S&P500 vs Inflation vs PE Ratio over 97 years

The above chart shows the 10 year performance of the S&P500 (blue bars) versus the 10 year average annual inflation (red bars) versus the Shiller PE Ratio at the start of each decade (green bars). There are several notable observations...

• The worst performance was during the 1930s when the US experienced a deflationary environment and PE ratio started very high
• The second worse performance occurred 2000-2009 when PE Ratios started through the roof (> 40) and contracted
  
• Other poor performances typically related to high inflation (1913-1919; 1970-1979) and/or PE ratio contraction (1940-1949)
  

So what do we start 2010-2019 with? A very high Shiller PE Ratio (~20.1), third highest to the start of the Great Depression and Tech Wreck/GFC decades. And, an outlook for inflation that is relatively low due to the very high unemployment that is expected to stay around for some time. The US economy has just seen an economic bounce largely on the back of inventories that are being built back up but this is not a sustainable growth driver and certainly from a sharemarket perspective not a justification for a high PE.

Whislt the US Economy recivers for decent sharemarket returns there needs to be some stronger growth drivers and what these drivers will be is a little unclear.

Interest Rates...relatively stable but a minor dip at the long end

Source: Reserve Bank of Australia

The government bond yield curve certainly expects another 50bps in RBA hikes this year with bonds yielding in the second half of this year trading around 4.3% to 4.4%. But since the start  of the year the yields in longer term bonds have declined a little...this indicates a slight drop in confidence of the Australian economy this year.

As has been widely published, the Australian economy has performed relatively well compared to other developed nations around the world and this is largely thanks to the strong links of the Asian developing economies and their continued hunger for our commodities. With China starting to tighten its credit belt a little there is no cause for alarm, but complacency is not appropriate.

In a week or two, the half yearly reporting season begins and after a few months of relative lack of volatility, I'm sure reporting season may well change that. With US, Japan, and much of Europe in a little economic disarray, the risks still exist, so it should be another interesting year for investors.

Economist Magazine says Australian housing overvalued by 50%!!!

I started reading this week's Economist mag yesterday and the lead article is about the asset bubbles that are appearing all around the world thanks to low interest rates. Article can be found here for subscribers.

In terms of housing the article suggested that the US is at fair value, whilst Britain is 30% overvalued, and Australia, Spain, and Hong Kong are 50% overvalued based on the current level of rental yields. Commodities were mentioed as being overvalued and as with my last post, so too are Emergin Markets.

"Today the prices of many assets are being held up by unsustainable fiscal and monetary stimulus. Something has to give"

I guess I'm off to a bearish start to the day today.

Why shouldn't I invest in China?

There's an excellent article in the 12 Jan Financial Times on investing in emerging markets...found here. The basic message is that there is no correlation between GDP Growth and stockmarket performance, in fact its slightly negative if anything, so be wary when investing in emerging markets.

According to Professor Jay Rittner of the University of Florida,

"Countries with high-growth potential do not offer good investment opportunities unless valuations are low"

Another interesting point made was that in fast growing economies, the companies that end up winning the race may not even be known yet.

"In the 1950s there were more than 100 motorbike companies. The market leader was driven out of business by the cut-throat pricing of a flaky upstart called Honda"

The conclusion in terms of value is that the biggest emerging economy of them all, China, is in a current bubble and valuations are far from low, in both equities and real estate, where valuation metrics are above what Japan was at its peak in 1990. What is frightening with regards to China's valuations, is that twenty years after Japan's peak, its equity market is still trading around 70% lower.

Bottom line, be careful of investing in Emerging Markets and secondly, don't forget Australia's current reliance on China as any bust could be catastrophic for both our economy and markets.

Current thoughts on some investing risks and themes

We have seen numerous investment trends come and sometimes go over the last X number of years whether it be technology, commerical property, Buffettology, CDOs, high yield, hedge funds, mortgage funds, etc, but at the end of the day a balance of the key investment risks wins through....i.e. the risks relating to equity, liquidity, interest rates, credit, currency, and inflation.

