Market yields to upturn
At first glance, the biannual corporate show-and-tell seemed to be all show and little tell.
Never have so many chief executives, from BHP Billiton to Network Ten, been rolled just before or during a profit-reporting season.
All those asset write-downs are hardly a vote of confidence, either.
Yet more telling is the surprising rise in revenues among non-mining stocks, extending even to lower-than-feared drops for the loss makers.
Another thing. About half the stocks in the ASX 200 lifted their dividends, the best sign of all that a board is confident that things are on the mend.
No board wants to lift the dividend if there's a risk of having to drop it again the next time. In many cases the dividend was lifted by more than the rise in earnings, too, not that we're talking large percentages either way here.
But bear in mind that most companies were reporting on the second half of last year, which economists say was a particularly bad patch. Then there's all that cost-cutting and staff-shedding.
With a lower cost base, at least when the economy picks up, the rise in profits will be amplified.
The official economic forecast expects it to be a bit worse than last year, but picking up towards Christmas.
Considering last year hasn't turned out to be so bad after all for profits, maybe the market isn't running ahead of itself as many fear.
Then again, a double-digit jump in three months is a stretch.
So what changed for the better?
Well, nothing really. It's just that last year's rate cuts are finally coming home to roost. Better late than never.
Low rates have not only cut the cost of borrowing, both for corporations and households, but also made it less attractive to save.
Indeed, there are some faint signs of a pick-up in home building as well as spending by households.
Fortunately if these falter - the prolonged election campaign sure won't help - the Reserve Bank has promised to cut rates to give them a nudge on.
It has to be said much could still go wrong internationally, but so long as central banks are pumping liquidity into the system, sharemarkets have nothing to worry about.
The funny thing is that although our market is being driven by a rush into high-dividend-yielding stocks, such as the banks and Telstra, these have also posted some of the biggest price gains.
How about that? You buy for the yield, and you get the bonus of a healthy capital gain.
In fact, the gains in their share prices have been way above what they've paid in dividends over the past year.
If you ask me, it sounds too good to last. As the crowd climbs on the yield bandwagon, there's a risk the banks become overvalued. The higher their shares go, the less safe they become because of the increased damage a fall could wreak on those who jumped in last.
Besides, the banks can only grow marginally while credit growth is so low.
But other blue chips aren't as constrained. Take BHP Billiton.
It yields a modest 4 per cent with franking credits but is sitting on a huge mound of capital, some of which eventually will finish up in shareholders' pockets one way or another.
And did I mention the export boom?
Remember: in the global financial crisis it was the banks, not BHP, that cut dividends and put their hands out for more capital.
Twitter @moneypotts
Frequently Asked Questions about this Article…
The article notes roughly half of ASX 200 boards raised dividends as a sign of confidence that conditions are improving. Many companies cut costs and staff last year, lowering their cost base, so modest earnings improvements can be amplified. Boards generally avoid increasing dividends unless they believe the payout can be sustained, so the lifts were interpreted as a vote of confidence even though most reports covered a weak patch in the second half of last year.
High-dividend yield stocks such as the banks and Telstra have attracted buyers and produced strong price gains in addition to dividends. The article warns this can make banks look overvalued: as their shares rise, downside risk for late buyers increases and bank earnings growth is constrained while credit growth is low. In short, yield-plus-capital-gain outcomes have been attractive recently, but investors should be cautious about overpaying for yield.
According to the article, last year’s rate cuts have started to take effect by lowering borrowing costs for companies and households and making saving less attractive. That has contributed to early signs of increased home building and household spending, which in turn supports corporate revenues and profits as the economy recovers.
The article highlights that widespread cost-cutting and staff reductions have reduced corporate cost bases. With lower costs in place, even a modest recovery in demand can produce amplified profit increases when the economy picks up, which helped explain better-than-feared results for many non-mining companies.
The article points out many CEOs were replaced and there were notable asset write-downs, which aren't positive signals. However, these negatives were balanced by surprising revenue gains among non-mining stocks and broadly higher dividends. Investors should be mindful of both the governance and accounting concerns and the operational signs of improvement when assessing companies.
The article describes BHP Billiton as yielding a modest ~4% with franking credits and holding a large capital position. That capital could eventually be returned to shareholders in various ways, and the company stands to benefit from an ongoing export boom, making it an example of a blue chip less constrained than banks.
The piece suggests the market rally may be partly justified because last year’s rate cuts are beginning to feed through and corporate earnings haven't been as bad as feared. Still, the author cautions that a double-digit jump in three months is a stretch and implies some risk the market could be running ahead of fundamentals, so investors should be prudent.
The article warns a prolonged election campaign could weaken household spending momentum, and international developments could still derail the recovery. However, as long as central banks continue to pump liquidity into the system, sharemarkets have less to worry about — though geopolitical and economic risks remain important to monitor.
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