- Money Morning Australia

The Primary Colours of Investing


Written on 28 February 2013 by Kris Sayce

The Primary Colours of Investing

Two things move markets.

That’s right, only two things.

You wouldn’t know that from all the fluff you see in the mainstream.

Based on what you read elsewhere, we would forgive you for thinking that markets (including stock markets) are much more complicated.

The truth is you don’t need a physics, maths or engineering degree to understand it all.

You just need to know the two things…just two things…that move markets. If you get that you’re well on your way to understanding how and why markets move, and how you can potentially profit from those moves…

We know our colleagues in the financial services industry won’t like this, but investing isn’t difficult.

It’s not like performing open heart surgery, taking apart and fixing a car engine, or building a house from scratch. That’s tricky…and it’s why you won’t find your editor tackling any of those tasks.

As far as stock investing is concerned the only two things you need to look for…the two things that move markets…are interest rates and earnings.

If you break everything down to the base elements, you’ll find that everything results from these two factors. You can call them the primary colours of investing

The Importance of Investing’s Primary Colours

We did some fishing around earlier this week. The amount of meddling in financial markets has created a lot of confusion for investors.

The most confusing has been the amount of money printing and interest rate meddling.

Just yesterday we posted a link on our Google+ page to a Daily Mail article. The article suggests the Bank of England could move to a negative interest rate environment. That simply means the Bank of England would charge banks to hold cash at the Bank of England.

Why would they do that? The idea is that if banks hold cash at the Bank of England it means they aren’t lending it to consumers and businesses…and that’s why the economy is in recession. The charges would deter banks from holding cash at the Bank.

Of course, that’s not the reason for the recession. The reason is that there has been too much credit for too long. The economy needs to readjust.

A recession is simply the economy telling people it’s exhausted and needs to stop growing…the Bank of England is trying to ignore that.

But let’s break that down. What’s at the core of this issue? That’s right, interest rates and company earnings.

This link is the key to how an economy will perform. The thing is over the past few years the link between interest rates and earnings has flipped. And investors better get used to it, because it isn’t going to change…

The Key Chart Explains it All

One of the things we wanted to find out was the link between interest rates and earnings. The best way to show this (in our opinion) is to show a chart of interest rates and dividend yields (earnings paid to investors).

The chart below shows you the Reserve Bank of Australia (RBA) Cash Rate (blue line) from January 2000 through to February 2013. The red line is the dividend yield for stocks in the All Ordinaries index:

RBA Cash Rate compared to the dividend yield for stocks in the All Ordinaries index

Data Source: AFR Smart Investor

As you can see, between 2000 and mid-2008, the RBA Cash Rate was higher than the All Ords dividend yield. In fact the Cash Rate was an average of 1.79 percentage points above the All Ords’ yield.

That relationship flipped as the financial system collapsed and the RBA cut interest rates to a record low. Things appeared to revert to normal during 2010, but that didn’t last long.

Since 2009, the average spread between the Cash Rate and dividend yields is now -0.64 percentage points. In other words, dividend yields are now higher than the Cash Rate.

So, what does that mean? Well, it’s the key to investing over the next two years…

Why This ‘Flip’ is Great News for Growth Stocks

To be honest, we can’t see that relationship flipping back anytime soon. The RBA will have to keep interest rates low in order to try to stimulate the Australian economy (not that we agree the RBA should do this, we’re simply saying this is what they’ll probably do).

That will force normally conservative investors to buy dividend-paying stocks.

We’re reluctant to use the word, but it could create a temporary ‘floor’ for Aussie stocks as long as the central bank keeps rates low. Note the emphasis on ‘temporary’.

Interest rates look set to stay low for the time being. That’s typically good news for stocks. All that remains to know is whether companies can maintain or grow earnings and dividends.

As we said at the top, that’s all that really matters in the stock market – interest rates and earnings.

That said, we also believe that dividend stocks have already boomed.

We don’t think you’ll see further big gains. If dividend stocks do go up, it’s more likely to be low single-figure gains, even if as Doc Cowie expects, you see a new credit boom due to low interest rates and China’s infrastructure spending.

In short, if the days are over for income and growth from dividend stocks, it’s only natural that speculators will look for big gains elsewhere. That should mean a good year ahead for growth stocks, especially small-cap growth stocks.

If the last six months was all about yield, our bet is the next year will be all about growth.

Cheers,
Kris

Join me on Google+

From the Port Phillip Publishing Library

Special Report: The Gold Mirror of Kaieteur Falls

Daily Reckoning: Ben Bernanke… What a Fraud… What a Phoney

Money Morning: Revealed: Inside a Share Trader’s Den

Pursuit of Happiness: Exclusive: Your Eight-Point Wealth Protection To-Do List



Already a subscriber to Money Morning... or simply, just like what you're reading? Then show your support and spread the word...
Share this post on...
Share

Kris Sayce
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays. Read more about Publisher and Investment Director Kris Sayce.

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au




FREE INVESTMENT REPORT: Why Dividend Stocks Are The Key To Retirement Wealth


In this report discover how dividend stocks can give you income long into retirement — even if stock prices don’t rise.

PLUS you'll get Money Morning every weekday...absolutely free.

Enter your email address below and hit the 'Claim My Free Report' button now.

Privacy Statement
We will collect and handle your personal information in accordance with our Privacy Policy.
You can cancel your subscription at any time

WWD dvd

World War D was billed as ‘the biggest investment summit of the decade’

It didn’t disappoint…


Absolutely mind-blowing beyond my expectations

– D.A.C. Hall


The BEST INFORMATION available,
contrary to mainstream economic reporting.

– L. Sceresini


Exciting, dynamic, passionate, informative, challenging, so professional... Brain-stretching.

– D Finlay


Click here to watch
the brand new Highlights Reel.

Openx pos2

  • ^NDX4082.559+16.286 - +0.40%
  • ^FTSE6825.31+5.56 - +0.08%
  • ^AORD5629.300+4.700 - +0.08%
  • ^AXJO5629.800+3.900 - +0.07%
  • AUDUSD=X0.9337
  • USDJPY=X104.298

Openx pos3

Diggers and Drillers

After three years in the doldrums…

Aussie resource stocks
are now a raging BUY
 
The last time resource stocks traded this low we saw a two and a half year rally that saw them gain 124%...
 
Now they’re getting ready to do it again. Read on to discover why…and three tiny Aussie miners that could explode up many times higher than that in 2014…click here.

Openx pos4

Openx pos5

Openx pos6

Openx pos7

Openx pos8

More Recommended Reading Below...

The Pursuit of Happiness & The Daily Reckoning

  • The Pursuit of Happiness
  • The Daily Reckoning Australia

The education system as we know it is preparing for a world that no longer exists. This will be Aust [Read More...]

This is something investors need to remember when adding stocks to their portfolio. Don’t panic over [Read More...]

Many Australian investors are turning to alternatives. Led by the SMSF crowd, investors are piling i [Read More...]

I wanted to know what Joe Hockey would do about the hundreds of millions of dollars the government. [Read More...]

This morning the Australian dollar trading for 93 US cents. It hasn’t managed to regain parity since [Read More...]

You prevent a bank run by reassuring depositors that no matter what happens to the bank, they’ll get [Read More...]

Bypassing the banks, the US Federal Reserve will put their newly digitized money directly into the h [Read More...]

You’re about to see, you can do a lot better. You can win at the stock market when you use the power [Read More...]

There are many things I don’t know. High on that list is the mystery of Qantas; how does it manage t [Read More...]

The longer we spend in France, the more similarities we see between its economic problems and those [Read More...]

TESTIMONIALS

"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery