The power of dividends + Do you own a property in these high-risk suburbs?

Happy Friday everyone,

Big news on the personal front with the birth of our 9th grandchild since the last newsletter. Heidi Merkel is the first child of our youngest daughter Georgie and husband Alex, who live in London.

She was born on the night of Port Adelaide’s finals loss to Geelong last week and continues the Koch curse. Our eldest granddaughter was born during the 2007 Grand Final loss to Geelong and now, Heidi in another finals loss against Geelong.

Suffice to say I’ve now banned all Koch children from any hanky-panky over Christmas and New Year.

In this week’s newsletter:

• My conversation with the Treasurer continues on how he should be fighting inflation.

• Capital stable superannuation investment options were the best performers in August.

• Property values in a third of all Australian suburbs have fallen over the last 3 months.

• The property suburbs most affected by climate change. And does it affect values?

• The power of dividends on share investments.

• The eye-watering returns from US tech stocks

The Treasurer continues our discussion on fighting inflation

Last week I bluntly challenged Treasurer Jim Chalmers to step up and help the RBA fight inflation.

I received a pretty terse note from the Treasurer challenging my assumption the Government was to blame for prices rising and driving up inflation, and for also accusing the Government of making the economy both cold and hot at the same time - it has to be one or the other according to the Treasurer.

They are fair points the Treasurer makes. I apologise for being too blunt, but I stand by my view. Let me explain:

I’ve used a few graphs here to make the point because I find it easier to visualise economic data rather than just look at a bunch of numbers.

Last week’s economic growth figures showed an economy slowing to a crawl and in economic recession, if you take out population growth from immigration.

The Treasurer is saying the Government is keeping the economy afloat and the situation would be a lot worse without its help. Well ... yes and no.

This graph paints a clear picture of how government spending (economists call it “new public demand”) is at record high levels. Higher than even the huge economic stimulus spending during the COVID lockdowns which kept so many businesses afloat.

My challenge to that argument is that we don’t want government spending to prop up an economy, except in the most extreme instances - such as when the whole world shuts down because of a global pandemic.

A healthy economy is driven by households and businesses growing, while government spending is used to finesse the economy around the edges ... not carry it on its back.

This graph shows the contribution to economic growth of the different major sectors. The black line is 2023 and the red line this year. Annual economic growth has dropped from 2.3 per cent to 1 per cent.

Look at the dramatic drop in consumption (spending by Australian households), housing, investment by businesses, and exports. But public (government spending) has more than tripled its contribution to economic growth over the year.

So yes, government spending has tried to plug the gap.

The question is whether the Government should be plugging the gap? Is it, in fact, creating both a hot and cold economy?

The Reserve Bank has wanted consumption and investment to cool, as a slowdown would take the heat out of the economy by reducing demand and hopefully slowing price increases and inflation.

But the Government is countering the RBA’s cooling measures by adding its own heat through record spending. That’s why inflation is “sticky” and high interest rates will stay at these levels for longer. Government spending is directly countering what the RBA is trying to engineer.

Admittedly a lot of the Federal and State Government spending is on much-needed infrastructure and energy transition projects, along with the NDIS. But that spending has to be reined in for the time being until inflation is tamed. It’s government spending that is keeping inflation sticky and high, when it should be coming down because of the big drop in consumer spending and business investment.

The Treasurer says this spending is keeping the economy afloat. My view is that the spending is delaying much-needed interest cuts which would ease the financial pressure on average Australians and small businesses.

The US will cut its interest rates this month, following cuts in Europe and a number of other western economies. Overseas inflation is slowing a lot quicker than ours.

The Treasurer also challenged my view that prices and price rises can be determined by the Government. Obviously the price of direct government services are determined by governments, and governments influence a wide range of other prices through the economic environment they create.

While the economy is currently slowing, it has been operating at close to full capacity, which is reflected in the surprisingly low unemployment figures.

At a time when the RBA wants to reduce demand in the economy to slow price growth, a government which is spending at record levels is actually creating more demand which pushes prices and inflation up. That is the influence of the Government.

When a government allows strong immigration numbers and doesn’t encourage more home building to accommodate these new Australians, this shortage of housing pushes up property values and the cost of rents. That’s the influence of the Government on prices.

When governments spend big on infrastructure, which takes workers out of home building and construction, builders have to pay more to attract those workers back. This flows through to higher building costs, which have been a major driver of inflation. That’s the influence of the Government on prices.

Inflation in the services sector has been a worry for the RBA. Wages are a major cost component of service industries. So when there are increases in the minimum wage, and in healthcare and childcare, that flows through to increased prices. That’s the influence of the Government on prices.

