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Rates go sub-zero, markets go red-hot

As interest rates drop to below zero in some nations, we explore why it’s important to keep a grounded demeanour when it comes to Australian equities.



In recent months, we’ve seen a renewed move to lower global and local interest rates. In Denmark, for example, rates have fallen to -0.75%. While we have had negative real yields (yields adjusted for inflation) in many jurisdictions for a few years now, the move to negative nominal yields (before inflation) is something new. Should this unprecedented situation persist or propagate, it may lead to some uncertainty about whether central banks are capable of ‘engineering’ a recovery. 

From an Australian equities point-of-view, this phenomenon has been one of the factors driving the market higher for the past two months.  The latest leg down has seen the fervour for yield reach even higher levels. These looser global monetary conditions have been accompanied with a local rate cut by the Reserve Bank of Australia and a lower Australian dollar. Locally, this makes the move out of cash more urgent as offshore players buy more Australian stocks particularly those with strong yield characteristics. 

These forces combine to form a ‘wall of money’, which appears to be a strong effect in the red-hot run the market has enjoyed during the past two months. While this is great for the market and those of us fully invested, we need to appreciate that some of these flows may be fickle and they don’t appear to be too valuation driven. 

While it’s easy to get excited, it’s important to keep a grounded demeanour and not give into the temptation to buy for momentum’s sake or on takeover potential. Instead, investors should keep an eye on fundamentals, the progress of earnings and their derivative dividends. A wise old investor once said in the short-term, the stock market behaves like a voting machine but in the long-term, it acts like a weighing machine.
 

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