Want to boost expected returns on fixed income? Here’s how

It’s been published everywhere, we’re all aware of it. Retirees and savers can’t stand it, borrowers can’t get enough of it. I’m talking about interest rates.

Today, nominal interest rates are below zero in many countries, including Germany, Denmark, Switzerland, Sweden and Japan. The common belief that zero is the lower bound for rates have been turned on it’s head. Contrary to what the financial media are publishing, negative real returns across countries have been quite common.

Why are real rates of return important?

In 1975, a loaf of bread cost 24 cents. A litre of milk cost 35 cents (more for soy), and petrol cost 57 cents a litre. Today, a loaf of bread costs $2.84, a litre of milk costs $1.45 (almost $5 for Bonsoy!), and petrol costs $1.20 a litre.

Source: McCrindle

It’s simple, when the prices of goods and services increase, consumers can buy fewer of them with every dollar they’ve saved. This is called inflation, and it eats into investors’ returns.

When financial boffins talk about real return, they’re talking about returns adjusted for inflation. This is super important, because inflation affects our cost of living, investors must consider the inflation-adjusted, or real return of their investments. When inflation outpaces the nominal returns on an investment, investors experience negative real returns and actually lose purchasing power.

A brief history lesson

Exhibit 1 shows the annual real returns on one-month US Treasury bills. From 2009 to 2015, the annual real return was negative. This circumstance is not unprecedented. Since 1900, the US has had negative real returns in over a third of those years. And negative real returns on government bills are not exclusive to the US. All countries listed in Exhibit 2 have had negative real returns on their respective government bills in at least one out of every five years from 1900 to 2015.

If you think Australia is immune to this theory, think again folks. Australia experienced negative real returns 36% of the time!

Please sir, I want some more

I get it, rolling over short-term deposits/bills doesn’t seem appealing, and rightly so. Exhibit 3 shows that the return of one-month US Treasury bills has not kept pace with inflation over the past 10 years. But even when the real return on bills is negative, a relatively common occurrence, bond investors may still achieve positive and much higher expected real returns by broadening their investment universe.

The bond market is composed of thousands of global bonds with different characteristics. Many of those bonds allow investors to target global term and credit premiums, which in turn may provide positive real returns even in low interest rate environments. Exhibit 3 also shows that the Barclays Global Aggregate Bond Index has outpaced inflation while maintaining low real return volatility of 3.4% annualised over the past 10 years.

Global diversification is often thought of as a tool for reducing risk. However, when it comes to fixed income, global portfolios can also play an important role in the pursuit of increased expected returns. Even if the expected real returns of bonds in one country are negative, another yield curve may provide positive expected real returns. The flexibility to pursue higher expected returns by investing in bonds around the world can be an important defence against low, and even negative, yields.

The end game

The goal of many investors is to grow some (or all) of their savings in real terms. Even in a low interest rate environment, there may be bond investments that can still achieve this goal. In particular, investors who target global term and credit premiums should be better positioned to pursue higher expected returns.

Source: DFA

Here’s where the Aussie property market is at

My parent’s are looking at selling their family home with the intention to downsize. It’s the typical story, they’re reducing work hours, house is too big, and there’s a bit of equity tied up in the family home. We’ve spoken to a couple of the primary agents in mum and dad’s area, who do a good job in keeping us informed of what’s going on in the property market (and of course it’s always going well, right?).

Anyway, Melbourne hosted 1,179 auctions over the weekend, higher than last week’s 1,114, but down from 1,398 a year ago, down about 15%. Clearance rates continue to remain quite strong at 79%.

You can see from the chart below, the number of auctions have been rising, although weaker from this time last year. So too has the clearance rate, creeping back up to the 80% mark.

Source: CoreLogic

Here’s the latest national data. Perth and Brisbane putting some pressure on the solid numbers in Sydney and Melbourne.

Source: CoreLogic

This information is encouraging for mum and dad. There is plenty of supply on the market and people are buying. Let’s take a look at what people are paying these days. Here’s Melbourne’s median house and unit/apartment prices since 2006.

Zooming out to take a national view point, here’s the annual price change across all capital cities. As you can see, Sydney is an obvious standout. Strip Sydney out of the equation, and the rest of the country is hardly as strong as the commentary claims. Then again, anyone can slice and dice the data to support their case.