As I said earlier, much of the current record government spending is important but it’s all in the timing. Slow the spending now to help the RBA tame inflation and start cutting interest rates, then ramp back up later.

Capital stable was the best performing superannuation option over August

August was yet another turbulent month for markets, but according to leading superannuation research house, SuperRatings, median returns for a balanced fund came in at 0.4 per cent for the month. Interestingly, the most conservative capital stable option had the highest return for the period.

The median growth option grew by an estimated 0.3 per cent in August, while the median capital stable option, cushioned by a lower exposure to shares, rose an estimated 0.5 per cent.

Pension returns followed a similar pattern, with the median balanced pension option increasing by an estimated 0.4 per cent. The median capital stable pension option is estimated to rise 0.6 per cent over the month, while the median growth pension option is estimated to rise 0.3 per cent for the same period.

Property values in a third of Australian suburbs actually fell over the last 3 months

We get so focused on the monthly property surveys that we often lose a bit of perspective. That’s why I was fascinated with CoreLogic’s latest chart pack, which shows almost 30 per cent of Australian suburbs suffered a fall in property values over the three months to the end of August.

The property market in some States is certainly turning.

Melbourne (79.1 per cent) and regional Victorian suburbs (73.8 per cent) made up the majority of falls over the quarter. But values also decreased across more than half of the suburbs in Hobart (54.3 per cent), Darwin (51.2 per cent), and Canberra (51.6 per cent), while all suburbs in Perth saw values rise over the quarter. There was not one Perth suburb which lost value.

High interest rates, cost of living and affordability challenges are certainly biting.

In Melbourne, declines were most concentrated in more affluent regions, with 100 per cent of suburbs in the Mornington Peninsula recording decreasing values, while just one suburb in the Inner-South (Carrum) and three suburbs in the Inner-East (Box Hill, Deepdene, Canterbury) saw values rise over the quarter.

A similar pattern played out in regional Victoria, with Ballarat (100 per cent), Geelong (97.8 per cent) and Bendigo (89.3 per cent) recording the highest concentration of falls.

Behind Melbourne, Sydney has seen the biggest increase in the share of suburbs in decline over the past year, from 3.8 per cent to 25.9 per cent.

The time it takes to sell property has trended a little higher relative to one year ago nationally. As with capital growth trends, selling conditions vary depending on the market. Properties are selling quicker than a year ago in Perth and Adelaide, with the median selling time at 11 and 27 days, respectively.

Assessing the risk of properties in ‘Black Zones’

A fascinating report this week from real estate giant, Ray White, identifying suburbs/towns which are most at risk from climate change.

Beaches face rising seas, rivers may flood more often, and bush areas are at risk of wildfires. Despite these growing threats, house prices in many of these areas keep climbing.

The Ray White report looks at whether home buyers are considering climate risks, particularly flood risk, when buying in these locations, or if the dream of an ideal lifestyle is making the potential danger and rise in insurance costs worth the cost.

Climate Valuation is a company that provides climate risk analysis to individual property owners. In June 2024, they produced a report looking at suburbs and towns with a high risk of flooding. Across Australia, 4 per cent of all properties are considered to be high risk, i.e., they carry a high risk of being uninsurable or prohibitively expensive to insure for flooding.

Overall, the report found that Queensland had the highest proportion of homes at high risk (5.1 per cent of all homes) with the ACT having the lowest (1.6 per cent).

Ray White looked at whether the risk of being uninsurable for flooding has an impact on home values. In particular, whether the areas most at risk under or over perform relative to the wider market. By doing so, it provides some measure as to whether people are pricing in flood risk, or they are buying in these areas despite the risks.

Overall, it appears that the risk of becoming uninsurable for flooding has a limited impact on demand for property. In total, 13 suburbs are considered to be Black Zone suburbs with more than 80 per cent of properties in these areas at high risk.

Of the 13 suburbs, all of them experienced price growth over the past five years, with more than half of them (seven) seeing price growth stronger than the Australian average. Grafton, Chinderah and Ballina all have more than 99 per cent of properties considered to be high risk but all of these suburbs’ house price growth outperformed the Australian average over the past five years.

Overall, it appears that climate risk has a limited impact on demand for homes in high-risk suburbs. While we only looked at one risk factor (flooding), it is likely we would see a similar trend for other climate linked events such as bushfires. The drive to live near water and close to the bush seems to outweigh the elevated cost of insuring homes in these areas, and the potential danger that wild weather events can create.

The power of dividends on your returns

With just under $35 billion of dividends being paid out to investors between August and October 2024, that nice little cash bonus into your portfolio always comes as a nice surprise. And also, a reminder of the power of dividends on total returns.

This year’s payout is up 5 per cent on a year ago and if you include dividends by major banks in late June and early July, dividends were up around 7 per cent on a year ago to $45 billion.

