Key points
- The current currency trend is your friend. Currency cycles are the longest cycles of all.
- Don’t buy resource stocks for yield. The hedge fund shorting world could gang up on the likes of BHP if they think the yield is unsustainable.
- On weak S&P/ASX 200 index days, try nibbling on Australian industrial reliable dividend payers and key US dollar earners like Westfield Corp, Brambles, Macquarie Group and CSL.
The global cross-asset class volatility I forecast has well and truly arrived, and thankfully in my new role as a fund manager I have entered this period with a blank sheet of paper.
This week alone we have seen huge intraday moves in currencies, commodities, bonds and both domestic and global equities. This is a serious pick up in volatility driven by the Greek “no” vote and a violent correction in Chinese equities.
US dollar power
In these moments the world heads straight back to the US dollar as a safe haven. That is the only certainty in all this and the US dollar Index (DXY) is about the only “green” on the screens. Gold isn’t even working due to the expectation of rising US interest rates.
I remain a major structural bull on the US dollar. That clearly has negative ramifications for anything denominated in US dollars such as the euro, NZ dollar, Australian dollar and commodities.
Unfortunately for the Australian dollar it now faces the perfect storm of a rising US dollar and collapsing commodity prices driven by over-supply/falling Chinese demand. The next negative for the Australian dollar will be its relative and absolute yield premium to the world being cut.
I continue to believe the RBA will be forced to cut cash rates in the second half of 2015 as our key export prices collapse (and stay down). I continue to target a 1.50% cash rate and 65 US cent Australian dollar (AUD).
The AUD/USD cross rate is really about interest rate differentials. At 106 US cents the Australian cash interest rate premium to the US was 4.50%. At 74.50 US cents today the cash interest rate premium to the US is 2.00%. I am predicting that premium to fall to 1.00% over the next 18 months as the Fed raises cash rates to 0.5% and the RBA cuts ours to 1.50%. If I am right and the cash rate premium narrows to 1.00%, then you can be certain the Australian dollar will have a six in front of it.
This is important for all Australians and one of the key reasons I set up my global absolute return fund. I am trying to help you get some money out of here to protect your wealth in global dollars. The AUD/USD is already down -9% in 2015 and very few Australian’s are benefitting from that fall due to a massive “home bias” asset allocation in favour of Australian assets in Australian dollars.
The key to long-term performance is a balanced asset allocation strategy. Volatility equals opportunity but volatility also increases risk. A balanced approach to asset allocation is essentially a risk minimisation strategy. This is particularly important for the majority of self-managed super funds where asset classes are predominately weighted to domestic equities.
Rest of the world for growth
You know the way I approach asset allocation: Australia for income, rest of world (ROW) for growth. The ROW for growth can simply mean being parked in US dollar cash and generating capital gains on my cash that way. US dollar cash returned 14% from mid last year to Australians and to me looks on track to return that again (or more) in 2015.
One of the very first things I have done for my fund is start moving to US dollar cash. I think the fundamentals and technicals (key support broke at 75.50 US cents) are aligned for further AUD/USD falls. On a risk reward basis I see far greater downside than upside in AUD/USD and that is why I have started allocating to US dollar cash, even at a 6-year low in AUD/USD. The trend is your friend here. Currency cycles are the longest cycles of all.
While the falling Australian dollar has clear and ongoing ramifications for asset allocation and stock selection in Australian (US dollar earners ex resources), the good news is a lower currency will eventually be good for the Australian economy. In the short term however, history shows that the prospect of further falls in the Australian dollar will deter foreign investors who invariably wait for the “currency knife to stick in the floor” before committing new investment funds.
If I am right and the Australian dollar does get a “six handle” then the ramifications for migration, population growth, inbound tourism, manufacturing, agriculture, residential property and even commodity producers are positive. We simply need a lower currency to help drive our global competitiveness and GDP growth. At this moment in time Australia is lacking growth and a lower currency would clearly help our GDP growth forecasts.
However, in the interim there is going to be continued commodity price and equity price volatility.
Reporting season outlook
I still believe the pending Australian reporting season (ex-resources) will be solid and have faith that earnings and dividends from banks, insurers, REITs, building, materials, telcos and infrastructure stocks will be solid. I remain a supporter of Australian reliable dividend income stocks as we head towards lower cash rates.
The only difference between my fund and most Australian investors is I can own these reliable dividend income streams, yet have the ability to swap out the Australian dollar currency risk into US dollars. I can also write call options against my Australian dividend income stocks to enhance the yield one more notch.
One thing I must warn you about is NOT BUYING RESOURCE STOCKS FOR YIELD. The commodity prices we see in front of us today will lead to consensus earnings and dividend downgrades for FY16. That is for certain.
What that means is the prospective resource sector dividend yields we see in front of us today are wrong. They are too high and I strongly encourage you to be cautious buying any Australian resource stock purely for dividend yield. Those dividend yields are unsustainable.
That includes BHP Billiton which, by my calculations on today’s iron ore, coal, copper and oil prices, will have to borrow money or continue to cut capital expenditure (lowering future growth) to keep paying their progressive US dollar dividend. Borrowing to pay dividends is not a good look, even if the borrowings are quite small. Just be a little careful here because the hedge fund shorting world could gang up on BHP if they think the yield is unsustainable. Personally I’ll be waiting for a better buying opportunity in BHP later in the year.
However, as I always say “in volatility there is opportunity”. On weak S&P/ASX 200 index days I’d encourage you to nibble on Australian industrial reliable dividend yield payers and key US dollar earners (Westfield Corp, Brambles, Macquarie Group, CSL, Magellan Financial, Platinum Asset Management etc). I’d also be encouraging you to move some money to US dollar cash.
No doubt we are in a tricky period. There is very high global cross-asset class volatility. It is a time to be sensible, disciplined, yet contrarian at the right time.
I hope I can do exactly that as a fund manager.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.