Low Interest Rates Mean Stocks Remain The Only Game In Town

Love them or hate them, low interest rates are here to stay.

Im torn.

On the one hand, my cash buffer is earning less and less. My 87 year-old fathers term deposit recently rolled over at 2.5%.

But on the other hand, while interest rates stay low, and perhaps are cut even further, by comparison, the share market looks very attractive, particularly  dividend paying stocks.

As the folks at Trapeze Asset Management said in their recent investment letter

Under current conditions, compared to other asset classes equities are the best, if not the only game in town.

The RBA meets later today to discuss interest rates. The overwhelming consensus is they will stay on hold, especially with house prices running hot.

Im with the consensus. All of which means, dont expect the  great dividend chase  to stop any time soon.

The old saying goes theres  always a bubble somewhere.

Today, its Australian property.

Writing in the  AFR. the excellent Christopher Joye continues to  ring the warning bells.

• Australias speculative housing boom is as big as the last investment bubble in 2003.
• Last financial year investors made up nearly 39% of new housing finance commitments, an almost identical level to the peak boom in the early 2000s.
• Unlike then, the SMSF sector can leverage its cash five times when purchasing properties. And they are piling in.
• Gross yields for houses in Melbourne and Sydney are only 3.2% and 3.6% respectively, less than inflation after transaction costs.
• Australian home values, measured relative to disposable incomes, are currently breaching the all-time records set in both 2007 and 2010.

Joye expects the boom, which he says is  turning into a bubble. to continue until the RBA starts raising interest rates.

He concludes by saying

Anyone not worried about current Australian house price dynamics is a fool. This only ends two ways: higher interest rates and/or macro-prudential brakes on lending.

My bet is its the latter.

A rise in interest rates puts the brakes on the speculative property boom, but also kills the economy, through an even higher Aussie dollar, and by putting even more pressure on many overly indebted households.

Citing over-inflated house prices, Credit Suisse recently said it thinks the peak in domestic interest rates would be below 3.5%.

It didnt say when. Dont expect term deposit rates to get back to  anywhere near  6% for a very long time.

Bubbles either burst, or slowly deflate.

The Lucky Country has lived up to its name in the past 23 recession-free years. Through a combination of population growth and two mining booms courtesy of the once-in-a-generation Chinese investment boom weve managed to avoid the economic problems plaguing many Western economies.

If this property bubble keeps on inflating, the RBA will soon be backed into a corner.

Even if the economy needs another kick-start, in the form of lower interest rates, the RBA wont be able to cut for fear of  further inflating the bubble.

Lower interest rates could yet happen.

In yesterdays  The Age. Australian Ethical Investments fund manager Andy Gracey  said

With unemployment heading up, inflation within the Reserve Banks target band, and the currency stubbornly high, it makes perfect sense to lower interest rates in 2014.

No-one wants to oversee the bursting of a bubble, particularly Glenn Stevens and his merry band of bankers. If they did end up cutting interest rates this year, theyd likely also impose higher buffers to curb risky lending.

Whichever way you look at it all,  the headwinds for Australias popular big four banking stocks  look to be increasing, especially when you consider their valuations today.

Still, the party goes on, for the time being.

Westpac Banking Corp  (ASX: WBC) trades at close to an all-time high. Based on its price to tangible book value,  Commonwealth Bank of Australia  (ASX: CBA) is one of the most expensive banks in the world.

Dont get me wrong. Im not here to tell investors their baby is ugly. Many fortunes have been made buying, holding, and reinvesting dividends in the Australian big four bank stocks.

I am saying, from here, they are NOT risk-free investments. Sure, in this low interest rate environment, their  fully franked 5% dividend yields  are attractive, and absence any shock, that yield will put a floor under their share prices. Just dont say you didnt hear the warning bells.

As you might guess, I look elsewhere for my investing kicks, outside the popular ASX 20 stocks.

Like  Contango MicroCap Limited  (ASX: CTN). for example, now  up 18%  since I said its  7.3% dividend yield puts term deposits to shame. I liked the stock so much I bought some for my family. Even after these impressive gains, the stock still trades at a discount to its net tangible assets.

Reporting season has come and gone for another six months, characterised by companies returning cash to shareholders, often in the way of  sharply higher dividends.

Its music to my ears, and more importantly, cash in my bank account.  Fully franked dividends  have the added benefit of being a highly  tax effective  form of income.

I was surprised to read the  S&P/ASX 200 Index  finished August flat. If youd have asked me to take a guess as to its direction for last month, Id have said up. Thats recency bias for you.

No doubt Im influenced by my own portfolio, which had a great month and thats despite one of my largest holdings, Canadian-listed oil junior  Manitok Energy. plunging 13% on the last day of the month.

On the bright side, because of the appreciation of a number of my other holdings, the fall didnt hurt me nearly as much as it might have previously.

Also on the bright side, Im convinced the market has over-reacted to Manitok cutting its production guidance for 2014. Its a pure timing difference. Based on flow tests, Manitok has drilled three of its best five wells in its corporate history in the last four months. Admittedly before the company revealed these unexpected facilities issues, the aforementioned Trapeze Asset Management said in just three years, a reasonable valuation would justify a share price for Manitok  more than three times  todays levels.

In the coming weeks, and after The Motley Fools strict share trading rules allow it, Ill be adding even more Manitok shares to our familys portfolio. With that sort of risk-reward, its a bet Im happy to make, even though, as was so clearly on example last week, bad things can and do happen to junior oil stocks.

I realise small Canadian-quoted stocks are not everyones cup of tea. Luckily, there are  plenty of birds in the bush  for ASX investors.

To prove the point, last week  Motley Fool Share Advisor s  Scott Phillips  revealed his  brand new  ASX stock recommendation, exclusively to subscribers of our premium stock picking service.

The company in question has reliable earnings, attractive growth prospects, and a very significant competitive advantage just the way we like our  Motley Fool Share Advisor  stocks. If its anything like previous picks like  Sirtex Medical Limited  (ASX: SRX) and  SEEK Limited  (ASX: SEK). up  239%  and  157%  respectively since we recommended them to members, the sky could be the limit.

Successful investing need not be difficult buy great companies, trading on reasonable valuations, and hold them for the long-term. Let the miracle of compounding returns weave their magic.

Yet many people are not satisfied with getting rich slowly. They want to find the next  Liquefied Natural Gas Limited  (ASX: LNG). up 2000% over the last year.

Good luck with that. For every  Liquefied Natural Gas. there are many, many more big losers. Its literally like trying to find a needle in a haystack.

Thats not to say there arent some rule breaker stocks trading on the ASX that have the potential for huge gains. Heck, we even have a stock picking subscription-only service Motley Fool Hidden Gems   dedicated to the cause.

One of our  Motley Fool Hidden Gems  picks has  already doubled. which is great doubly so because I also own it but we dont  expect  short-term fireworks. Any that do come will be an added bonus.

Slow and patient wins the investing race.

• Hold on to your stocks when the market inevitably wobbles.
• Regularly add new money  to your portfolio, ideally monthly.
• Run your winners.
• Cut your losers.
• Hold a cash buffer.

The end.

You’d better take a look at this. especially if you own bank shares!

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