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What a US recession means for Australian share investors

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How should Australian investors respond to the prospect of a recession in the US? Photo: Getty
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It has been a confusing, and potentially concerning, week on global markets.

This week’s big falls in the US sharemarket have been due to concerns about slowing China growth, US-China trade tensions and the risk of a US recession – signalled by an inverted yield curve (the interest rate of 10-year Treasuries fell below two-year bond rates).

As Australia’s sharemarket (and other global markets) generally are reactive to any falls in the US – and we’ve seen that play out on our market – how should Australian investors respond?

Sell or wait – depends on your objectives

Many investors will be spooked by the falls and may rush to sell their shares.

For short-term investors or traders, this may make sense, but longer-term investors may need to take a deep breath and think carefully before selling into a falling market.

Investing for yield, in particular, is likely to be an ongoing objective for many investors, especially with an ageing population with more people reaching retirement age and living off their superannuation.

Selling high-yielding shares that are funding a retirement income stream will need to be replaced with other high-yielding assets.

Otherwise retirees will have to sell down assets to fund their retirement.

At this point in time, other high-yielding investments, especially outside the sharemarket, may be difficult to find.

The last recession in the US lasted 18 months from 2007 to 2009 (according to the US National Bureau of Economic Research).

The S&P500 Index fell more than 50 per cent, bottoming in February 2009, just before the official end of the US recession in May 2009 (see Chart 1).

how the US recession will affect Australia
The S&P 500 index performance over the past 20 years to August 2019 with US recessions (grey bars). Source: www.macrotrends.net

During the last US recession, Australia was lucky, as although the sharemarket’s performance mirrored that of the US, a recession did not eventuate, with the mining sector propping up the economy.

Australia’s not so lucky this time

This time around, if the US does go into a recession, Australia’s position may not be as favourable.

Although, Australian GDP growth has continued to be positive – albeit at a slow pace – wages growth is nonexistent, and interest rates seem to be heading to zero.

Investors concerned about yield have focused on higher-yielding shares, and with interest rates on a downward trend with the cash rate down from over 7 per cent in 2008 to to the current low of 1 per cent, this situation is likely to continue.

High-yielding will remain in vogue

The S&P/ASX 200 Index has had a good run this year, up 20 per cent before the recent sell-off, and including dividends, the returns would be closer to 26 per cent (before franking credits).

Investors in the usual high-yield shares are going to find alternative sources of yield hard to find – especially if attracted to the relative stability of blue-chip companies that are usually good sources of yield.

But, investing for the long term will provide less volatility in overall portfolio performance, rather than focusing on daily moves in the sharemarket.

An example of where high-yielding share funds or ETFs are likely to be investing their money is the Vanguard Australian Shares High-Yield ETF with the majority of the ETF invested in the top 10 shares.

Top 10 holdings in Vanguard Australian Shares High-Yield ETF

The risk of a recession in the US will not remove the hunt for yield, especially with the Australian official cash rate heading to zero.

Good-quality shares with strong management and continuing growth prospects will underpin investing in high-yielding shares.

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