Dangerous Dividends Down Under

ETF Trends

The Australian economy, the world’s 12 th -largest, has enough superlatives attached to it make other developed markets green with envy. Australia is into a multi-decade streak of dodging recessions. That despite the fact the economy there is heavily dependent on materials exports.

Australia also sports a benchmark interest rate of 2.5%, which is low by the country’s standards, but high relative to the rest of the developed world. Additionally, Australia has an AAA sovereign debt rating. Low interest rate countries such as the Japan, the U.K. and the U.S. do not have AAA credit ratings. [Aussie Dollar's Ascent May Not be Over]

One benefit of higher interest rates is that those elevated rates usually mean higher dividend yields. For example, the iShares MSCI Australia ETF (EWA) has a trailing 12-month yield of 5.68% while the WisdomTree Australia Dividend Fund (AUSE) features a distribution yield of 6.62%. By comparison, the S&P 500 yields a paltry 2%. [Australia ETFs the High Yield Way]

Not surprisingly, the average payout ratio for Australian stocks is well above that of the S&P 500. As of mid-September, the S&PP 500’s payout ratio was 31.8%. In Australia, that number is 70%, up from 55% in 2011, according to Goldman Sachs. That may sound good, particularly when considering the S&P 500 has not had a payout ratio north of 40% since 2009.

Still, the Aussie dividend situation may come with some warning labels.

Goldman Sachs Chief Economist Tim Toohey “says that historically when pay-out ratios have risen above 65 per cent, earnings growth cannot be sustained and dividend per share growth falls to an average of only 1.5 per cent,” reports David Uren for The Australian.

One reason Australian companies have not been shy about raising dividends is the strong Australian dollar makes it difficult for these firms to reinvest in their businesses.  The Reserve Bank of Australia, which has slashed interest rates by 225 basis points over the past two years, is desperate to generate non-mining sector growth. That growth has not materialized yet.

AUSE has a 13.2% weight to the materials sector, while EWA’s allocates 18.5% of its weight to that sector.

For now, betting on a pullback in Australian stocks (the S&P/ASX 200 is at highest levels in since June 2008), appears dangerous. The reason: Investors are banking on bank dividend increases from the country’s largest financial services firms.

That could be good news in the near-term for EWA and AUSE, which have weights to the financial services sector of 51.7% and 20.6%, respectively. How much longer Australia’s payout ratio can keep growing without non-mining sectors contributing to economic growth, well, that is anyone’s guess.

iShares MSCI Australia ETF

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EWA

ETF Trends editorial team contributed to this post.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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