Source: CoreLogic, AMP

You don’t need to search very far to find the latest commentary on why Australian property prices are overvalued. There is ample research to support this theory. Here’s a simple yet effective valuation method of Australia’s house prices, relative to their long-term trend. Please note this is in real terms, that is, taking into account inflation.

Source: ABS, AMP

So we’re sitting above our long-term trend. I don’t think this should come as a surprise to anyone. Markets can remain overvalued and undervalued for long periods of time for various reasons.

Higher prices have gone hand in hand with higher household debt. In fact, over the last 25 years, Australia has gone from a debt to income ratio from the low end of OECD countries to around the top. Although, interest paid is down to the lowest rate since about 2004.

What has caused higher prices?

Of course, lower rates have encouraged investors to turn to property, so too has the uncertainty in the global economy. Having said this, we cannot forget the fundamental driver of prices, supply.

We hear so often about oversupply danger. The over supply in apartments. In fact, the RBA only last week highlighted pockets of danger for the Australian economy, one of which being oversupply danger in apartments.

Since 2009, apartment approvals have sky rocketed, pushing private residential building approvals to nosebleed territory. Detached housing however, flat lining since 1991 with a few bumps along the way.

Even pulling the data period out further, we can see detached housing has been treading water for the last 33 years. So too have apartments, until 2009.

Source: ABS, AMP

Going out even further really puts the high rise construction boom into perspective. What goes up must come down.

Source: Peter Wargent

Are we building more and more of the stuff that people don’t want, notwithstanding the fact that they are selling. Is this part of the problem that is causing the price of detached housing to sky rocket?

Taking a look at the data, we continue to supply a fundamental supply issue – although well and truly down from its peak in 2014 of 100,000 dwellings. Current data suggests we won’t hit ‘oversupply’ territory until 2017/2018.

Source: ABS, AMP

Is there a crash coming?

Yes folks, there is. When? Who knows. In short however, I reckon there will be a few triggers: 1) Oversupply. We’ll need to see the current rate of construction continue for a few more years. As we discussed earlier, current figures don’t see this occurring for a couple more years. Furthermore, supply is being created in the apartment market and not detached housing. 2) A recession. We then need to ask ourselves, what will cause a recession. 3) Higher interest rates. I don’t think we need to spend too much time on this one.

Is property a sound investment?

To date, property has been a solid investment. More recently however, we’re seeing rental yield’s dropping dramatically, which means the real cash return from these investments are looking less and less attractive.

The price investors need to pay today to get into the property market is clearly much higher than it has been before. Like any asset class, to expect growth rates to continue in the short-term as they have for the last few years will be foolish.

Investors need to ensure their portfolios are diversified. Naturally, Australian’s have a large allocation to property, in fact around 60% of their wealth.

Over the long-term however, Australian residential property has returned around 11% pa, very similar to Australian shares, in fact with lower volatility that shares. This is probably because it’s not valued as frequently as shares.

Source: ABS, REIA, Global Financial Data, AMP

For mum and dad, the current situation is quite opportune, although it won’t last forever. We’ll no doubt see a correction, which may drag down the price of their home 15%, 20%, who knows. Although I don’t believe this will be the case in the immediate short-term. Enough time for them to sneak in a sale I reckon.

According to dad however, property never goes down. Maybe because like all good investors, he doesn’t look at the value every second day.

How the US stock market performs in election years

For most folk, the end of the 2016 US elections cannot come any sooner. Then again, I’m sure most folk can’t wait for the next presidential election either…if you know what I mean. Although the outcome of the election is uncertain, what is certain is the speculation that will continue between now and then as to the impact on the stock market and investor portfolios. Before we start getting too caught up in what might happen, let’s take a look at how markets have performed historically.

Typically, the stock market has a positive return in election years. In fact, 82% of the time.


Here’s a summary of the average returns for the US stock market during presidencies since Hoover.




Can you detect a pattern? Okay, let’s keep going.

Let’s look at it a little differently. Here’s the growth of $1 invested in the S&P 500 back in 1926 through to June 2016.


