New data from Japan and China suggest Australian exporters will struggle to grow earnings in the coming years, which leads us to conclude its better to invest in bonds over shares in this sector
Ultra low Bank of Japan interest rates
Japan’s central bank, the Bank of Japan (BoJ), has taken the extraordinary step of penalising those holding cash by shifting the BoJ’s cash rate to below zero.
The move is not a new one as the ECB (European Central Bank) has previously held rates at -0.3%. It is also not quite as bad as it sounds as it is only on new deposits with the BoJ.
What is extraordinary is the new Japanese 10 year government bond yield, now at just 0.07%pa. In other words, if you invested $100.00 today, you would get $100.70 back in 10 years time. That’s not the Japanese central bank setting that price; it’s the market determining the fair value of the 10 year bond based on their expectations of cash rates in Japan over the next 10 years.
And it certainly says a lot of about the BoJ’s view of the Japanese economy when they feel forced to make a move to penalise banks that add new cash to their reserves rather than lend it into the economy.
We maintain our long held position that the Japanese yen is not a currency to be held by conservative long term investors.
More relevantly for Australian investors, Australia generates around 15% of its export trade with Japan. Continuing weakness in Japan is a poor result for the global economy, but particularly poor for Australia.
China manufacturing data weak, again, but services sector holding up
China’s PMI index fell again in January, reaching its lowest point for three years. The PMI, Purchasing Managers’ Index, is a measure of demand for factory product which is typically used as an indicator of health for the manufacturing sector). This is a government produced survey, but the privately produced Caixin-Markit survey showed a similar result.
Showing the continuation of the transitioning Chinese economy, the services sector PMI came in at 53.4. A measure of more than 50 is an indicator of expansion, literally meaning that purchasers of services bought more in January than they did in December.
This two-speed economy is the core of the challenge for investors; the manufacturing sector has been in decline for five years, but the services sector is growing at nearly 10%pa. The challenge is to find ways to invest in the services sector without getting swept up in the overall pessimism surrounding China’s economy. The outlook for China is more of the same with the manufacturing sector having massive excess capacity, made worse by excess capacity across South-East Asia and the US; but continuing strength from consumer spending and services sectors.
Investment strategy
With Japan’s overall economy and China’s manufacturing sector in a multi year rut, earnings growth for Australian exporters of product will be very hard to achieve. When earnings growth is likely to disappoint, investors are better positioning in high quality bonds of the exporters as they will typically be oversold by institutional traders.
Resource stocks and high yield bonds of exporters should be held by investors in small positions only. Those with a higher appetite for risk will look for opportunities to re-enter the equities market if oversold, but this is not a strategy for the ordinary investor in such uncertain market and economic conditions. The downside risk for these investments outweighs the upside.
Conservative, income seeking investors should switch from resource sector equities and into investment grade bonds such as BHP’s USD or GBP bonds, or for a very conservative position, infrastructure bonds.