A move to higher-yielding shares could inflate a bubble
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.
Frequently Asked Questions about this Article…
The article explains that a cut to the cash rate tends to push investors out of low-yield cash products and toward higher-yielding shares. That can boost share prices of dividend-paying stocks but also raises the risk that those shares could move closer to 'bubble' territory.
Term deposit rates have fallen (around 4% now versus about 6% two years ago), while many bank and high-yield shares offer higher effective yields (about 7–8% after franking credits). As term deposits mature, the lower interest on new deposits is likely to push money into higher-yielding shares in search of better returns.
Yes — the article notes growing concerns that strong investor demand for higher-yielding stocks could push their prices toward 'bubble' levels. The rotation into these shares started after the Reserve Bank began cutting rates, and continued demand could inflate valuations further.
According to the article, bank shares yield about 7–8% after franking credits, while term deposits currently pay roughly 4%. If banks pass on most of a recent 0.25 percentage point cash rate cut to depositors, term deposit rates could fall closer to 3.75%.
The article says banks may not pass on the full 0.25 percentage point cut, but if they pass most of it the typical term deposit interest rate could move from about 4% to roughly 3.75%.
Shane Oliver warns that lower term deposit rates will prompt investors to 'step up the chase for yield,' which would likely push valuations of higher-yielding stocks even higher. He also notes that a lower cash rate should help stimulate the economy, which could moderate the gap between share prices and earnings.
The article suggests that when economic growth eventually picks up, growth stocks may outperform and higher-yielding stocks could take a back seat. It also notes the view that the share prices of higher-yielders are unlikely to fall back sharply.
Investors should be aware that heavy demand for higher-yielding shares can inflate valuations and create bubble-like conditions. The article highlights the risk that prices may move ahead of earnings and that performance could shift if economic growth returns and investors favor growth stocks.
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