These are my current thoughts on these risks and some investment themes...

• Liquidity Risk - forgotten for many years (particularly by the MTAA Super fund, and mortgage investors...remember Estate Mortgage???) but it still exists...forget chasing returns and having liquidity at the same time!!! Know what liquidity you need and hold CASH...not the so-called liquid Asian High Yield securities Basis Capital used for liquidity or even Enhanced Cash funds...CASH in a bank or pure Cash Management Trust that get's it returns from 11am, government securities, and bank bills.
• Equity Risk...guess what? equity risk doesn't just turn up in...equities! It can also be found in corporate bonds, hybrids, hedge funds, property securities, and many others...it is essential to understand the true equity risk a portfolio has and don't push some of that risk into the more conservative asset classes like fixed interest. Equity risk can be scary, is required for growth, and shouldn't substitute for anything else...like...an inflation hedge!...investing in equities is often a poor hedge to inflation as the 1970s showed...high inflation is not good for equity performance at all
• Interest Rate Risk...too many have ignored this one...but it can work in your favour in a crisis and can provide some portfolio stability...stockbrokers should try them some day...the whole "everything correlates to one in a crisis" is absolute rubbish...during the global financial crisis, those who diversified their portfolio with pure interest rate risk (i.e. little to no credit risk) from boring government bonds or conservative bond funds received double digit returns from this risk. During a crisis, investors run to quality and boring government bonds are just that...why don't retail investors want to invest in quality???
• Credit risk...in times of crisis this is highly correlated with equty risk...as a result when building portfolios ensure your credit securities do not result in overweighting the exposure to equity risks. However, always keep in mind that credit securities have a negatively skewed return distribution...limited upside with massive downside...so why not just invest in equities instead and leave the fixed interest to boring governemnt bonds???
• Currency risks...what's the Australian dollar going to do? Answer...absolutely no idea. So what to do? Being unhedged was favourable during the GFC as Yen carry trades returned to Japan and the flight to safety went to the US (yep....good ol' Australian currency wasn't considered that safe!). So perhaps unhedged is the go...however, the reverse was true in the recovery...market timing is very very difficult so if you don't know, and I don't, perhaps 50% hedged, and 50% unhedged is the go for global share allocations. Its difficult to invest in international bonds without being hedged to the Australian dollar...I guess if you want ot investin bonds for their safety and income then currency risk removes the safety aspect and perhapd hedged is best.
• Inflation risks...this is my favourite...bonds are best during deflation but the only investment that (hopefully) guarantees strong performance during high inflation is INFLATION LINKED BONDS!!! Governments around the world, including Australia, are issuing more...woohoo!...let's get on board and reduce inflation risk from our portfolios. Life companies issue inflation linked annuities also...let's look at them as well.
• Commodities can also can be a good inflation hedge also but they certainly carry a few other risks but are worthy considerations as they provide diversification with other asset classes. The only thing with commodities is...they mostly supply and demand driven!...there's not really much added value there, so...good luck with picking supply and demand!!!
• Hedge Funds...these guys carry equity risk and/or credit risk...when markets crash...SO DO Hedge funds...the marketing myth of positive returns in any market has been exposed by the GFC and there's two other things...its very very difficult to get your money out and their fees are so big that they have to take on significant risk to get the return...but at the end of the day if you don't know how a fund invests you don't know the risks so...don't invest in hedge funds!
• Emerging Markets...all the rage because of their economic growth...guess what...there is no evidence that shows high returns from countries displaying high economic growth. If Emerging markets aren't in a bubble today...they probably will be tomorrow...so proceed with caution. 
• Mortgage funds...they're gone for a long time
• Australian economy...had an amazing run and is the leading economy in the developed world but keep this in mind...we're basically a hole in the ground and reliant upon commodities. If the emerging economies falter and decide to stop buying our commodities then look out Australia...things may not be so rosy...just keep it in mind...and stop being so complacent about the Australian economy...I know you are so stop it!
• Property...I think I need a new Post for this one! Stay tuned

Perhaps House Prices are a bit high in Austraila?

