What a day for stocks.
What a day for financial stocks.
The Aussie blue-chip index, the S&P/ASX 200, fell 1.4% yesterday.
The S&P/ASX 200 Financials index did even worse. It fell 2%.
Australia’s biggest company, Commonwealth Bank of Australia [ASX: CBA], slid to $75.50. That’s its lowest level since late October.
Not for the first time (nor probably the last) this year it leads us to ask the question: Is this a warning to get out of stocks now or simply another chance to buy on a short term pullback?
We’ll give you our take below…
As you should know by now, the big reason for rising stock prices in 2012 and 2013 was low interest rates.
The big dividend paying stocks benefited the most from this surge.
As the interest rate on bank savings accounts and bonds fell, investors (especially those who derive income from their savings) started looking for investments with a bigger income stream.
Where else should investors look for an income-boosting quick fix than the stock market?
It’s fair to say the dividend rally ran out of puff in March this year when stocks fell. They rallied again into May before running out of steam again. The latest move started in June as stocks again took off, this time hitting a brick wall in October.
So, what can we expect to happen next?
Is this just the latest round in the stock sell-off and rally cycle? Or is it a sign that stocks really are overbought and the market is heading for a crash?
Our position on this is clear: interest rates will not rise in the medium term. Therefore investors will demand assets that pay a higher income than typical fixed or variable interest cash investments.
You only have to look at this week’s statement from the Reserve Bank of Australia (RBA):
‘The Australian dollar, while below its level earlier in the year, is still uncomfortably high. A lower level of the exchange rate is likely to be needed to achieve balanced growth in the economy.‘
There’s not a snowball’s chance in heck of the RBA raising interest rates. That will be true for as long as the Aussie dollar is above US$0.80. That means investors will keep piling into stocks as long as dividend yields stay attractive.
We know, the folks who say that interest rates are bound to rise will call us bonkers. They’ll say that central banks are holding interest rates artificially low and that this can’t last forever.
And that’s true. It can’t last forever. But that doesn’t mean it won’t last for a long time…potentially a very long time.
This is why we see the current fall in stock prices as a great chance to buy stocks. The thing investors need to remember is that the days of 8% or 9% dividend yields are behind them. They also need to remember that the days of 6% or 7% interest rates on savings accounts are behind them too.
So when you come across stocks paying dividend yields in the range of 4% to 6% you’d be foolish to ignore them.
Take Australia and New Zealand Banking Group [ASX: ANZ]. You may not like the banks (we don’t) and you may not like how they’ve benefited from banker bailouts and government support, but based on the current price ANZ is trading on a trailing dividend yield of 5.2%.
If you take into account franking credits and depending on your marginal tax rate, that could turn into a 7% dividend yield. With Australian 15-year government bonds currently paying a yield of 4.8% and 2-year government bonds paying 2.75%, it’s hard to imagine big investors ignoring the big yielding Aussie stocks.
However, it’s a mistake to think the only place you can get yield is in the big stocks.
We’ve focused on the dividend and growth opportunities among the smaller companies on the ASX. In fact, around one-third of the stocks on the Australian Small-Cap Investigator buy list pay a dividend.
And many of these pay better-than-cash dividends too. But that’s not the only benefit. With small-cap dividend plays you also get the potential for stock growth and dividend growth – in many cases these growth rates are better than anything you can get from blue-chip stocks.
Now, this isn’t to say we’re blind to the bigger issues facing the Aussie economy. We get it. But we also ‘get’ what most other people don’t. The market is in a constant panic that the US Federal Reserve will begin cutting back on its bond buying program.
We’ll tell you right now that like the RBA, the Fed won’t do anything that will lead to higher interest rates. At some point others in the market will figure this out. And when they do, like before they’ll head straight back to stocks…and that means higher stock prices.
Until that happens you’ll continue to see volatile markets and stock prices falling during the lead up to Fed meetings (the next Fed meeting is on 17-18 December).
So our take is this: whatever the negative view towards stocks, the stock market is still hands down the best, easiest and most cost-effective way for ordinary investors to build wealth.
This year the market has only given investors two big opportunities to buy stocks before the market has rallied. If our reading of the market is right, this current sell-off could be the third – and last – opportunity this year to buy dividend and growth stocks before prices begin another move higher.
It’s a risk, but in our view settling for lower yields elsewhere is a much greater risk to your long-term wealth building plans than the risk of investing in stocks.
Cheers,
Kris+
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