Hold on for income

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There are interesting times ahead for the local markets, with some seeing flashing amber warning lights from changes in US interest rates and the US dollar. Could “interesting” turn into “dangerous” times? Has our stock market become detached from the US market and entered a different phase?

Watch the signs

How cautious investors react to the signs will depend on their road speed: are they still accelerating in a growth phase (where temporary speed bumps can be handled) or have they entered the income phase (where their main concern is not to lose their investment capital)?

The current caution among investors was clearly evident in a recent Westpac-Melbourne Institute index of consumer sentiment survey, which showed that 60% of investors preferred to have their money invested in bank deposits (34.3%) or real estate (25.7%). Only 12.5% preferred shares or superannuation. These are fairly extreme choices – particularly when US indices are at record levels. Hopefully most SMSF trustees have been taking a more balanced approach to their portfolios.

The survey tells us that people see better capital growth in property than in shares. More sceptical, income-minded investors might doubt this, when yields from leading shares (after franking) provide income at least double the most optimistic, after-tax yield from residential property or bank term deposits.

Despite this, speculative interest in residential property continues to the point that there are growing indications the government is looking to new measures – short of lifting interest rates.

Investors unsettled by the market mood need to decide whether they believe in tactical asset allocation – that is, shifting weightings in various asset classes in line with expected returns – and, then, whether they feel confident enough to make changes. In the old days, of course, this was called market timing and there have been plenty of studies, which suggest that gains from market timing are illusory or over-blown, especially for amateurs.

Dividend decisions

Still, there are signs income stocks have come off the boil. However, investors mainly seeking income may not want to switch out of bank shares and other yield stocks simply to pick what might be the temporary top of a market. No one is suggesting the banks or Telstra are likely to cut their payouts. Hold on for yield, is often the medium-term decision.

Especially now in the midst of dividend payments, which will, over the next few weeks, see Australia’s major listed companies paying out a bonanza in dividends, as final dividends for 2013-14 hit investors’ bank accounts. CommSec recently totted up the good news – more than three-quarters of reporting companies maintained or increased their dividends and, over the next two months, more than $20 billion will be injected into the economy – and SMSFs’ coffers.

As well, there have been special dividends or capital returns from Wesfarmers and Suncorp Metway, record dividends from CBA and a higher payout and share buyback from Telstra. The four largest current dividend payers (CBA, BHP, Telstra and Wesfarmers) are paying almost $8.9 billion in coming weeks.

It might also be worth paying some heed to the muted mumblings about the future of dividend imputation. While eliminating imputation would enable the government to claw back a lot of tax revenue, it would be a deeply unpopular and inequitable change. Still, company boards need to be aware of this when framing their dividend policies – especially if they have large reserves of undistributed imputation credits.

In all this, investors should keep their focus on income; as long as the supply of credit continues, some investors will behave like speculators, chasing stocks like the recently listed Alibaba to dizzy limits. As in the run-up to the GFC, when most players wanted to keep dancing as long as the music was playing, investors will have to keep a close watch on the orchestra.

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.

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