Seniors embrace land girt by yield

IT’S only February but it’s clear this will be the year our investment market will reveal itself as a logic-defying enterprise.

Seniors grab land girt by yield

IT’S only February but already it’s clear this will turn out to be the year our investment market will fully reveal itself as the unique, logic-defying enterprise it has become: an enterprise underpinned by older Australians and a curious tax system that greatly favours high-dividend shares and residential property.

It’s a trend you better not fight and one that rewards ... handsomely.

This week bank stocks beat all expectations again: Commonwealth Bank pumped out better-than-expected results and moved convincingly higher on the market. This was not supposed to happen. Similarly, we had confirmation house prices rose 10 per cent nationwide last year and investors now account for 40 per cent of all new home loans. This is not supposed to be happening either. To top it off ANZ, a financier of the house price surge, went to the market to raise $1 billion and a legion of mum--and-dad investors queued to take the offer.

According to the textbooks, these three key developments defy logic - bank stock prices should be lower because they ran too high in recent times. Moreover, bank profits are not supposed to rise 14 per cent if the economy is growing at only around 3 per cent.

House prices should be flat for the same reason, especially since our cities already carry some of the most expensive real estate in the world.

And textbook theory also tells us mum and dad should not so readily accept the risk of bank hybrid notes because they are not sufficiently protected for the risk taken. In reality many of those applying for ANZ’s “unsecured, perpetual, subordinated” notes will pay little attention to the details, focusing instead on two things: a return of 3.4 per cent higher than cash and an implicit guarantee the investment is quite secure because it’s offered by a big four bank.

Here’s the thing ... older Australians, typified by the million people who are now part of DIY funds, don’t give a fig for textbook economics and less so for the opinions of overseas “experts” who question Australian valuations. Rather, they want investments that work for them and that means “income stocks” with dividend yields of 5 per cent plus and rental properties that offer, maybe, 4 per cent.

Remember a stock that offers, say, 6 per cent dividend yield translates to more than 7 per cent after tax. Likewise, a rental property may offer just 4 per cent rental yield but that’s hardly a problem if its capital value lifts 10 per cent in a year. Both these propositions look a hell of a lot better than 3 per cent offered for cash deposits.

This is a genuine megatrend and, crucially, even the major financial institutions themselves are bowing to it. This is what will make 2014 different.

Until now older Australians wrested for control of the market with the major financial institutions that have ruled for generations. This year we see more and more confirmation that power is shifting towards our army of retirees.

It’s the income- seeking of older Australians that now dominates. Here’s a direct quote from global institutional investor Credit Suisse in a recent report on the issue: “We have come to our senses and step out of the way of these considerable flows.” Credit Suisse tells its own institutional clients it’s time to stop trying to outwit older Australians. Rather, the money is to be made getting in line behind them.

And that’s just concentrating on the sharemarket; in the property market older investors can exploit a range of tax incentives uniquely Australian - while their homes can be magnificent, they can still draw a state pension. Separately, if they have residential investment property in their DIY fund the income is tax-free.

No amount of sober real estate analysis of over-pricing and historic cycles is going to counterbalance those attractions.

Mind you, there is one truism that still holds in this odd market: follow the money. Returning to that Credit Suisse report, the bank also explicitly suggests that Australian sharemarket success will continue to come from picking those stocks with a “high, rising and franked dividend yield”.

It’s no surprise to find the smarter chief executives on the market are highly aware of this bigger picture and moving to follow the money.

Take Orica and chief executive Ian Smith as a case in point. The explosives and chemical company wallowed with the rest of the industrial sector until a few months ago when Smith took a leaf from the banks’ playbook and announced Orica was moving to lift its dividend not just once but as a long-term policy. The stock reacted straight away, moving from under $19 to about $24 or so in the following months - gains that have been retained.

Even the big mining houses, which have been notoriously low dividend payers (they used to sell themselves on growth), have moved en masse to a strategy of lifting dividends.

Where will it all end? Badly, I expect, but not until it is fully played out, which will take years. Paying ever higher dividends means profits don’t get ploughed back into business; rather the profits finance the lifestyle of our older Australians.

Likewise if houses are continually sold to older richer members of the community, they end up being landlords to a generation who will never own their own homes ... but that’s down the track, too. For now, the trend is your friend.

This article is part of the It’s Time series in Eureka Report focusing on new opportunities for investors in 2014.

James Kirby is managing editor of Eureka Report.