Australia has had quite a few crises fly past our economic windscreen since ‘the recession we had to have’ in the 1990s. The East-Asian crisis, the tech wreck, September 11, the global financial crisis, the European sovereign debt crisis and any we’ve forgotten. But Australia chugs on as ever.
So is it safe to invest your money and to keep what’s already committed working hard for your retirement? And what are the risks?
Do we, for example, have resource curse and Dutch Disease? Both those terms refer to what your local newspaper editor might call a ‘two speed economy’. Resources can dominate all other parts of the economy and cause the exchange rate to appreciate beyond what the rest of the economy can handle. This happened to the Netherlands in 1959, hence the name Dutch Disease, when they discovered a vast natural gas field. Just like Australia has in the Cooper basin, for example.
The effect of Dutch Disease is that resource-exporting countries tend to struggle suddenly, as their economic wellbeing becomes tied to international resource prices. And government revenue can unexpectedly implode because so much of it is derived from the one dominant sector. Malcolm Turnbull spoke about all this just a few days ago here.
The thing is, Australia may or may not have Dutch Disease. We just don’t know…yet.
But that’s not the only risk for the Aussie economy. Does Australia have a housing bubble? We’ll be diplomatic, because this article isn’t about the housing bubble so we’ll answer ‘maybe’. We don’t know either…yet. But notice what happened to countries that did turn out to have housing bubbles. The US triggered a global financial crisis with its mortgage meltdown and half of Europe is in a funding crisis after having to bail out its banks.
The Risk of Debt
Connected to the housing bubble risk is the risk of debt generally. This risk shows up in all sorts of different ways. For example, the size of the financial sector. Gerard Minack, from investment bank Morgan Stanley, pointed out on the ABC that Australia’s finance industry has grown in terms of profit and contribution to GDP. That can’t last, in his opinon.
‘I mean, we’ve had 20 years of banks effectively being a GDP plus growth sector, with credit growth running way above income growth. And, you know, the best case is it flatlines. If it starts to shrink, then you’re all fighting over a smaller pie.’
Notice that those 20 years coincide mightily well with the amount of time we have been recessionless. Debt relative to GDP has also seen a ‘huge escalation’ according to Minack. By the way, this is the point that economist and crisis predictor Steve Keen harps on about.
An Investment Mistake
Another risk Australia has, which you may not have heard, is the problem of malinvestment. A malinvestment is an investment mistake made because of artificially good times. (Technically speaking, those artificially good times are caused by artificially low interest rates thanks to central bank meddling.)
As soon as tough times strike, these investments are exposed as errors. They have to be, as fellow Austrians Arnold Schwarzenegger and economist Ludwig von Mises would say, ‘liquidated’.
Australia hasn’t had tough economic times for more than 20 years – if you take a recession to mean ‘tough times’. How many businesses out there have profit margins too small to take a hit? How many people are in so much debt that a lost job would spell disaster? The answer is probably a lot, simply because we have become used to a stability that just doesn’t last forever.
All of these points are the signals that many financial crisis predictors used to foresee what happened to the US in 2008, Europe today, East-Asia in 1997 and so on. We reckon the most important one is the level of debt. So much borrowing from the future means less growth in the future.
If you’re wise enough to worry about these risks, even if you don’t think they’re justified, what should you do? Move to New Zealand?
The answer might be almost as drastic. You see, Australians are obsessed with the idea of capital gains. But if that’s the focus of your investment returns, you’re also putting your capital at risk. And probably a very large portion of it. That’s not a good idea in the face of the risks we just outlined.
A New Investment Mindset
So what’s a strategy that keeps you in the game of gains, while minimising the danger of losing your initial investment? The answer is to reset your investment criteria to prioritise income over capital gains. Income producing assets don’t require selling out to realise gains. That’s the crucial difference, because a success is measured over a long period of time, not just at two certain points in time (when you buy and when you sell).
A market crash at the wrong time can mean disaster if you are banking on being able to sell out at a high price. An income investor might have to lower their standard of living if their income falls, but they are still sitting pretty by comparison because they’ve been earning cash in the meantime.
There are plenty of income producing investments out there for you to choose from. Corporate bonds, term deposits and hybrid investments (these are usually structured to be a combination of debt and equity, but trade like a share on the ASX) for example.
But most of those don’t have the big advantages that dividend paying shares do. First of all, dividend shares can still go up in price. So you might be less exposed to a market rally than by buying growth stocks such as Rio Tinto and BHP Billiton, but dividend paying shares do still go up.
Secondly, dividends can grow over time. You might buy into a dividend stock at a 5% per cent dividend yield, but dividend hikes could see that yield rise dramatically. Of course, if that happens, it will probably come with an increasing share price too. But too many investors see that gain and get greedy. They sell out of a position that’s earning an impressive dividend yield.
Ask yourself, would you be tempted given this scenario:
Campbell Brothers has gone up 1475% in about 9 years.
Campbell Brothers
(CPB)
(CPB)
That’s quite a capital gains success story. But how does the dividend side of things stack up?
In 2003 CPB had a 6% dividend yield. Not bad. It has since grown its dividend almost five fold, giving you a 37.8% dividend yield on your initial investment. That’s an annual payment of 37.8% of whatever you invested, or a 1475% capital gain. Which would you choose?
Remember, if you reinvest your capital gains, you are putting them at risk. And very few income opportunities pay a 37.8% return straight up. We reckon that the income stream outweighs the benefits of the gains. Unless you’re planning on buying a yacht!
All this analysis of Campbell Brothers is based on just nine years of data. If you don’t sell out to realise the capital gains, and the dividends continue to grow, a $100,000 investment in 2003 could just about give you the income you need to fund your basic living expenses in retirement. Of course, we’re not suggesting putting so many eggs in one basket. But a diversified bunch of picks similar to CPB today is a good idea.
That’s the kind of solution you should be looking for. But finding it is just as difficult as finding the kind of stocks that go up in price. That’s the task we’ve set ourselves as our new advisory service nears its launch date.
It involves a surprising way to magnify the gains from dividend investments alongside the stocks we think will grow their dividends in the face of troubling economic times.
Nick Hubble
Editor, Money Morning
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