It appears there is a breakdown in the relationship between unemployment and house prices. I hazard a guess that its due to the low home loan interest rates we currently have (see my previous post) but given it appears the Reserve Bank looks like increasing rates further this year, for how long will this breakdown last?...probably not too long...my guess....house price growth is unlikely to be sustained and the property purchaser needs to be careful.

The last 12 months....Australian Government Bond Yields

Certainly an interesting 12 months has transpired in financial markets. The above chart shows the movement in the AUstralian Government Bond yield curve and this time last year the sever downward slope indicated the market was expecting the Reserve Bank to drop interest rates to below 3% during 2009. Clearly that didn't happen but there was a rapid decline down to 3% which was maintained until the last few months.

The yield curve was incredibly steep at 22 Jun 09 indicating an expected strong economic bounceback, however over the last six months the longer term yields have dropped suggesting the economic outlook has subdued a little. What we are left with is still a strong upward looking curve which is a good sign for economic prospects and the market appears to expect continued interest rate rises by the Reserve Bank. However, with a one year government bond yield of approximately 4.25% the expectations of the level of interest rate increases appears to have diminished a little so there's no guarantee of a rate rise in February but a good chance of a 25bps increase in March or April.

A Simple 2009 Review and Outlook piece for clients

The year 2009 has turned out to be a significant turnaround year for the global economy and sharemarkets. At the start of the year, the word depression was mentioned often as many economists, investment professionals and politicians thought entering the world’s second great depression was a potential reality. Thankfully, around March 2009, “green shoots” of the global economy started to appear and whilst they haven’t blossomed into anything too beautiful, we have at least witnessed the emergence of many other “green shoots” that have improved conditions in credit markets, share markets, and in the US some positive signs in their housing market.

Sharemarkets bounce...
For investors in sharemarkets, the year 2008 was one they would rather forget and this continued into the first quarter of 2009 where the S&P/ASX200 index bottomed at the start of March. This was the lowest level for the sharemarket since 2003 but despite a lot of paper talk of the market potentially going lower, as is often the case, when the news out of the sharemarket is at its worst prices start to rise. Although the news continued to be bad it wasn’t as bad as expected and between March and October the S&P/ASX200 increased by almost 60%...an astonishing rebound.

The same was true for global shares despite the US, Japan, and Europe’s economic woes that continue today. For the global share investor, returns were also strong double digits. Unfortunately, for the unhedged investor, which is most of us, the strength of the Australian dollar reduced investors global sharemarket gains and many may well see negative performance for the 2009 calendar year.

Bonds subdued...
The economic “green shoots” that contributed to the increase in sharemarkets from March of this year also contributed to increases in interest rates. Unfortunately for the bond investor, an increase in interest rates results in the decline in the value of bonds. For the local bond investor the strength of the Australian economy resulted in some of the strongest interest rate rises in the world and overall returns for Australian bond investors may well be flat. Global bond investors have fared a little better as the overseas economies have struggled significantly more than in Australia and interest rate movement has been minimal to negative. As a result global bond investors may see annual returns between five and ten percent.

Economic Landscape...
The Australian economy has certainly fared very well compared to the US, Europe, and Japan and this is largely due to three main factors:

1. Strength of our banking system which is significantly more conservative than some of the largest banks in the world
2. Strength in our commodity export sector and geographci position close to Asia. This has provided the ability to leverage from the significant growth in China
3. Strength of our government’s balance sheet who in the good times had budget surpluses allowing these savings to be used for the tough times that turned out to be the global financial crisis

Looking forward it is near impossible to know how investment markets will perform but indications are that overall the global economy will be slow as global households continue to reduce debt and high levels of unemployment (which are expected to still rise) provide a drag on consumer spending. Whilst the global economy is improving there remain significant risks as evidenced by the default in its debt payments by Dubai World. Credit markets are far from normal and this is a strong indication that full recovery is a long way off yet.

