Stocks Beating Bonds for First Time Since 2009: Australia Credit

RBA Governor Glenn Stevens
Glenn Stevens, governor of the Reserve bank of Australia, cut the cash rate to match a half-century low of 3 percent this month. Photographer: Mark Graham/Bloomberg

Australian stocks are set to beat bonds for the first time since 2009 as record-low yields prompt investors to favor the developed world’s highest dividends.

The Bank of America Merrill Lynch Australia Broad Index of corporate and government bonds gained 7.6 percent this year, compared with a 20 percent surge for the S&P/ASX Accumulation 200 Index. Global stocks returned 17 percent, outpacing the 5.4 percent for debt securities. Commonwealth Bank of Australia, the country’s biggest lender, handed equity investors a 35 percent return in 2012, almost four times more than debtholders.

UBS AG and Citigroup Inc. predict further equity gains in 2013, driven by Australia’s average forecast dividend yield of 5 percent, the highest among the world’s 12 biggest stock markets. Benchmark 10-year sovereign yields sank to a record-low 2.698 percent this year as the Reserve Bank of Australia undertook the most aggressive interest-rate cuts among advanced economies.

“Lower rates for cash and bonds will ultimately help drive more allocation towards equities,” said George Boubouras, Melbourne-based head of investment strategy at UBS AG’s Australian wealth management unit, who forecast Australian stock prices will rise 6.8 percent by the end of 2013. The Swiss bank has about $1.5 trillion under management. “Equity market valuations are compelling.”

Share Returns

The S&P/ASX 200 Accumulation index, which includes reinvested dividends, is poised to top total returns on the MSCI World Index of developed-market equities for the first time in three years, Bloomberg data show. The global measure has a forecast dividend yield of 3 percent for 2013, the data show.

Australia’s government bonds climbed in 2012 as foreign investors, including central banks, sought the highest-yielding debt among the seven nations with stable AAA grades from all three major ratings companies. Benchmark 10-year yields were at 3.35 percent as of 2:39 p.m. in Sydney, with the gap to U.S. Treasuries falling to 158 basis points, from as much as 214 basis points in March.

The spread between the S&P/ASX 200 dividend yield and Australia’s cash rate this month rose to the highest since July 2009, according to data compiled by Bloomberg.

Widening Spread

The gap has widened as RBA Governor Glenn Stevens cut the cash rate to match a half-century low of 3 percent this month to bolster the economy as a record mining investment boom approaches its peak. That was the sixth reduction in 14 months, completing the most aggressive rate cuts among advanced economies.

Commonwealth Bank, Westpac Banking Corp. and Telstra Corp., Australia’s largest phone company, contributed the most to the benchmark stock index’s increase this year, according to Bloomberg-compiled data. Commonwealth Bank shares climbed 4.4 percent this month to close at a record A$62.33 today in Sydney.

The perceived risk of holding the companies’ bonds also declined, credit-default swap prices show. The benchmark Markit iTraxx Australia index, which includes the three companies, fell 57 basis points this year to 123 on Dec. 21, according to data provider CMA.

Australia’s banks, the biggest borrowers in domestic debt markets, “are in a strong position to see off a slowdown in the economy in 2013, based on their strengthened balance sheet and solid profitability,” Fitch Ratings wrote in a Dec. 16 report. “Subdued credit growth will allow banks to improve their funding profiles.”

National Australia Bank Ltd., Westpac, Commonwealth Bank and Australia & New Zealand Banking Group Ltd. have four of the five highest trailing dividend yields among the world’s biggest 25 banks, with NAB in first place at 7.1 percent, Bloomberg data show. Telstra pays out 9.2 percent.

‘Heightened Demand’

“We have seen evidence of heightened demand among international investors for Aussie banks given they have some of the highest yielding bank shares in the world,” said Craig Williams, Melbourne-based analyst at Citigroup Inc. “This has driven bank share price outperformance in the past six months and may continue to be a supportive thematic for Australian bank share prices into the new year.”

Commonwealth’s share-price increase gives the lender a market capitalization of about A$100 billion ($105 billion), compared with HSBC Holdings Plc, Europe’s largest bank, at $195 billion and Citigroup Inc.’s $118 billion value.

Equities advanced across the globe this year as central banks from the U.S. to Europe and Japan took steps to support growth. Buying of securities by the Federal Reserve, that will probably push its balance sheet beyond $3 trillion, will stop only when the labor market improves “substantially,” the Fed said this month.

More Cuts

Traders see a 54 percent probability that the Reserve Bank of Australia board will reduce the country’s benchmark rate to a record-low 2.75 percent when it next meets in February, interest-rate swaps data compiled by Bloomberg show. There’s a 64 percent chance the RBA will have cut by at least 50 basis points by the middle of the year.

Australia’s economic growth will slow to 2.75 percent next year from 3.5 percent in 2012, according to strategists’ forecasts compiled by Bloomberg. That’s still more than double the 1.2 percent pace foreseen for Group of 10 currency nations.

Surplus Scrapped

Australian Treasurer Wayne Swan admitted Dec. 20 that a “sledgehammer” hit to revenue makes a planned budget surplus unlikely, adding to concern that economic growth is waning. A slowdown in the pace of expansion in China, a faster drop in commodity prices or an escalation of the sovereign-debt crisis in Europe would temper expectations for equity-market gains, said Kapstream Capital’s Kumar Palghat.

“The biggest risk is that you get some macro-economic event that impacts the economy in a big way,” said Palghat, a managing director at Kapstream Capital, which oversees A$4.7 billion. “Corporate earnings will be a lot weaker, equity markets go down and it pushes investors into bonds.”

The South Pacific nation’s benchmark stock gauge trades at 14.2 times estimated earnings, compared with the 13.9 multiple for both the S&P 500 and the MSCI World, according to data compiled by Bloomberg. Australia’s S&P/ASX index’s forecast dividend yield of 5 percent compares with 2.4 percent for the S&P 500, the data show.

“Dividend yield has been the market darling,” said John Conomos, Sydney-based quantitative analyst at Macquarie Securities Ltd. “In a low return and low interest rate environment, we expect this to be an ongoing focus for investors.”

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