Why a Growing US Deficit Will Hurt Your Favourite Income Stocks

Australian investors will be used to hearing our market described as a ‘yield’ market. Meaning that it’s a place to invest your money if you’re after income.

If it’s growth you’re after, though, perhaps you might have to look elsewhere.

Of course, there will always be local small and mid-cap stocks on the way up. But for fund managers, who have to invest in the bigger end of the market, pickings can be slim on the ground.

Bank shares have gone nowhere for the best part of a decade. Wesfarmers Ltd [ASX:WES], owner of Coles, is only slightly higher than it was in 2007. Arch rival, Woolworths Limited [ASX:WOW], is still a few dollars below its pre-GFC high.

The exceptions at the top end of the market are star performers Macquarie Group Ltd [ASX:MQG] and CSL Limited [ASX:CSL]. Though Macquarie’s has been a more of a rocky ride.

Apart from the odd hiccup, CSL’s trajectory has continued to be on the up. From an IPO price of $2.30 in 1994, it has traded recently above $180.

To put that into context, the government received less than $300 million from selling CSL. Today CSL’s market-cap exceeds $83 billion.

Macquarie too has been on a tear, increasing more than five-fold from its 2011 low. However, it took Macquarie more than a decade to break its previous high, when it came within a whisker of hitting $100 in 2007.

The hunt for yield

When interest rates started their spiral down a decade ago, plenty of global money found its way into the Australian market. It was all to do with the search for yield.

Those that bought into stocks like CSL and Macquarie will of course be petting themselves on the back. Who wouldn’t want those size returns?

While those kind of returns are a huge boon, it’s a pretty short list of stocks that have performed this well. Especially at the big end of the market.

What global investors were primarily after, though, was yield. With yields of 6–7% available on some of our biggest companies, it wasn’t really surprising to see money flow our way. Especially when what was on offer was several times higher than that offshore. 

But as interest rates bottomed in the US, and started to head higher, some of this global money has headed back home. As you would expect, this too has to do with yield.

It’s not only because interest rates have bottomed and yields on bonds are increasing. It also has a lot to do with the US’s ever-growing deficit.

The US deficit isn’t only growing in size, it is also increasing as a percentage of GDP. And because of tax cuts, the US will need to fund this widening gap with less immediate tax income.

As the US Treasury issues more bonds to fill this gap, it will likely need to offer higher rates to get their bond issues filled. And that will pull more money back to the US.

Don’t forget the currency

There is also another issue at play, and it has to do with the exchange rate. Although US rates have started heading back up, the Aussie cash rate remains flat. Its last move was a 0.25% cut all the way back in August 2016.

While many believe the RBA’s next move will be up, less certain is the timing. The housing market already seems to have cooled.

Plus, household debt is at record levels, with wage growth barely existent. It is only just keeping pace with inflation which is also anaemic.

Any move upwards by the RBA could put the Aussie economy under pressure. Not to mention all those already suffering from mortgage stress.

The upshot with rising US rates, and flat Australian rates, is that the US dollar has strengthened against the Aussie dollar.

That means that when global asset managers sell their Australian holdings, and convert those dollars back into US, they run the risk of losing money due to the exchange rate.

There’s little point holding a stock paying a 5% yield, if the currency falls by a similar (or larger) amount.

Plus, if our higher yielding shares fall, there’s little chance this yield will offset those losses. What the international fund managers don’t want is a potential hit on the currency as well.

Apart from a lack of real growth, this is why some of the more popular income stocks are struggling to find support.

The good news is, though, that unlike the global fund managers, private investors are free to invest in what they like. And that which suits their needs.

That means they can invest in some of the other income stocks on the ASX. These are stocks in which the big global fund managers don’t invest (and can pull their money), and pay a handy yield.

All the best,

Matt Hibbard,
Editor, Total Income


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