In Australia, markets have priced in further increases in interest rates by the Reserve Bank with another 0.5% of rises expected by March or April 2010. Rising interest rates is a sign of strong economic conditions so with a bit of luck if there are no further economic shocks there is a stronger sharemarket into the first half of 2010. Given the volatility of sharemarkets this is far from a sure thing but on the positive side, we are coming from the worst global economic conditions since the Great Depression and we are still a long way off our sharemarket highs which were reached in November 2007.

Dubai World Default

Early signs in the US are that the Dubai World default may not really mean too much. Sure US Stocks fell by more than 1%...which isn't too uncommon nowadays...but conversely, US Bond Yields are up suggesting there isn't too much "rush to quality". Time will tell but I'd suggest this is quite a tame reaction.

Nouriel Roubini, famed GFC forecaster, apparently believes this may be the first of more sovereign defults...if so, then that's a different kettle of fish. But at this stage...the US markets aren't convinced.

Krugman says US Fed's Cash Rate ideally should be minus 6.7%

My favourite Nobel Prize Winning economist's article can be found here…This is quite an astounding conclusion but not too far fetched given the evidence. What really concerns me is that whilst the US Cash Rate ideally should be much lower, our Reserve Bank and (judging by the Yield Curve) our markets envisage significant cash rate hikes over the next 12 months….mmm…do you think we Australians are being just a little optimistic about our growth potential or expectations given the clearly disastrous economy of the US (& Japan,  UK, Euro zone etc)?

State of the US Economy

For a fascinating outlook for the US Economy and property sectors, Federal Reserve of San Francisco's Janet Yellen's 10 November speech is a must read. Access it here.

Australia's unemployment creeps back to 5.8%

With the government downgrading its June 2010 unemployment expectation to 6.75% it appears we will be creeping there slowly given we have been around 5.8% for much of the last 6 months. This is largely thanks to a drift from full time to part time employment and of course the downside is that on average we are working much less and therefore earning less.

The number of unemployed persons in Australia is now 669,000 (increasing by 34.3% over the last 12 months) and this is the highest since late 2001. From an Australian perspective, we must be thankful thta we are no where near the horrific unemployment levels of the US at 10.2%...things must be very tough there with small signs of recovery but most economists believe that US recovery will exclude employment growth.

Economic Growth does not mean High Equity Returns

One of the more frequent queries I receive is from planners who want to invest their client's funds into high economic growth countries of India, China, and emerging markets. My response is fairly standard in that I wonder why they believe that would provide their clients and the response is typically along the lines of "their growth potential is greater than the rest of the world".

Last week, one of my favourite bloggers, Buttonwood (The Economist), provided commentary on this phenomenon, titled "The Growth Illusion". I know I'm doubling up and perhaps you can read it yourself but in essence, "the faster an economy grows does not mean the faster corporate profits grow and therefore the investor receives higher returns". A study performed performed by Dimson, Marsh and Staunton (they're a few academics involved in the production of Credit Suisse's Global Investment Returns Yearbook this year), showed that there was in fact a "negative correlation between investment returns and growth in GDP per capita, the best measure of how rich people are getting"...so no go there.

A second study showed that the better returns from 1990 to 2005 did not come from the highest growth economies. And a third study showed "no statistical link between one year GDP growth rate and the next year's investment returns".

Another study by Paul Marson of Lombard Odier, showed there is no correlation between GDP Growth and Stockmarket returns of Emerging Markets.

The most likely reasons for all of this rests with a few reasons stated in the Buttonwood blog...

• the potential is already recognised and factored into prices so that they are bid up to very high levels
• the stock market does not represent a country's economy and vice versa
• "growth is siphoned off by insiders at the risk of shareholders"

The best recent example I can think of is China. It may have had one of the best growth rates in 2008 but the sharemarket still crashed by 70%. With all of this good news flowing through for the month of August China's stockmarket was still down 20% (albeit up by 70% beforehand). Maybe investing in a growth economy will produce the good or maybe it won't, but as the first point above alludes to...everyone knows this so why wouldn't it already be priced in?