Did it really matter who or which party was in power over the long-term? Sure, you might ask who has a 90 year time frame? Take a look however at any 10-20 year rolling time frame, my guess is that the odds are in your favour for a positive return.

Although returns tend be to positive at the outset of a presidency, they climb throughout a president’s fourth years. The president may attempt to pass most legislation in the first two years when a perceived ‘mandate’ follows an electoral victory. If legislation doesn’t pass in the first two years, it will almost never get through in the back half of the term. Fourth years aren’t quite as strong as third years, but are still overwhelmingly positive.

Here’s the percentage of positive versus negative returns in each year of presidency.


Clinton and Trump are probably the most disliked candidates in history. Does that mean this time is different? Let’s take a look at history from a different angle.

The chart below shows the frequency of monthly returns (expressed in 1% increments) for the S&P 500 Index from January 1926 to June 2016. Each horizontal dash represents one month, and each vertical bar shows the cumulative number of months for which returns were within a given 1% range (e.g., the tallest bar shows all months where returns were between 1% and 2%). The blue and red horizontal lines represent months during which a presidential election was held. Red corresponds with a resulting win for the Republican Party and blue with a win for the Democratic Party. This graphic illustrates that election month returns were well within the typical range of returns, regardless of which party won the election.



Short-term trading

Trying to outguess the market is often a losing game. Current market prices offer an up-to-the-minute snapshot of the aggregate expectations of market participants. This includes expectations about the outcome and impact of elections. While unanticipated future events—surprises relative to those expectations—may trigger price changes in the future, the nature of these surprises cannot be known by investors today. As a result, it is difficult, if not impossible, to systematically benefit from trying to identify mispriced securities. This suggests it is unlikely that investors can gain an edge by attempting to predict what will happen to the stock market after a presidential election.

Long-term investing

Predictions about presidential elections and the stock market often focus on which party or candidate will be “better for the market” over the long run. The chart above shows us the growth of one dollar invested in the S&P 500 Index over nine decades and 15 presidencies (from Coolidge to Obama). This data does not suggest an obvious pattern of long-term stock market performance based upon which party holds office. The key takeaway here is that over the long run, the market has provided substantial returns regardless of who controlled the executive branch.

Bringing it all together

Equity markets can help investors grow their assets, but investing is a long-term endeavour. Trying to make investment decisions based upon the outcome of presidential elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, in order to pursue investment returns.

Whether it’s the US presidential elections, Brexit, European elections, IS, risks will always be present. If there were no risk, you should not expect to be compensated. The stock market is not a place for those who cannot stomach short-term volatility, rather, for those that can see the compelling long-term evidence. Warren Buffet once said, “The stock market is a device for transferring money from the impatient to the patient”.

Source: Visual Capitalist, Dimensional Fund Advisers

The biggest regret I don’t have

I love my job. I wouldn’t even call it a job. A hobby? Not yet. However, I genuinely wake up each and every morning looking forward to the day ahead.

It’s something I’ve wanted to do for a long time. To build a boutique wealth management company dedicated to advising a small, select group of clients. The decision to set up my own firm was not a financial one. Sure, money is important, but it wasn’t the primary driver. The challenges, the possibilities, the sense of achievement. It’s all there, waiting for whoever wants to take it on. It’s something I didn’t want to look back on and have the “what if…?” question repeating over and over in my mind.

In my line of work, I’ve met and learnt from so many inspiring people with so much life experience. Enough to help me make better decisions not only for myself and my family, but in the discussions and advice we give clients.

Over the years I’ve listened to countless stories filled with success, achievement, disappointment, and even regret. I’m not sure whether this is surprising or not, but I’ve found when people reflect on their biggest regrets in life, they more often than not regret the things they didn’t do, not the things they did.

In fact, the results of a US national survey showed inaction regrets lasted longer than action regrets, and that greater loss severity corresponded to more inaction regrets. They also found that regrets more often focused on non-fixable than fixable situations. The survey found 13 common sources of regret. They are, in order: romance, family, education, career, finance, parenting, health, “other,” friends, spirituality, community, leisure, and self.

A little while ago, Jim Wagner, a writer, shared his biggest regret in life. Here’s what he said (via Quora):

Jim’s biggest regret

I’m 43. I regret not choosing to spend more time with my parents, in my twenties. I lost my mother in 2000, and I feel the loss of the friendship we never had.

