Shares, Property or Cash?!

For the past five years as a whole, bonds and cash have been the place to be. While yields on bank deposits have been single digit, they have been higher than the returns from both shares and residential property. Of course, some shares and some property locations have done well but the broad experience has been poor, as the global financial crisis and its aftermath have weighed on returns from growth assets. This flight to "safety" has been a worldwide phenomenon. The trouble is that all investment trends end up getting pushed too far, eventually giving way to a reversal. We are likely now at, or close to that point, in the case of cash and bonds relative to growth assets like shares. What's the outlook? The return from an asset is a function of the income flow or yield the asset generates and capital growth. Of course, in the case of cash or term deposits, the yield is all that drives the return. And on this front the return outlook for cash is looking less promising. Cash Over the last year the official cash rate in Australia has fallen from 4.75 per cent to 3 per cent, as the Reserve Bank has sought to boost activity in areas like housing and retailing, as momentum in the mining investment boom slows and inflation is benign. While this is not the only influence on bank term deposit rates, it is the major one. As a result, while term deposit rates of 6, 7 and even 8 per cent were available a few years ago they are now nearer 4 per cent and falling. Given the softness in the domestic nonmining economy and the prospect for further RBA rate cuts, term deposit rates are likely to fall even further. This means that the prospective return on cash is rapidly dwindling. Property By contrast, residential property already offers comparable yields and will benefit as economic growth improves. House and apartment yields are running around 3.7 per cent and 4.8 per cent respectively, which are well up from their lows last decade. With mortgage rates well off their highs and likely to fall further, the residential property market appears to have bottomed out after falling since mid-2010, with a mild cyclical recovery likely over the next 12 months. However, short term gains from property are likely to be limited as buyers remain cautious about taking on excessive debt, particularly as job insecurity remains high. Furthermore, capital growth in residential real estate is likely to be constrained over the next five years by still very high property prices relative to incomes. There are two risks for property. The main downside risk is that China has a hard landing, with the hit to export earnings resulting in higher unemployment, forced sales and in turn, lower house prices. The risk of a hard landing in China seems to be receding though. The other risk is on the upside; there is always a concern that the old housing bubble is reignited by the latest collapse in mortgage rates. Again this seems unlikely though, given Australian's more cautious approach to debt since the GFC.