Last week, China was formally welcomed into the monetary easing dance party. Previously, the People’s Bank of China (PBOC) had taken tentative steps, but with the 100 basis point cut in the reserves requirement ratio (RRR), China officially took to the monetary easing dance party floor. Make no mistake, this represents an aggressive policy move by the PBOC, despite comments to the contrary. Currently, the US remains the only missing participant, but with the release of further soft data over the weekend and last night, the Federal Reserve is dancing only just outside the party door.

The case for an RBA cut

Locally, there has been much speculation on the timing of the next domestic rate cut. Following the RBA’s decision to leave the cash rate unchanged in April, the market is now pricing in a 56% chance of a 25 basis point cut in May, compared to 80% just two weeks ago. Just last week, a major bank became the first to officially tip ‘no 25 basis point cut’ in the cash rate in May. Indeed, there is some speculation that we are at the low point of the cycle. Personally, I believe the RBA remains committed to at least one more rate cut this year. I continue to forecast a 25 basis point rate cut in May before the Federal Budget.

I refer readers to the comment by the RBA governor in New York last week when he said that an interest rate cut was “still on the table.” In central bank-speak, the inference is that the RBA retains an easing bias, dependent on incoming data releases. In this regard, the domestic economic outlook remains soft. Annualised headline inflation is just 1.3% per annum and the unemployment rate is 6.1%. Both are expected to contain wages growth at historic lows of 2.5%. In addition, economic growth is expected to be further downgraded in the RBA’s May statement. As such, the domestic case for another rate cut remains undeniably strong.

This should provide ample ammunition for at least another 25 basis point rate cut. But there is another important reason. As I have previously mentioned, the RBA has committed to a competitive currency devaluation through a lower interest rate policy. If there was any doubt about that commitment, the proof was on display again last week. After the PBOC’s decision to cut the RRR by 100 basis points, the Australian dollar rose a full cent to US 78 cents. The very next day Glenn Stevens responded with a reiteration of the RBA’s easing bias. The Aussie dollar was at US 80.23 cents yesterday and a rate cut rather than jawboning is now required.

The yield bonus

The attractiveness of grossed-up fully franked dividend yields, which remain at a 500 basis point premium over the cash rate, remains obvious to all investors. But the contribution to total returns is even more compelling. While the S&P/ASX 200 remains roughly 15% below the all-time high, the S&P/ASX200 Accumulation index has long-passed the previous high. Currently it is 24% above the previous all-time S&P/ASX 200 high set in 2007. That is the compounding power of dividends. The S&P/ASX Accumulation Index has returned 55% over the last five years compared to 24% for the S&P/ASX 200 prices index. The 31% difference is the annualised contribution of dividends (ex franking credits) to total returns. As a result, dividends have contributed about 56% of total returns of the last five years and that is BEFORE the value of franking credits to Australian resident taxpayers.

ASX200 Accumulation Index (XJOAI) vs. ASX200 Index (XJO) last 5 years common base

ASX200 Accumulation Index (XJOAI) vs. ASX200 (XJO) last 20 years common base

S&P/ASX 200 companies are expected to return a record $90 billion ($80.5 billion in dividends and $9.3 billion in buybacks) to investors this year, a 9% increase on the $82.5 billion paid last year. It also represents a payout ratio of about 73%, compared to less than 40% in the US. In the reporting season to 31 Dec 2014, a total of 68% of companies increased dividends over the previous year. This is remarkable given earnings fell more than 20% over the same period. To put it in perspective, the $90 billion in dividends expected to be paid this year is roughly 5.5% of GDP, or nearly six months of retail spending. That is the power of dividend yield.

In addition, history shows that companies that pay higher dividends deliver higher shareholder returns than companies that have high capital expenditure budgets. The reason is they are less efficient allocators of capital. The mining sector is a prime example. They have an abysmal track record of misallocating excess capital. At the peak of the boom, mining companies were reinvesting in future growth rather than returning capital to shareholders in the form of higher dividends. Now, the reverse has happened. Go figure?

The “search for yield” and the attractiveness of fully franked dividends can only accelerate if the latest, but dated, figures from APRA are correct. In the December quarter last year, the average SMSF still had cash levels of 16.5% compared to 17% in the Sept quarter. This compares to the decade average of 10%. With nearly $80 billion in annual super inflows, cash levels are compounding rapidly. This is even more important given my expectation of another fall in the cash rate.

Still banking on it

Strategically I remain a buyer of sustainable Australian fully franked dividend yields at a reasonable price. I think the recent trading pullback in the major banks is a clear buying opportunity ahead of their record interim dividends in May.

While CBA, Macquarie Group and Westpac are in my “Nifty 15”, I’d also be buying NAB, ANZ, Bank of Queensland and Bendigo & Adelaide Bank into any slight dips, ahead of what will be a cracking reporting period for the banks.

Other dividend growth companies in my “Nifty 15” include Goodman Group, Telstra, Transurban Group, Sydney Airport, Wesfarmers and Westfield Corporation.

Dividends are never out of fashion. They (plus franking credits) will continue to contribute a high proportion of the total return available in Australian equities.

Australia remains the yield market of the region. Faster growth is available elsewhere in the region. So a portfolio of domestic income and regional growth is the answer.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.