Economic prospects 2016-17

Posted by in Economics

Unbiased economic advice is so hard to find – every commentator has an angle to sell for their own advantage. But when the commentator is the Australian Financial Review releasing their annual stock picks for self-managed super fund investors, AFR’s credibility and therefore their subscription income is on the line, and its reliable analysis. Here’s their key points:

From early March to the end of April, more $3.2 billion in dividends was paid to members of the million-strong SMSF movement. This may seem like a lot but SMSFs will actually receive about $1 billion less than last year.

Pumped up by incredibly high payout ratios, generous franking credits and progressive dividend policies, companies that could least afford it were forced to distribute more and more capital to income‑hungry shareholders. It was only a matter of time before overstretched companies turned off the taps of cash.

So far, the trend was contained. In fact, the shortfall in interim dividends from this year can almost entirely be sheeted back to our largest mining companies as they bit the bullet.

Now, investors will be keen not to count their chickens before they hatch, especially as the ASX 200’s yield reaches another peak. The market’s current yield is 4.97 per cent before franking credits. It is the third-highest yield the market has thrown off in the past 25 years.

The payout ratio, or the percentage of profit a company pays out as dividends, is also peaking. Just four years ago the average payout ratio for an ASX 200 company was 65 per cent. Today it is an unsustainable 106 per cent. That’s right, in aggregate, companies are paying out more than they are earning in order to appease shareholders.

Over the past 10 years dividends have contributed the lion’s share of total returns from equities, contributing 4.6 per cent a year compared with capital returns of 3.6 per cent a year, according to CommSec.

Looking at the economic outlook, AMP Capital’s Shane Oliver expects gross domestic product to ebb. Oliver says this means that another rate cut from the Reserve Bank is now a line-ball call, noting that the job market has been holding up well even though he expects economic growth to slip back to 2.5 per cent.

The prospect of a rate cut is bad news for savers who are struggling to generate returns above inflation. It is, however, good news for the broader Australian sharemarket, which could receive a fillip from those seeking higher returns.

The bad news is the deteriorating outlook for future profits and dividends. As Macquarie Group aptly puts it, revenue growth was absent, profit margins were below expectation, earnings guidance was non-committal, and earnings expectations declined. Ouch!

Corporate Australia has done a good job of cutting costs in the face of almost zero revenue growth for industrial companies in the first half of 2015-16. But potentially negative revenue growth next financial year will force analysts to lower earnings estimates.

“It’s critical to focus on opportunities that have a track record of delivering reliable earnings and distribution growth and are not based on significant leverage. In other words, make sure the yields are sustainable.”

Justin Christofel, portfolio manager with the world’s largest asset manager, BlackRock, sums up the challenge facing readers. “It is important to be mindful of where you seek yield, particularly if capital preservation is a portfolio objective.”

Source: “How to build a portfolio of reliable dividend payers” James Frost AFR Smart Investor May 2016