Yield Curve looking Good...is it too good?

As the above chart shows, the Australian government yield curve has been steepening ever since the end of last year. This yield curve is a good indicator of the future strength of the AUstralian economy. As it shows, during June of 2008 the curve was negative (i.e. sloping downwards) and worst case scenario, is that a negative yield curve signals potential recession as there is no premium for long term rates like you would expect. Right now, 5 August, the curve is incredible steep with current interest rates at 3% and 5 year government bonds yielding around 5.5%. This curve indicates there is only one direction for rates to go and that is up...and that is only likely to occur if the economy is strong.

There is no doubt the outlook for the Australian economy and global economy) has improved in recent months, but the speed of the improvement, whether sharemarkets or the strengthening of the above yield curve, has been startling. Whilst yields aren't what they used to be, has this rapid improvement been to fast, so is there a short term opportunity for bonds? If not, then can this yield curve get steeper?

How many bank failures?

Just back from holidays with a week off...anyway...another couple of bank failures in the US...First Piedmont Bank, Winder, Georgia and BankFirst, Sioux Falls, South Dakota ...these
are the 54th and 55th banks to collapse in the US since the start of this "Great Recession".

Other interesting US economic points of note...

• The state of Michigan (home of the US Car Industry) has the highest unemployment in the US at 15.2%; Rhode Island has the second highest unemployment level at 12.4%
• FOMC (a component of the Federal Reserve) staff revised up its projection for the increase in real GDP in 2010, to a pace above the growth rate of potential GDP. As a consequence, the staff projected that the unemployment rate would rise further in 2009 but would edge down in 2010. Meanwhile, the staff forecast for inflation was marked up.
  

Hedge Funds vs Banks

Whlst hedge funds have their problems, thanks to lack of transparency, high fees, etc; lets never forget that hedge funds did not cause this global financial crisis...banks did

Is there value in inflation linked bonds?

The RBA provides daily reporting on three Treasury Capital Indexed bonds. They each mature in the month of August in 2010, 2015, and 2020 and are currently yielding 2.40%, 3.11%, and 3.02% respectively as at 30th June 2009. If we compare these Capital Indexed yields to the Treasure Fixed Rate yields for similar maturing securities we achieve the market's estimation of inflation over the term to maturity.

The yield of the Treasury Fixed Rate Coupon Bond maturing August 2010 is 3.45% indicating the expected inflation through to August 2010 is 1.05% (i.e. 3.45% - 2.40%) which is clearly very low.

Applying the same logic using April 2015 and April 2020 Fixed Rate Bond yields of 5.32% and 5.62% respectively we achieve an inflation outlook of 2.21% and 2.60% over each respective term.

The inflation outlook is:

• 1.05% to August 2010
• ~2.21% over the next 6 years to 2015, and
• ~2.60% over the next 11 years to 2020

Whilst I agree that inflation is likely to be relatively low over the coming years, for the fixed rate investor, inflation will always be a significant risk. If you invest in a government bond yielding 5.62%pa over the next 11 years high inflation could easily wipe out any value in this type of investment. As a result, despite, these subdued inflation outlooks, there appears to be significant long term value in inflation linked bonds whilst yields appear to be at historically low levels and also whilst the outlook for inflation appears low.

The risk for the inflation linked bond investor is that inflation turns out to be even lower than the above-mentioned forecast...if you think inflation will be lower than stick to the fixed rate bond, otherwise inflaiton linked bonds are definnitely worth serious consideration.

US House Prices

Source: www.calculatedrisk.com

I last published this chart two months ago and the trend has not abated. US House prices continue to decline and are currently around February 2003 levels. Include inflation and the housing prices are even lower.

I guess some of the lessons in this include:

• never take increasing house prices for granted like many of us do in Australia
• household wealth in the US continues to decline whilst their biggest asset continues to decline in value
• the economic crisis is not over yet

With continued declines this will probably mean more people defaulting on their loans and more problems for the US banks. Whilst a handful of banks have paid back some of their TARP money there are still a few that haven't yet. This housing problem is part of a vicious cycle that needs to stop so hopefully the fiscal stimulus in the US will kick in soon.

