Monday 10 December 2018 by FIIG Securities FIIG Securities Sales commentary

BondCast – New Westpac USD subordinated Tier 2, AUD investment grade bonds looking attractive and heading towards more defensive assets in 2019

Learn more about which bonds are on the move with the weekly podcast with Elizabeth Moran and Jake Koundakjian. 

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[00:00:01] Elizabeth: Good afternoon. Welcome to another edition of BondCast. My name's Elizabeth Moran. I'm director of education and research here at FIIG Securities. With me, I have today Jake Koudakjian, how are you Jake?

Jake: Very well.

Elizabeth: Interesting to see markets in the last couple of weeks … complete backflip rate rises are no longer really on the table in Australia in fact more people are coming out saying the next right move will be a cut. What's your take on the situation?

[00:00:29] Jake: Well, the data not only in Australia but around the world seems to be turning negative it seems like we're coming off the boil. In Australia specifically, we've got the real estate sector that's pulling back and that's kind of I guess tempering the enthusiasm of growth in this country overall and hence the potential for rate rises gets pushed out further. [Elizabeth: And interesting of course the US share market is down considerably and our market seems to follow – wiping out gains of the last year, I think the banks are down more than 15 per cent now.

[00:01:03] Jake: I was looking at the 52 week low list today –  it was a very very long list ANZ I saw there and quite a few other financials were part of that list and it's been a painful period for equity holders. Coming back to that GDP, it's been certainly noticeable.

I follow U.S. data pretty closely because I feel like it's the pied piper for the rest of the world really and the data seems to be pointing to slower growth to where we were. I followed jobless claims very closely, it's a weekly indicator. I follow all kinds of other things: retail sales; durable goods; industrial production; the price of lumber; Purchasing Managers Indices are – all pointing to slower than where we were and it seems kind of natural that we came from a place where they were very accommodative, interest rates, very accommodative governments, to pulling back on that accommodative background and then you had a tax cut which is another “press the gas pedal”, and then eventually the trade wars kick in as well.

So there was a lot of durable goods that were picked up leading into before the trade wars kicked in. So, you had a really excellent environment for growth to occur. So now here we are a year later, and the year on year comparisons are not going to look as good. Growth assets, like equities, they require growth. Defensive assets like bonds, they don't require growth.

[00:02:25] It's more defensible.  So looking forward, it looks to me like GDP growth is going to be lower. And I would expect the GDP in the U.S. which prints at the end of January, to surprise to the downside personally. It's a bit far out but that's what the data is telling me. But also expect inflation to start decelerating as well as the commodities are certainly screaming that and profit margins to also come down.

00:02:51] Elizabeth: Yeah, well oil's down and plenty of stocks are down as you say and people are looking now switching into defensive assets. In fact we saw the U.S. 10 year government bond yield climb to about 3.25 per cent I think, at the peak. It's well under three now. (Jake: 2.85?) Yeah, and the margin between it and the three year government bond rate is about – 40 basis points – its really low. So a flattening yield curve, you know long term horizon, flat rates.

[00:03:22] Jake: Where do you head? You head into more defensive bonds, a natural place for people to invest.

That’s kind of the message I'm trying to pass along. It seems like growth is decelerating just get more defensive. We have to expect lower returns going forward and just be comfortable with the return of your capital rather than return on your capital as lower growth is being reflected pretty violently in the equity space. In the bond space we haven't seen very, very major moves. But certainly you've seen some moves, especially in the U.S. area.

[00:03:55] Elizabeth: So what are we liking at the moment? I know that we have a new, US Westpac subordinated  Tier 2 bond – that's been traded quite well hasn't it?

[00:04:05] Jake: Yeah it's relatively new for our customers. Our research teams have looked it over and it’s just a good quality company. You know it's easier for me to say Westpac is going to survive rather than they're going to grow. And you know looking at the share price today, I think it’s at a 52 week low. We're recording this on December 11 so it's easier for me to say that Westpac will survive than it is to grow and so offered to me around that 5 percent right now. A longer dated bond – 2026 – but I don't think the US is going to be in a rush to really raise rates. And I think in the US they're already starting to pedal backwards. So a really tough job for the U.S. whether they continue to raise rates or backtrack on their word.

