Australian emergency workers used to ask patients who the Prime Minister was in order to assess their mental alertness. That practice was firmly put to bed last summer when former treasurer, Scott Morrison became the fifth Australian Prime Minister in five years after his predecessor, Malcom Turnbull, was ousted after yet another in-party coup.
Turnbull’s resignation from the leadership of the unstable Liberal-National governing coalition raised the prospect that a general election would follow and, with the Labour Party leading in the polls, result in a much more freely spending administration. As a result, an additional question mark hung over Australian bonds at a time when there was general malaise towards the global bond market.
Bond yields tend to be affected by what is happening in the US, and although bond yields had been pushed up during the first few years of Trump’s tenure when tax cuts reignited the economy, by the fourth quarter of 2018, signs of a slowdown in the US economy saw the bond market reassessing whether interest rates would continue to track upwards.
The Rates and Currencies team are active bond selectors, and we spend our time and effort analysing the fundamentals of a country in depth so as not to get distracted by the short-term noise we see in markets. The more we analysed this slowing in economic momentum, the more we realised that a whole lot of uncertainty that the market was attaching to bonds – globally and in Australia – was misplaced.
© Getty Images AsiaPac.
Australia’s economy, for example, has strong links to China, with Australia exporting large amounts of iron ore to China annually. China’s economic growth rate is currently moderating as the authorities try to reduce financial risks building up from high levels of domestic credit, and it struck us that, regardless of the Australian political outlook, slower growth in Australia’s major trading partner would likely translate into lower domestic interest rates, not higher.
What’s more, within Australia’s borders, underlying factors are very supportive of bond investments. The country has a AAA credit rating – one of the few to retain this top grade – and has low debt. Whereas the US has 95 per cent debt relative to its GDP, Australia’s debt currently sits at 18 per cent. The Australian government earns more in a year than it spends, so this debt is forecast to reach a mere 1.5 per cent of GDP by 2028/29, exceedingly low by contemporary standards.
Baillie Gifford’s approach to investment gives us two advantages in the market: the ability to be contrarian and the ability to be patient. We took the decision to buy Australian bonds at a time when they were out of favour, and it has been a rewarding investment for our clients: Australian bonds have performed more strongly than those of other developed countries. It is true that a lot of this premium has since been taken out as the market has caught up with the story, but Australian long-dated bonds are still desirable and earning a 2.5 per cent yield.
The country is now gearing up for another election and Prime Minister Scott Morrison is warning of recession should there be a Labour government but, political shenanigans aside, the country has a strong economic backbone. Cutting through that short-term noise and focusing on the fundamentals and resilience of an economy allows us to make clear judgements for our clients that reward insight over instinct.
All data is to 31 March 2019 unless otherwise stated. The views expressed in this blog should not be considered as advice or a recommendation to buy, sell or hold a particular investment and it does not in any way constitute investment advice.
This communication was produced and approved on the stated date and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Investment markets can go down as well as up and market conditions can change rapidly. The value of an investment in the fund, and any income from it, can fall as well as rise and investors may not get back the amount invested. Bonds issued by companies and governments may be adversely affected by changes in interest rates, expectations of inflation and a decline in the creditworthiness of the bond issuer. The issuers of bonds in which the Fund invests may not be able to pay the bond income as promised or could fail to repay the capital amount.
Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions. This blog contains information on investments which does not constitute independent investment research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
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