to easily find stocks paying much more. We would rather a 4-5% dividend that could sustainably grow to over 10% of the initial investment over a few years, than a 10% dividend for a company in terminal decline.
Most Macrovue clients have been smashing the ASX 200 last year, despite headwinds from the trade war
Typical issues which Aussie investors have with investing offshore include a more limited knowledge of companies outside, sky high brokerage costs at the major brokers and not knowing where to start. We side-step these issues through developing a platform called Macrovue, where a top performing fund manager identifies attractive international investment opportunities for us to look at. We pay $15 a trade for brokerage and have a clear direction on which economic trends we are investing in. As one of the only platforms offering managed portfolios without performance fees, it’s worth looking at a couple of the themes we are looking at. The portfolios each have several stocks that investors can pick and choose if they wish:
Warren Buffett Top 10 (11.21% LTM): While the Oracle of Omaha needs no introduction, the $400k price tag of one of his class A shares prices many investors out of the company. To address this issue, we created a portfolio tracking his top 10 holdings, allowing you to instant access to the wisdom powering the 20% average returns for 60 years that Buffett delivered to his investors.
Luxury goods (+4.82% LTM): Luxury goods producers have high profit margins and sticky customer bases, making them excellent long-term investments. They are particularly well positioned to take advantage of growth in China, given the high levels of luxury goods expenditure amongst the nation’s booming middle and upper class. Many of the companies in this view have significant family ownership stakes, including Hermes and LVMH, protecting them from short term biases in decision making.
5G Wireless Technology (32.65% LTM): 5G technology is the driving force enabling most of the game changing technologies over the next decade, from autonomous cars to smart homes. With most of the US and Europe poised to roll out 5G technology over the next few years, companies exposed to this trend are expected to see massive revenue growth.
This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
(“ASR”). ASR is part of Amalgamated Australian Investment Group Limited (AAIG) (ABN: 81 140 208 288 Level 13, 130 Pitt Street, Sydney NSW 2000).
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