Here’s the one simple reason why share markets are falling, yet there’s no reason to fear a full blown stock market crash

583

In the twinkling of an eye, volatility has suddenly returned to world stock markets, impacting on Australian shares, with the ASX 200 in danger of slipping back below 6,000.

While you could blame trade wars, elevated valuations and that we are overdue a stock market correction, the real reason markets are falling is because the return on risk-free assets is looking attractive again.

Specifically, I’m talking about the yield on US 10-year bonds. Right now, you can buy US government bonds and earn around 3.2 per cent on you money, virtually risk-free.

That 3.2 per cent return looks attractive when compared to investing in shares, which is the alternative.

Many Australian investors will roll their eyes when reading about US bond yields, given we’re highly unlikely to invest directly in such an asset.

But it does impact Australians in at least 3 ways…

  1. Rising US bond yields, and the increasing gap between the equivalent Australian bond yield, shows up in a falling Aussie dollar.
  2. Australian banks are reliant on offshore funding, and rising US bond yields mean the banks are paying more to borrow. This additional cost shows up in higher mortgage rates for Australian home owners despite the RBA cash rate being on hold at 1.5 per cent for 26 months in a row.
  3. US investors buy bonds, likely selling equities to do so, pushing Wall Street lower. Where the US share market goes, the ASX follows.

Here in Australia, if you shop around, you can grab a term deposit returning around 2.75 per cent for 6 months.

While that yield has nothing on the Commonwealth Bank of Australia (ASX:CBA) fully franked dividend yield of 6.2 per cent (or 8.9 per cent gross), unlike CBA shares, term deposits are risk-free. The CBA share price has fallen 10 per cent over the past 12 months, not something that happens with term deposits.

And you wouldn’t be faring too well in 2018 in many of the popular managed funds and index tracking ETFs either, seeing as the ASX 200 index has returned almost exactly 0 per cent so far this year.

Source: The Capital Club

By comparison to a flat stock market, you’d take a 2.75 per cent yield on a term deposit any day.

Hindsight is a wonderful thing, but you don’t get rich observing backwards looking charts. Nor do you earning 2.75 per cent on your money.

Looking ahead, budget for annualised returns from the blue chip ASX 200 index of around 6 per cent, on average, over the next five to seven years.

This is lower than the historical average of around 10 per cent because inflation is low, economic growth is low, and stock market valuations are relatively high.

The returns from small cap ASX stocks should be better, given their higher growth rates. Many leading small cap funds target annualised returns of around 10 per cent per annum, on average, over the medium to long-term.

Whilst this current bout of stock market volatility may make you nervous, it’s unlikely to be the precursor to a full blown stock market crash.

The reason why US bond yields are higher is because the global economy is growing nicely, not something that usually signals stocks are about to crash.

If you’re in the stock market, stay in, and add more money, slowly, steadily, and methodically.

If you’re out of the stock market, get in, gradually and regularly.

Invest with money you don’t need to touch for the next 3 to 5 years.

The rest, keep in the bank. A term deposit earning 2.75 per cent is not too bad when the RBA cash rate is just 1.5 per cent.

Commonwealth Bank shares don’t look cheap, but these 3 shares do…

Combining countless hours of research with over 30 years of hands-on stock market investing experience, The Capital Club’s founder Bruce Jackson has just published his definitive list of 3 Cheap and Good ASX Stocks for 2018.

Commonwealth Bank was not one of them, but the list does include one tiny gold mining stock, and the company one top fund manager calls the cheapest stock in the ASX 100.

Find out why these 3 Cheap and Good Stocks could be better buys than Commonwealth Bank. But you better hurry… these stocks may not stay cheap for long.

See the 3 stocks

Read Next

Here are 6 of the best dividend stocks on the ASX for 2018 and beyond

Here are 10 ASX 200 shares to beat the traditional blue chips over the next 3 years

5 ASX blue chip shares for 2018 and beyond

Top fund manager names this iconic company as “the cheapest stock in the ASX 100”

Contributors to this article may own shares in some of the companies mentioned in this article. The Capital Club has a thorough disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
Bruce Jackson has 30 years of hands on investing experience. He is passionate about stock market investing, running his own portfolio and SMSF. His focus is on small cap growth stocks. You can contact Bruce at brucej@thecapitalclub.com.au