Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 71

Australia’s default: shares versus bonds through the crisis

In the first three parts of this series over the last month, we have explored the ways governments can avoid repaying their debts in full; how Australia’s big default and debt restructure occurred in the 1930s; and the returns achieved by bond investors before, during and after the debt restructure.

In part 4, we look at the returns from the broad stock market versus the government bond market during the 1930s crisis. We see how the impact of the Greece-like default and restructure of government bonds affected bond returns, compared with the impact of the 1929 crash on share returns.

Bonds versus shares during the crisis

Despite the default and restructure for all domestic Australian bonds, bond investors who held on during the crisis (and refinanced their old defaulted bonds with new ‘haircut’ bonds), did better than share investors.

The chart below shows total returns (including capital gains/losses plus income) from the start of 1929 to the end of 1932. Share market returns are measured by the Sydney Commercial Index (the main index of large stocks across all of the main industries), including dividends paid. Bond returns are based on Commonwealth bonds maturing in five years or longer, including interest coupons.

For a snapshot of the key events during the period, refer to the chart in Part 2 of this series.

Income return was the same for shares and bonds but capital losses different

Share and bond investors received the same investment income over the four years: dividends from the broad share market gave investors 19% in total over the period, the same as the 19% interest paid on bonds.

The big difference was in the market prices of shares versus bonds. Share prices fell twice as far as bond prices, dropping 46% from the peak in 1929 to the bottom in August 1931. Share prices started to recover in September after the August 1931 debt restructure deal. The broad share index was still 20% lower by the end of 1932, whereas bond prices had recovered to par. However the 20% capital losses on shares were almost made up for by dividend income, leaving investors almost square after four years, and ahead 15% in real purchasing power terms after the general price deflation of 17% over the period.

These are very good investment returns for the four years during the worst of the ‘Great Depression’: 29% real total returns from government bonds, including the default and restructure, and 15% real total returns from shares, including the 1929 stock market crash!

Three phases of the crisis

There were essentially three phases of the crisis, and shares and bonds did different things in these three phases. The first phase was late 1929 to September 1930. During this phase share prices collapsed while bond prices remained strong. Investors dumped shares in the panic and bought government bonds as a ‘safe haven’. Some safe haven, as the government defaulted.

Share prices nearly halved over the period, which included the October 1929 ‘crash’, which was much milder in Australia than in the US because Australia did not have a wild speculative bubble in the late 1920s, and so there was no bubble to burst. Australia was already in recession, in 1928-1929, commodities prices had already collapsed, and credit markets had already dried up for Australia (thanks primarily to the profligate NSW government).

The second phase was between September 1930 and the August 1931 debt restructure. Share prices stabilised after the August 1930 ‘Mobilisation Agreement’ under which the commercial banks agreed to lend the Commonwealth government £3 million per month to pay interest on debt and to keep the government running. Shares stopped falling but bonds (the so-called ‘safe haven’) collapsed, all the way to the August 1931 default and restructure.

The third phase was after the August 1931 debt restructure, when prices of shares and bonds recovered strongly together.

Not only did Australian shares suffer less than US shares, they started to recover a year earlier than US shares. The main reasons were that Australia abandoned the gold standard and depreciated its currency more than a year earlier (from January 1930), and also because Australia did not go on a Keynsian debt-funded spending spree – because it was simply unable to borrow from domestic or international debt markets.

Investors’ worst fears were realised

As usual, the best returns were received from buying in the depths of despair, when there is ‘blood in the streets’. Investors’ worst fears were realised: the government failed to pay interest and principle on its entire stock of domestic bonds and notes. Interest payments were slashed 22.5% across the board and bond holders had to wait up to 30 years to get their money back. The ‘worst case scenario’ turned into fact, but returns were still very good for bond investors, even through the default and restructure.

The same was the case for the defaulted Greek bonds in 2012. The ‘worst case scenario’ came true – the government failed to pay and the debt was restructured in a ‘haircut’ deal, but there was still plenty of money to be made. Several hedge funds made a mountain of money buying off panicking investors at the depths of the crisis. The losers were the investors (mostly European banks and pension funds) that sold into the fear.

Australian investors, bonds and listed bonds

By the way, recently there has been much chatter in the ill-informed national media about Australians not being accustomed to bond investing, and also not being accustomed to bonds being listed on the stock exchange. This is complete nonsense.

The recent listing of bonds on the ASX is nothing new. Bonds were listed on Australian stock exchanges for more than a century. Bond-holding has exceeded share-holding for Australian investors for most of our history. In addition, bond trading has exceeded share trading on the main public exchanges in volume and depth for most of the history of stock exchanges in Australia.

Shares only overtook bonds as the preferred investment for Australians in the late 1960s, thanks to two main factors. The first was the speculative mining boom of the late 1960s, in which almost all of mining stocks that appeared in the boom promptly disappeared worthless in the crash that followed. The second factor was tax: specifically the removal of tax rebates on bond interest in 1969, followed by the granting of franking credits to shareholders in 1987. Australia is like almost all other ‘developed’ countries in the world, where bond investing has been more popular and more widespread than share investing for most of its history.

This concludes our 4-part story of Australia’s big government debt default.

 

Ashley Owen is Joint CEO of Philo Capital Advisers and a director and adviser to the Third Link Growth Fund.

 

RELATED ARTICLES

Australia’s default: who do you rescue?

Australia’s default: A primer on government debt, default and inflation

Lessons from a century of virus plagues

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Welcome to Firstlinks Election Edition 458

At around 10.30pm on Saturday night, Scott Morrison called Anthony Albanese to concede defeat in the 2022 election. As voting continued the next day, it became likely that Labor would reach the magic number of 76 seats to form a majority government.   

  • 19 May 2022

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Welcome to Firstlinks Edition 455 with weekend update

The resolve of many investors to focus on the long term with their share portfolios is increasingly tested as the list of negatives lengthens. There is a lack of visionary policies during an election campaign and stimulatory spending is contradicting the aims of tighter monetary policy.

  • 28 April 2022

Latest Updates

In praise of our unique democracy and its sausage

For all the shortcomings of our political campaigns, our election process is the best. We are blessed with honest administrators and procedures that we all trust to hand over power peacefully, with a big snag. 

Investment strategies

Is the investing landscape really different this time?

Many market analysts argue that the pandemic has changed everything but we must judge whether the circumstances are as drastic as billed. A quick review of four major events helps decide if this time is different.

Economy

Comparing generations and the nine dimensions of our well-being

Using the nine dimensions of well-being used by the OECD, and dividing Australians into Baby Boomers, Generation Xers or Millennials, it is surprisingly easy to identify the winners and losers for most dimensions.

Retirement

When will I retire? Economic impact of an ageing population

About 39% of the labour force is aged over 45. Intergenerational reports highlight the challenges of an ageing population and the impacts on consumption patterns, dependencies, public finances and economic growth.

The real story behind the crypto crash

The recent sell-off in the crypto market and its trigger - the collapse of the Terra UST coin - has affected many institutions either holding or trading crypto assets, including crypto fund managers.

Investment strategies

Cash is the nightingale, the bird in the hand

The bird in the hand is worth two in the bush, and it's an apt metaphor for investment choices. In 2021, as investors hunted in the bush for decent returns, demand overwhelmed supply. Cash is the bird in the hand.

Strategy

Book review of 'Putin’s People' and his motivation for war

Author Catherine Belton argues Putin’s sole ambition is to hold onto power. Her book seeks to understand why Putin invaded Ukraine after he became isolated and out of touch with reality during the pandemic.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.