She was very demanding, very strict, and from the perspective of a young man, very unreasonable.  It turned out, as I live through middle age, that most of the ideals I have today ended up being the ones she put on me.

Sometimes, after a setback, I feel the impulse to call her, and in the second or so that it takes for me to realize she isn’t alive to speak to any longer, I realize how much I still need her.

You cannot negotiate with death. It is final, often sudden, and personal.  The last night I had with her, at a hospice in Chicago, I was exhausted and asked her if she minded if I went home. She immediately whispered that absolutely, I should rest, and to be careful driving home. I curled her fingers around the nurses call button, and kissed her on the forehead. I remember I felt some relief that I was leaving.

I know it didn’t make a difference, leaving at that time, or leaving a few hours later. She was going to die either way. But reflecting on that moment today I know then that I didn’t understand how precious those minutes were, and how a door was being closed that would never open again.

There are many questions I would ask her now. I would want to know more about her immigration to the US from Peru. I would want to know about the time she spent in D.C. at George Washington University. I would want to know more about her dreams, her fears, and I certainly would do all I could to enable the simple pleasures I know she enjoyed.

I still have my father. He is 80. I’m lucky to have such an honest and decent man as my father and friend. When I was in my 20’s, I remember sometimes being annoyed at his stories. I wanted the subject to be about me, or things that interested me, or I just wanted to get away from him and spend time with my friends, or a woman I was seeing.

I have a second chance, so to speak. I listen to his stories. And the truth is, when he’s delivering the punch line on a humorous episode from his Marine Corps days in the early 50’s, even though I know the exact words he’s going to say, I enjoy hearing them again.

I don’t hesitate to tell him I love him. I don’t hesitate to share with him the disappointments I’ve experienced, or the difficulties in raising teenage kids. And I have a lot of questions too.

I know he will be gone soon. There will be no negotiating with how and why, or when, he passes. Because we both have developed the respect, trust, and enjoyment that comes with friendship, I will have many more memories to replay and pass on to my children.

For that, I am grateful.

So what?

We’ve all been faced with the harsh reality of life. Personally, the mortality of life motivates me. It’s a reminder that every single day we’re presented with options. We have the power to choose the path we wander down. But without goals, without direction, without clarifying what’s important to us in life, we could be wandering around aimlessly for a long time.

Set yourself goals. Write them down. Even if you don’t know how it’s going to happen, knowing what you want to happen and why, will help it become a reality. It also helps you set a benchmark to track your progress. Once you start ticking off some of the things that are really important to you, it’ll motivate you to keep going.

You can fear failure, or you can fear regret. The choice is yours.

Brexit – Hard or Soft Landing? Here Are The Options

As the Prime Minister of the UK, Theresa May, turned the heat back up on the topic of Brexit by advising the UK would trigger Article 50 by April 2017, the speculation resumed.

They rang the recession bell prior to the referendum, nothing but gloomy forecasts were printed, and the stock market took another dive as volatility increased. Here’s how Brexit shook up the stock market relative to other major events in the last few years:

Okay, so the stock market overreacted – what’s new?

Here’s a snapshot of how the economy was running post Brexit in 9 charts:








budgetdeficit     pmi

More people are working, they’re spending money, tourism is being boosted by a weaker pound, the deficit is shrinking, stock market is up, household confidence is higher, and inflation has slightly picked up. Having said this, survey’s point to a shrinking economy, although we’ll know more later this month when the GDP is released.

Although the outcome of the Brexit vote is certain, what is still uncertain is the impact this will have on the UK’s economy post exit from the EU, which, if there are no delays or extensions to the process, will happen by April 2019.

The question that is now being asked, is whether the exit will be a ‘soft’ or ‘hard’ landing. Remember the China soft/hard landing debate? Yes, the same one that is still going. Well, we can add the UK to this debate.

HSBC put out a great table explaining the difference between soft and hard landing. Here it is:

In the end, HSBC believe it comes down to whether the UK are able to maintain a high degree of tariff-free access to the single EU market.

Of course no one knows what will happen and what the impact will be, although many speculate. It’s an exercise we’ve never seen before. We’ll know more as 31 March 2017 approaches.