Paul Krugman on the GFC

Whilst the following statement from Paul Krugman is taken from a debate on how to deal with the global financial crisis and is quite a few weeks old. It still applies and is an excellent description of the current state of the Global Financial Crisis and why interest rates should stay relatively low despite massive budget deficitis from governments around the world...

Let's think about what is actually happening to the global economy right now. On the one side there has been an abrupt realization by many people that they have too much debt, that they are not as rich as they thought. US households have seen their net worth decline abruptly by $13 trillion, and there are similar blows occurring around the world. So the people, individual households, want to save again. The United States has gone from approximately a zero savings rate two years ago up to about 4 percent right now, which is still below historical norms; but suddenly saving is occurring.

That saving ought to be translated into investment, but the investment demand is not there. Housing is flat on its back because it was overbuilt; housing bubbles collapsed not only in the United States, but across much of Europe. Many businesses cannot get access to capital because of the breakdown of the financial system. But even those that do have access to capital don't want to invest because consumer demand is not there. Between the housing bust and the sudden decision of consumers to save, after all, we have a world with lots of excess capacity. The GDP report that just came out says that business-fixed investment, non-residential fixed investment, essentially business investment, is falling at a 40 percent annual rate.

This causes a problem. There are lots of people who want to save, creating a vast increase in savings, not only in the US but around the world, combined with a sharp decline in the amount that the private sector is willing to invest, even at a zero interest rate, or rather even at a zero interest rate for US government debt, which is what the Federal Reserve has the most direct impact on.

One way to think about the global crisis is a vast excess of desired savings over willing investment. We have a global savings glut. Another way to say it is we have a global shortage of demand. Those are equivalent ways of saying the same thing. So we have this global savings glut, which is why there is, in fact, no upward pressure on interest rates. There are more savings than we know what to do with. If we ask the question "Where will the savings come from to finance the large US government deficits?," the answer is "From ourselves." The Chinese are not contributing at all.

Those extra savings are, in effect, the savings that America has wanted to make anyway, but that US business is not willing to invest under current conditions. That is the way Keynesian policy works in the short run. It takes excess desired savings and translates them into some kind of spending. If the private sector won't do it, the government will. There is actually no contradiction between the Federal Reserve's actions and the actions of the US government with a fiscal stimulus. It's very much necessary to do both. By buying a lot of private securities, the Federal Reserve is essentially going out there and playing the role that the private banking system is no longer playing properly; by engaging in investment, the federal government is playing the role that businesses are not now willing to play. All that debt-financed spending on infrastructure by the Obama administration is basically filling the hole left by the collapse in business investment in the United States. There is not an excess demand for savings that is going to drive up interest rates. The only thing that might drive up interest rates—and this is a real concern—is that people may grow dubious about the financial solvency of governments.

Now, the great concern I have is that although we understand these things fairly well, there are thirty-eight Republican senators who say that the answer for the crisis is another round of Bush-style tax cuts that will reduce revenues by $3 trillion over the next decade.

This crisis has been so large and the political process has been so sluggish that the difficulties have been greater than expected. And yes, there are some green shoots. Things are getting worse more slowly, but we have not managed to head off a crisis that could turn out to be self-reinforcing, and leave us in this trap for many, many years.

We are a little isolated in Australia and there's little doubt we are positioned better than other countries around the world, but at the end of the day we are part of the global economy still in crisis so we should not be complacent and think all is well. For what its worth, in my opinion we have a long way to go yet. Markets have been responding sharply to the slightest bit of good news but whilst the crisis was created over many years, it will not be over in just a few months. Hang on for a rollercoaster ride.