[00:04:51] Elizabeth: Well there's a fine line isn't there, between raising rates and tipping the economy into a recession of course. And with that Westpac bond I think it's a perfect example of a good, solid defensive asset. The one risk we haven't really talked about with U.S. dollar bonds is of course the currency. Have you got any thoughts on the currency at the moment, or are you worried about it?

[00:05:17] Jake: I do think that with risk and foreign exchange risk, it’s one of those risks you keep as a smaller part of your portfolio. I guess my rule of thumb personally is less than a third of your portfolio in foreign exchange whether it's pounds or U.S. dollars or yen whatever it is. So that way, if you live in Australia, you still have two thirds your portfolio in the Australian dollar space and you're not too exposed to foreign exchange. So as part of diversified portfolio I think foreign exchange can have a place, but as far as where the U.S. dollar is going versus Australia, no one has any clue.

[00:05:52] Elizabeth: Well I think that's fair, we don’t.  Toss a coin! I don't even think the traders sometimes know the direction of the currency.

[00:06:02] Jake: 25 years in trading assets and I guess what I would take away from that and over the years, is that for me, the currencies are the stock price of a country. So if you think that the U.S. economy is going to be outperforming the Australian economy then you're saying that the U.S. currency is going be stronger than the Australian currency. I'm not a foreign exchange adviser. No one knows. But like I say, that's the way I've thought about it over the years, it's the stock price of the country. So if you think that the U.S. economy is going to improve compared to where Australia’s, then maybe you want to place that bet. But again, I'm not a foreign exchange adviser. I don't provide expert advice.

00:06:41] No, let's go back to the Tier 2s because there’s an Australian dollar Tier 2 that we've liked as well. I think that's quite a nice space at the moment, they're investment grade from well-known companies as you mentioned and in earn over 4%pa.   

Jake: Yeah, Bendigo and Adelaide is one that I still like. It's attractively valued in my opinion, getting a little bit north of 4.3%pa return and this is quite what I've talked to investors about – you don't need to shoot the lights out, you just need to make sure that the balance keeps going upward. So earning 4.3% is still going to be an OK return. It's not wonderful, but it’s sleep at night type of stuff.

Elizabeth: At a good margin over deposit rates at the moment too so that's a nice pick up. Tell me, are there any fixed rate bonds on your target list at the moment?

[00:07:30] Jake: Yes there certainly are. Aroundtown and AT&T, I find attractive. Again these are yielding about the 4.2-3% return. I'm just looking for stuff that is just quality investment grade and I don't have to think about too much and in fact, if they do not start to raise rates here, but cut them, then a lot of people forget that we can still go from 1.5 percent down to zero. These would be very very positive performing assets if that occurs. But ultimately, and generally speaking, these are more defensive assets and I expect a lower return which from an investor standpoint isn't always palatable.

[00:08:15] Elizabeth: No. And that's really sort of sums up FIIG research view of the market going into 2019 as well – is to be more defensive. So buy higher rated investments and reduce high risk investments. So risk off if you like.

[00:08:37] Jake: Well I think a diversified bond portfolio has aspects of both. But it also comes down to your own comfort level with risks. Some investors don't have the riskier equity type investments and maybe they want to take their risk essentially in higher yielding bonds. So each individual investor knows their own comfort levels and again work with general advisors at FIIG. So we don't know your specific risk criteria but we'll help you walk through the budget the best you can based on the marketplace we see.

[00:09:10] Elizabeth: Well I don't have anything else this week. Jake do you? Anything else you'd like to say? This is our last BondCast by the way for 2018.

[00:09:18] Jake: Well I guess I hope everyone has a very restful holiday. If you haven't invested capital, there's a very quiet period between now and probably mid-January where you could be earning interest. So call your relationship manager and see if you want to get that money working for you, whether it's a 4.3 percent or 8 percent, whatever it is. Give us a call.

[00:09:40] Elizabeth: Thanks very much for joining us and thank you for listening during the year. Please if you have any suggestions or things you'd like us to talk about please let us know. But on behalf of myself and Jake and the rest of the team at FIIG we wish you a very merry Christmas and a Happy New Year and we look forward to bringing you BondCast in 2019.

[00:10:00] Jake: Thank you.