How The World’s Most Boring Investment Could Rock Stock and Property Markets

For mine, watching the bond market is on par with watching budget night on the box. You know its important but it can be a tad boring. In fact, it’s about as exciting as watching paint dry sometimes.

However, that may change very shortly. The bond market could well become an excitement machine and the center of the investment universe. The knock-on effects for stock and property markets around the world could be significant.

But first, what is a bond?

A bond is a ‘debt’ investment in which an investor lends money to an entity (typically the government, treasury or a corporate) in return for a fixed rate of interest.

Think of a term deposit (TD). Investors lend money to the banks for a fixed term at a fixed rate. The only difference is bonds can fluctuate in price. But like TD’s, bonds are generally regarded as one of the safest forms of investment.

Oh so boring, but oh so safe.

The Impact on Stock and Property Markets

In the past fortnight, US Bonds (30 year Treasury bonds to be exact) have started to creep up and are now beginning to drag other bonds around the world with them. For example, in Australia, 10 year Treasury bonds have recently crept up from 2.23 to 2.85%. Quite attractive hey?

So why haven’t we heard more about this? Well, because they haven’t made a big enough dent in the investment universe, yet.

In the meantime, consider this juxtaposition.

An increasing number of rental properties in Sydney now only have rental yields of between 1-2% (after expenses) compared with 10 year bonds which are almost yielding 3% (with much less risk).

If bond yields continue to rise and offer better returns than shares and property, especially in an overheated property market, what do you think investors will do?

That’s right, they’ll switch out of stocks and property into bonds.

The last time we saw bonds have this sort of impact on the markets was in 1994. I remember it well. I had just finished Uni and was at home working like a dog in Mum and Dad’s hotel.

(Up at 4.30am, open 7am, close 12am, 7 days a week. Didn’t even get to my Uni graduation. But gee I learnt plenty).

Anyway, that year US 10 yr bonds went up 2 percentage points and Aussie bonds went up 3.5 percentage points in 10 months. Consequently, our stock market dropped 21% during the same corresponding period.

Comparatively, we were not in a low interest rate environment back then either, which only accentuates the knock-on effects this time around.

The 7 Year Itch

Now watch this.

In 1987, 1994, 2001, 2008 the market corrected by at least 20% in each year. Can you see the pattern? It corrected every 7 years. Got a bit itchy. Now what’s 2008 plus 7?

You got it. That wiped the sleep out of your eyes didn’t it!

And don’t think the property market is immune to this stuff either. 40% of buyers in the Sydney market right now are investors. And because they’re not as sticky as home owners, they’ll be off like a robber’s dog the moment they can get a better yield somewhere else.

So here’s the rub. It may not be long before bonds have some serious spunk factor about them again. And if you think they won’t get the attention of stock and property investors, just watch. A good looking bond can turn heads and move markets in a heartbeat.

Have a great week!

Adam

Back paddock – In case you’re wondering, there are two reasons why I elected not to do a budget review this year:

I. Almost every major announcement was leaked last week.

II. Given the number of back-flips and broken promises to come out of last year’s budget, I couldn’t see the point.

However, one thing is for sure. If Bill Shorten continues to block supply in the senate, don’t be surprised if we go back to the polls for a double dissolution.

But if you still have a budget question you would like to discuss, give me a call. Maybe we could catch up for a coffee and watch the paint dry together. Better still, let’s check out a few bonds.

P.s. thanks to all those for the lovely words re last week’s Moowsletter – For Mother’s Only. Very kind.