The power of dividends has never been so potent. Over the next few years, investing is going to be all about yield.

With uncertainty over the global economy and rising interest rates, there has been a massive shift in investor sentiment to cash and other income-producing investments.

During uncertain times, investors tend to shy away from the equities markets and head towards the apparent safety of traditional interest-bearing investments. But don’t be so hasty.

Returns on Aussie shares remain attractive versus bank deposits, bonds and overseas shares, with grossed-up dividend yields of around 4.9 per cent, even though that is below the decade-average of 5.7 per cent.

While most of us follow the fortunes of our share portfolio each day via their share price movements, that dividend payment twice a year often goes unnoticed. It shouldn’t.

Studies in the US show that over a one-year period, 80 per cent of a share’s return comes from fluctuations in share price. But over a five-year investment horizon, 80 per cent of a share’s return comes from dividend yield and dividend growth.

The same holds true around the rest of the world. In Europe, since 1970, 80-100 per cent of total share returns have come from dividends. In Japan, share valuations have gone backwards since 1970, while dividends have added an average 2 per cent.

Surprising isn’t it?

With many top 200 companies paying a dividend yield of 4-5 per cent, add the impact of franking credits and that return can jump to an impressive grossed-up 7 per cent.

Fully franked dividends are those from companies which have paid the full rate of company tax on their profits. As a result, the share of profits they pay shareholders as a dividend comes with a tax credit equal to the amount of company tax which has been paid, to avoid double taxation.

For example, the major banks pay the full 30 per cent company tax on profits so their shareholders receive a dividend with a 30 cent in the dollar tax credit. If a shareholder’s marginal tax rate is less than 30 per cent, then that dividend is tax-free, and if you accumulate excess franking credits, that can be paid as a cash refund.

The four major banks currently all have fully franked dividend yields of 4-5 per cent, and I bet they don’t offer that sort of tax-advantaged income return through any of their banking products to customers.

They are attractive returns and a powerful boost to investor returns but it must be acknowledged that dividend yields are a reflection of not only the share of profits a company pays out, but also its share price.

As dividends are fixed as a dollar amount twice a year, the percentage dividend yield will obviously go up if the dividend payout stays the same while the share price goes down. Or the dividend yield can fall if share prices go up - such as with the Big Four banks.

According to CommSec, while the ‘Big Four’ dividends appear to be sustainable, they have fallen to below-average levels, with the 12-month forward dividend yield for ANZ, CBA, NAB and Westpac at 4.3 per cent. This is below the long-run average of 5.7 per cent since 1997. That’s because their share prices have risen so strongly by comparison.

So, an investor has to balance up the current attractive dividend yield with the prospects of the individual companies. Is a low share price because the company is in a prolonged slump and may not be able to maintain its dividend payout? Or is it a short-term downturn and the company is strong enough to bounce back and maintain its dividend?

While BHP continued to pay the most dividends at $5.54 billion, this year it cut its final dividend by almost 10 per cent to fund growth in its potash and copper mining projects. The full-year dividend payout represented 54 per cent of its profits, the lowest payout ratio since 2016.

Retailers have surprised everyone by paying good dividends despite a slowing economy.

JB Hi-Fi is paying a special dividend of 80 cents per share, fully franked. Wesfarmers (which owns Kmart, Bunnings and Officeworks) increased its dividend up by 3.7 per cent and Woolworths added a special dividend of 40 cents a share.

But in this current financial year dividend payouts are expected to be cut by around 2 per cent, driven by energy and consumer discretionary stocks like retailers.

It’s all a question of balance. A good dividend yield from a company producing strong cash flows can provide not only a welcome income stream for investors, but also ensure a comforting buffer to a falling share price.

The key is to be selective and look for a strong dividend yield, dividend growth and good cash flow to ensure that dividend can be maintained.

The eye-watering returns from US technology stocks

There’s a debate in the US at the moment over whether the big American technology stocks are now overvalued. This comes after their stellar performance over the last year.

Many analysts are saying that while they are terrific businesses making big money, there is a point where their performance doesn’t match their valuation.

But if interest rates are coming down and the AI revolution is building momentum, are these stocks going to be the major beneficiaries?

Here’s a look at what $US10,000 invested in these tech stocks would’ve netted you over the past decade:

• NVIDIA: $US2,059,483

• Broadcom: $US155,889

• Tesla: $US113,953

• Amazon: $US98,961

• Netflix: $US97,974

• Apple: $US89,245

• Microsoft: $US87,497

• Adobe: $US77,043

• Meta: $US64,751

• Mastercard: $US61,946

• Visa: $US52,160

• Alphabet: $US50,494