Student Email - June 09

Dear Tony

Greenshoots or not, there has been a profound change since March this year, vindicating the position that we have been taking, that 2009 will be the “Year of the Equities.” (Our detailed reasoning is in the paper of the same name that has been loaded to the LPAC website and is available for download from the home page).

In this month’s email we provide some important LPAC news that will be relevant to all past and present students, and then we cover the big debate for 2010 – why 2010 WON'T be the “Year of the Bonds.”

Some of you may have followed my product reviews, which I have been filing in the AFR Online for the last 18 months – these are all available for download now on the LPAC website, www.LPAConline.com.au, then click on “Research Article” in the menu bar.

Alan Kohler has been kind enough to ask me to write for the Eureka Report and I started a weekly “Investment Review” column 4 weeks ago. In that column, I will be unashamedly exposing the good, bad and ugly. What you don’t get from typical research houses, you will get in my weekly review! Macquarie were livid with my review of their Flexi 100 product, which I rated 1 star… compared to the far higher ratings given for products from Westpac, CBA and ANZ. (To ensure impartiality, I don’t write about products that I am involved with, or benefit from)!

You can set up a FREE test drive of the Eureka Report by going to www.eurekareport.com.au. Although Alan has a reputation for sledging advisers, his reports on investments are normally spot on and are read by many of your clients.

To further improve communications with you, I have set up a Twitter page, and by subscribing to Twitter you will get quick and simple notifications of my latest Twitter updates: see www.twitter.com/TonyRumble. When you get there, just click on the “Follow” button under my picture.

Now to the BIG issue for 2010 – the big wealth destroyers will be bond funds. Buying bonds directly is hard for most retail investors but hybrids are a great way to enjoy high returns for relatively low risk (but use your LPAC studies to evaluate the best of these). I will be writing more on this topic in coming weeks but for now you can get the gist of the argument from the following analytic supplied to me by William Keenan of Lonsec:

“I think the rise in bond yields has the potential to turn nasty.

Consider the US Govt has yet to even ramp up its bond issuance to fund the $1.7 trillion deficit.

My belief is that the Chinese, Japanese and Russians are wary of buying anything longer than 5 years. Yes they are buying US treasuries but only short-term paper where they can be sure of getting their money back and limit any potential losses from falling USD and rising bond yields. Investors are becoming wary of 5, 10 and 30 year paper. Would you invest in US 30 year bonds at 4.6%? Do you think that is a good return for a Country that has public debt approaching 100% of GDP?

The trouble for the US economy is that mortgage rates are tied to the longer dated paper. If these yields continue to rise because no-one wants the paper, then mortgages will rise also. Enter the Fed on its QE crusade to keep long-term bond yields down. Only problem here is that the Fed just buys the bonds with an electronic credit that it creates ie printing money. If the Fed has to do this on a large scale to keep bond yields down then the USD will weaken due to the large currency debasement that is going on by the US Fed monetising US Govt debt. This leads to further problems being rising commodities prices, which are measured in USD, and even less demand for USD denominated assets especially bonds. Hence bond yields rise because of less demand AND fuel prices rise in the US. Very nasty.

Which ever way the Fed goes, it can’t avoid rising bond yields.

Do nothing, bond yields rise as bond issuance ramps up massively.

Step in and buy bonds, USD falls and foreign demand for US bonds decreases further - the Fed has to step in to buy even more, which weakens the USD even further ...

The only way out of this dilemma is for the US Govt to face up to the fact that it cannot afford to keep racking up debt when it already has $10 trillion against an economy worth $14 trillion. It must reduce spending and /or increase taxes at some point soon. Both of which are unpleasant for the US economy and US consumers.

This is why I do not expect a V shaped recovery but a long L shaped flat period.

I do see the positives for the Aust market and commodities though, although I am wary that the case of commodities is based more on USD debasement than fundamentals. I think that China will stop stockpiling commodities soon, especially iron ore. You also have to consider that the AUD might shoot through $1.00 if the US Fed does get serious about buying US bonds. The rise in the AUD could offset most of the gains in commodities.

Overall it is a very tricky market that could ebb and flow between “everything is ok” and “when are those bond yields going to stop rising???”

On that note, we say farewell to FY 2009 and look forward to more opportunity in FY 2010.

Dr Tony Rumble


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