Good dividends key to recovery

John Collett
February 8, 2012

Are the days of cash as the first-choice investment of many risk-adverse investors numbered? With interest rates on their way down, you would think the cash yields on the big banks and stocks such as Telstra, at 7 per cent or 8 per cent fully franked, would beat the 5.5 per cent on term deposits - hands down.

Two years ago, term deposits paid almost 7 per cent as the banks sought domestic depositors due to the rising cost of overseas funding. The amount in term deposits is at record highs and the banks have decreased their reliance on overseas short-term funding.

Rates on term deposits are set to go lower but not as much as the cuts in interest rates. They still need to attract depositors and because term deposits are simple products, the banks compete only on the interest rates they pay.

Cash certainly makes a lot of sense, especially when the money is invested for a relatively short period or is earmarked for a specific purpose and when fear makes capital certainty king.

But a term-deposit return of 5.5 per cent taxed at the investor's marginal income-tax rate - unless inside the low-tax superannuation environment - does not leave much left after inflation. Cash has never been a solution for wealth creation.

At some stage, investors saving for long-term goals will have to re-embrace risk. Markets will turn the corner and begin the long-awaited recovery.

The head of investment research at Perpetual, Matthew Sherwood, says corporate earnings are in pretty good shape. It is negative investor sentiment, driven by Europe's debt crisis and lower global growth, that's the main obstacle to a sustained recovery.

But there are signs the crisis in Europe has stabilised, buying European governments more time to make lasting reforms. While global economic growth is weak, China is still growing at about 9 per cent, though it could slow further.

But the recovery in sharemarkets, when it comes, is unlikely to return to the double-digit gains common before the GFC.

Sherwood says income from investing, rather than capital growth, will play a bigger role for investors than it has during the past 30 years.

The head of Australian equities at Fidelity Worldwide Investment, Paul Taylor, says bad news is now priced into sharemarkets. ''Equity markets have their bear hat on, expectations are low and everyone is very well aware of the very negative macroeconomic global environment,'' he says.

With the hurdle set so low, all that needs to happen is for the bad news to get less bad and we could be in for better returns this year, he says.

In a lower-growth environment, you would expect those shares on good dividend yields that can deliver modest growth to do well. But there will be no bell to signal the beginning of the recovery.



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