15 May 2012

Yields on Australian government bonds have fallen to their lowest levels in almost 60 years as demand from offshore investors continues to drive bond prices higher (and hence bond yields lower). With most interest rates in most OECD countries remaining around 0.5 – 1.0% since the financial crisis of 2008, there is a genuine shortage of highly rated government bonds with yields over 3%. Australia is one of few remaining AAA rated countries and there is plenty of offshore interest in holding our government bonds. Bill Gross of PIMCO, one of the world’s largest bond managers has been publicly praising the benefits of holding Australian and Canadian bonds. The Chinese government has also been diversifying out of US treasuries and into government bonds from other countries such as Australia.

While this has seen a rally in the Australian bond market for some years now, the same cannot be said for our equity market where share prices have been going sideways over the same period. In July 2009 the All Ordinaries index rose above 4,000 for the first time since the 2008 crisis. Since then it has traded up to 5,000 and back to the mid-4,000s; today it is around 4,300. One of the reasons for this is that offshore investors are nervous about the Australian property market and what that would mean for our banks which have a large exposure to residential housing. Whether this view is correct or not, it has the effect of helping to keep our equity market flat while the bond market continues to rally.

The good news for value investors is that the income that can be gained from careful investing in quality shares is relatively high. While the resource companies typically pay low dividend yields, other sectors such as banks, telecommunications and infrastructure are providing very attractive dividend yields. This article in today’s Australian goes into more detail about the current relative performances of the equity and bond markets. Expect similar articles to follow over the coming weeks/months.

For those of you interested in learning more about value investing, please contact us at Whites IFM – you can use the Enquiries section on this website.