Tuesday's cut to the cash rate by the Reserve Bank will have even more investors flocking to the sharemarket's higher-yielding shares. The danger is that investors' love for higher-yielding stocks will push their share prices even closer to "bubble" territory.
Concerns have been building that a bubble may be developing in the higher-yielding shares. The rotation from cash to higher-yielding shares started in the middle of last year after the Reserve Bank commenced cutting the cash rate in late 2011. Bank shares yield between 7 and 8 per cent, after franking credits. Term deposits pay about 4 per cent. Two years ago, they were paying about 6 per cent. The banks may not pass on the full 0.25 percentage point cut in the cash rate to their term deposits. But if they pass on most of the cut, the 4 per cent interest rate on term deposits will be closer to 3.75 per cent.
There is still a lot of money in term deposits. Most of that money is earning much higher interest than can be earned on term deposits now. Much of that money is likely to end-up in higher-yielding shares when these term deposits mature.
Shane Oliver, the chief economist at AMP Capital Investors, said lower term deposit rates would prompt investors to step up the chase for yield. The valuations of the higher-yielders would likely rise even further but a lower cash rate should help stimulate the economy. That would moderate the gap between the share prices and earnings, Dr Oliver said.
When economic growth eventually picks up, higher-yielding stocks could take a back seat as growth stocks do better. However, he could not see share prices of the higher-yielders coming back sharply.