Seeking Yield, Thrills, and Capital Gains

Another week, and another round of reckoning begins. But what is there to reckon about when our all-conquering central banks have apparently succeeded in removing risk from the investment equation? No matter what the data, it’s all just an excuse to buy some asset class, usually equities. ‘Nothing to see here people…buy a stock, and move along.’

The reckoning business has become a tough job these days. I see risks wherever I look, but no one seems to agree. In Australia, the population is high on property…really high. The Financial Review reports today that a bunch of retail shops on the popular Chapel Street strip in Melbourne sold on a yield of just 2.7%.

Where’s the risk premium in that transaction? Granted, there are all sorts of justifications you could make for paying such a high price for quality property. But the only justification that stands the test of time when it comes to investing, as opposed to speculating on capital gains, is whether you are getting adequate reward for the risk.

2.7% for some shops on Chapel Street? Call me sceptical, but that sounds like a lot of risk for not much reward. It’s also a transaction that perfectly illustrates Australia’s screwed up policy towards property. That is, it encourages speculation and the targeting of capital gains over income. It does this via favourable tax treatment (negative gearing, capital gains concessions) and supply side restrictions.

But I’m not going to get into that today. Everyone knows that there will be no day of reckoning for Aussie property. It would be un-Australian.

Today I’m going to focus on risk…a much neglected concept recently. If you’re more interested in the reward side of things, check out Phil Anderson’s latest project. Phil’s bullish on the future, and sees plenty of rewards…especially in Aussie property.

Thankfully, there are still a few people out there who share our concerns. The Bank for International Settlements (BIS) released its 84th Annual report over the weekend and sounded a cautious note on the state of the markets and the global economy. Here are a few quotes from the introduction to the 200 plus page report, with my emphasis added.

’The global economy has shown encouraging signs over the past year. But its malaise persists, as the legacy of the Great Financial Crisis and the forces that led up to it remain unresolved. To overcome that legacy, policy needs to go beyond its traditional focus on the business cycle. It also needs to address the longer-term build-up and run-off of macroeconomic risks that characterise the financial cycle and to shift away from debt as the main engine of growth.

‘By mid-2014, investors again exhibited strong risk-taking in their search for yield: most emerging market economies stabilised, global equity markets reached new highs and credit spreads continued to narrow. Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.

‘In this second phase of global liquidity, corporations in emerging market economies are raising much of their funding from international markets and thus are facing the risk that their funding may evaporate at the first sign of trouble. More generally, countries could at some point find themselves in a debt trap: seeking to stimulate the economy through low interest rates encourages even more debt, ultimately adding to the problem it is meant to solve.’

In my view, the global economy is already in a debt trap. We haven’t recognised it yet because the leverage that the new debt provides is still working to the upside. The trap has yet to jam shut. But it’s coming.

Read the rest of this article at The Daily Reckoning