19/06/2007 - 22:00

Rates fallout from US bonds

19/06/2007 - 22:00

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Anyone watching the Australian stock market for the past few weeks could not avoid the feeling that it’s been bouncing across a ceiling, unable to get much higher, and looking extremely fragile every time it retreats.

The problem, which is too difficult for most casual observers to fully understand (including Briefcase) is the US bond market, or, more specifically, the fact that Treasury Bonds issued by the US government are falling in price, setting the scene for a major upward move in interest rates – worldwide.

All that’s missing from what looks to be a major change in the long-term performance of the market is knowing precisely when the tipping point will be reached, and when will the yield of 10-year US treasury bonds pass a point at which they seriously damage the stock market.

Watching treasuries, unless you’re a very sad case, is not an exciting business. For starters they are an ‘inverse animal’. In other words, a fall in their price represents a rise in the yield they generate, and yield means interest rate.

If the business of watching them is dead boring, the business of watching for the tipping point certainly is not because the US 10-year treasury is the benchmark by which the world sets its interest structure – a sort of interest rate atomic clock that cannot be ignored.

But – and this is the key to this week’s random thoughts of a disturbed and grumpy mind – there are several issues on the business agenda which are approaching, or at, a tipping point of some sort. And each of these represents a possible change in the rules of the game for business and government.

Let’s consider a few.

•••

Interest rates are the classic because they affect the price of shares, property and commodities. Rates are the 800-pound gorilla lurking in the corner of the room, which investors ignore at their peril.

Rising interest rates mean that cash (or bonds, or any secure fixed-or-floating instrument) becomes more competitive with shares. At some point, investors look at the return they are getting from an investment portfolio and ask the question whether they would be better to switch a portion to cash.

The magic number Briefcase has in mind for returns on investment in Australia is 7 per cent. In the current overall economic climate, that is considered fair and reasonable.

With most shares you can get that through dividends and capital appreciation. But, when the cash rate rises to match the 7 per cent (and you can get around 6.1 per cent from big banks) then ‘magic’ happens and cash flows to where it is most welcome and safest.

Driving our rates is that US 10-year treasury is currently sitting around a five-year high as the US battles an outbreak of inflation fears and the interlocked problem of the country’s falling currency, which we interpret (incorrectly) as a rise in the Australian dollar.

What is the tipping point, when rising interest rates have more appeal than shares? Briefcase doesn’t know, but suspects we’re getting close.

•••

The second event heading for some sort of tipping point is Western Australia’s acute labour shortage, a fascinatingly complex question of when is too much of a good thing too much.

Every business employing low-cost labour, such as the corner store, farmers and restaurants, is under intense pressure in this area. Some business will simply not stay in business because they can’t get workers.

•••

But, the real crunch point of the labour shortage is government. Not only are government jobs lowly paid, but government has stripped away one of the few reasons anyone ever considered working for government – job security.

Disregarding the utter nonsense of senior (and not so senior) civil servants having to routinely re-apply for their own jobs in some sort of perverse prostitution of the way business works, and you’re left with a place that no sensible person wants to be found.

The tipping point in this example is this: at what level does the shortage of police, teachers and nurses become critical, leading the three pillars of society that they serve (law, education and health) to spin out of control?

•••

Commodity shortages are a third area being set up for a tipping point crisis, which will be reached when a country that desperately needs a product, such as oil, cannot afford to buy it (or has been denied access to it) and marches across a border to take it.

Briefcase does not subscribe to the belief that the US-led invasion of Iraq was purely oil-induced, but it was a factor. And it is a pointer to what other countries might do in the future, especially in South America, where a bizarre form of what can only be called national/socialism is on the rise and the oil and gas trade is being politically manipulated.

This commodity squeeze has the potential to be an incredibly important issue if China and India continue to grow at break-neck speed. It is these in particular, with their cheap and plentiful supply of labour, which will soak up commodities, turn them into consumer goods, and enhance their roles as manufacturers to the world – putting out of business secondary players such as Vietnam, Malaysia and Indonesia.

The question is, when will the rise-and-rise of China put unbearable (tipping point) pressure on countries in the Asian region trying to compete with its 1.1 billion people, or India’s 1.2 billion?

•••

The fourth tipping point example is a bit more political than normal for Briefcase, but there is a remarkable situation emerging in Labor politics.

Unionism and the Australian Labor Party are fast approaching a crisis that is very familiar to business, if not left-wing politicians.

The question here is, at what time does a political party recognise that its traditional support base (the union movement) has dropped to 20 per cent of the workforce – which means a very heavy lift to get the other 80 per cent to vote for you?

It is this political version of the classic 80/20 rule (where 80 per cent of your business comes from 20 per cent of your customers) that is being applied in a perverse (or inverse) way which is not totally dissimilar to the bond market.

Union membership in the workforce is now totally out of proportion to union control of the ALP and, at some time, a tipping point will be reached when 80 per cent of the dog recognises that it’s being wagged by the 20 per cent tail.

•••

“The great secret of life is to not open your letters for a fortnight. At the expiration of that period you will find that nearly all of them have answered themselves.” Arthur Binstead, 1909 (well before the invention of that instant scourge, email).

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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