A simple economic/financial update for some planners

Over the past few months the global economy has seen the emergence of “green shoots”. As implied, there are indications that the global economy may be turning a corner. Like turning around a super tanker, turning around the global economy will take a long time and these signs aren’t so much an improvement but indicate a slowdown in the deterioration of the global economy. For example, in the US only 345,000 jobs were lost during May which is around half the average monthly decline of the previous six months. US Unemployment is still increasing but not at the rate it previously was.

Other positives include the gradual decline in the cost of credit (remember the Global Financial Crisis started as a credit crisis), stabilising financial markets, perceived future demand resulting in increasing commodity prices (Oil increased by 48% in USD terms over the past 3 months), and improving consumer confidence.

In Australia, our unemployment stands at 5.7% and the Australian Bureau of Statistics announced that we avoided a technical recession to the quarter ending March 2009 with positive real GDP Growth of 0.4% thanks to declining imports.

For the Australian sharemarket investor, returns for the 3 months ending May 2009 have been spectacular with the broad All Ordinaries Accumulation index increasing by a little more than 17%. Overseas sharemarkets also provided strong returns and the major sharemarket indices of the US, UK, and Japan increased by 25%, 15% and 25% respectively. With the Australian dollar appreciating over the same 3 months against the US Dollar, Pound, and Yen, by 25%, 11%, and 22% only the hedged international investor experienced the strong international gains as the strength of the Aussie dollar most of these returns.

The perceived improvement in the global economy combined with large budget deficits all around the world including here in Australia, government bond yields increased substantially. This means that investment returns for the bond investor were relatively weak (as high interest rates mean lower bond prices). The UBS Composite Bond index had a slightly negative return of -0.6% for the 3 months to May 31, and the global fixed interest index, JP Morgan Broad WGBI (AUD) Hedged Index, returned only 0.43%.

Whilst the short term sharemarket gains indicate positive signs for both the Global and Australian economy, there are still significant signs of weakness. Unemployment both here and overseas is still increasing which will continue to dampen demand and force households into increased savings instead of spending. Business investment is weak and companies continue to struggle, as evidenced with the recent collapse of General Motors and Chrysler in the US, and two of the largest agribusiness companies in Australia, Timbercorp and Great Southern. The last few months have shown the risks of being out of the sharemarket when everything appears to be at their worst. For investors, sticking to a portfolio with the risk profile designed to help achieve financial goals is essential.

Australia's Steep Yield Curve

An incredible steepening of the yield curve has occurred throughout 2009. As can be seen the latest 10 year bond yield isn't too far from where it was in the middle of 2008. This yield curve tells us several things about the state of current markets and economy...

• the market is starting to think that the next RBA move will be an increase in interest rates and not a drop...the 3 month yield is only 2.95% versus the 3% cash rate and longer term yields are above 3%
  
• The steep normal looking yield curve is typically a sign that Australia's economy is looking up and this steepening has increased throughout the year in line with increasingly positive news
  
• The sharp increase in steepness has happened so quickly....does this mean that bonds are oversold?

Overall this is a good looking positive yield curve despite global economic news continuing to be mixed. We are still in the 'green shoots' phase of a global economic recovery so this steep yield curve looks to be a relatively attractive buying opportunity to me.

Today's RBA Rate Prediction

The current September 2009 government bond is yielding 2.77% indicating the market is expecting (most likely) only one more 25bps rate reduction over the next few months. Most economists expect the RBA to stay steady today and given the RBA reduced rates last month by 25bps I also expect it to stay steady as they have indicated in the past their desire to see how their actions are received before reducing again.

The budget is only one week away and it may be packed with enough goodies to provide the economy with a boost but no matter what, the global problems will still overwhelm the Australian government's action so there's a long way to go. With inflationary expectations still very low, I see no reason why the RBA shouldn't cut rates, but I still expect a 3% cash rate tomorrow.

US House Price Data...down again

Because the current global financial crisis started with declining US House prices many believe that it will finish with improving US House prices. The primary index used in the US that assesses house price movement is the Case-Shiller Composite Index. As can be seen unfortunately the plummet in prices continued in February and prices fell to 2003 levels.