Having completed a full cycle of reports on each of the 11 major sectors of the ASX 200 since October 25, 2012, I now plan to update all of those reports – but turning my attention to any good stocks, including those that are outside the top 100. A good, solid equities portfolio needs a core of top-100 stocks – but including a few smaller capitalisation stocks might add that little bit extra. But before I get to the sector update, I will report on a two-part overview across all of the sectors.
A lot has happened over the last six months to change the balance of how sectors are performing. The key feature of this shift appears to have been the flight from cash to high-yielding stocks to supplement the income from an asset allocation. Of course, leaving the safety of term deposits and the like requires investors to have some renewed confidence in the market.
Four sectors are typically considered to be the high-yielding sectors: financials (ex property), property, telcos and utilities. Many of these stocks come with franking credits, which are particularly attractive for funds in pension mode. A yield of, say, 5% that is fully franked climbs to 7.1% [= 5 x (1 + 0.3/(1 – 0.3))] for a corporate tax rate of 30%. Of course the May budget may do something about corporate tax rates and/or the return of franking credits – so watch out!
The capital growth in these four sectors since the start of 2012 has been staggering: Financials (45.6%), Property (39.6%), Telcos (49.3%) and Utilities (27.1%). No doubt this stellar growth helped attract cash from the sidelines for yield and perhaps further capital gains. Interestingly, a distinct pattern emerged in the yields of these four sectors. As can be noted from Chart 1, there was a gap of about 2 percentage points between the highest (Telco) and the lowest (Utilities) at the start of 2012. Since then, the massive – but disparate – capital growths forced yields down and to a much tighter cluster.
[1]
Finding the floor
What caused this conversion? All four sectors had attractive yields and investors needed to find enough stocks and get some sort of diversification to help reduce risk – particularly on the capital gains side. But there is a floor to how low these yields can reasonably fall.
There are risks associated with investing in stocks that are not shared by the almost riskless term deposits and the like. Investors need a premium over the term deposit rate to compensate for this additional risk – called the equity risk premium. It appears to me – by the nature of the convergence – that the ‘floor’ yield has almost been reached. Unless earnings improve and/or payout ratios increase, further capital growth in these sectors would force yields down further. As a result it looks to me that investors should not expect too much more capital growth but a fully franked dividend yield of over 7% still looks attractive – so no need to bail out if it is long term gains that the investor seeks.
This convergence is unusual. If we take the data used to construct Chart 1 back to 2002 – the earliest data we have – it becomes clear that the current behaviour is most unusual.
[2]Perhaps the nearest comparable period is in 2007 – just before the onset of the GFC. Stock prices then tumbled but dividends largely held up so the expected yields looked massive and many of these ‘super’ expected yields were converted into actual yields for those brave investors who bought at the bottom. Interested readers can go back to my reports on these sectors here [3] – these will be updated in due course.
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.
Also in the Switzer Super Report
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- James Dunn: Small agricultural stocks WBA, TAN worthy of support [5]
- Gavin Madson: S&P defaults provide guidance [6]
- Kim Tracey: Fundie’s favourite – Sirona Dental Systems [7]
- Tony Winterbottom: Defence Force Housing – a hands-off investment [8]
- Tony Negline: Question of the week – borrowing to buy shares [9]