Our base case sees a moderate recession in most major developed economies in 2023. We believe that equity markets have already priced in a lot of the bad news in 2022, but stocks which provide an attractive income appear more reasonably valued than those with little or no income (Exhibit 13). Investors who are more cautious than us about the outlook may want to focus on this cheaper segment of the market to hopefully limit further downside.
Exhibit 13: Low income stocks still look quite expensive
Relative valuation of global higher dividend yield stocks
x, valuation spread based on earnings yield
Source: J.P. Morgan Asset Management. Index shown is a subset of the S&P Global BMI Index, which includes both developed and emerging market stocks with a minimum market cap of c. USD 1 billion. Valuation spreads are calculated by subtracting the median valuation of stocks in the lowest ranked quintile for dividend yield from the median valuation of stocks in the highest ranked quintile of dividend yield, and then dividing this by the median valuation of the market. 1st percentile is cheap, 100th is expensive. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022.
Of course, the income stream from dependable dividend payers can also help buffer returns. Strong, dividend paying companies often go to great lengths to maintain dividends, even when earnings are under pressure. With payout ratios relatively modest at present, maintaining current dividends looks more feasible than in some prior recessions (Exhibit 14).
Exhibit 14: Dividends tend to fall by less than earnings
MSCI World earnings and dividends drawdowns
% drawdown from rolling 2-year high, EPS and DPS
Source: Bloomberg, J.P. Morgan Asset Management. EPS is earnings per share and DPS is dividends per share. Periods of “recession” are defined using US National Bureau of Economic Research (NBER) business cycle dates. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022.
Another factor worth considering is that the universe of companies currently paying healthy dividends is fairly diverse, spanning a wide range of sectors. Some of the usual suspects like utilities remain in the pool but we believe sectors such as financials, healthcare, industrials and even some parts of tech contain a number of dependable dividend payers that can also grow their dividends over time. As a result, should the macro backdrop not improve, and stagflationary pressures persist into 2023, we would expect income paying stocks to prove relatively resilient.
In conclusion, even though we expect a challenging macroeconomic environment in 2023 and downward corporate earnings revisions, we think income stocks could have a good year with dividends proving more resilient than earnings. For investors that are tentatively looking to increase their equity exposure, an income tilt could prove relatively resilient in the worst-case scenario, while also providing the potential for outperformance in our more optimistic scenario for markets given attractive valuations.
Karen Ward
Maria Paola Toschi
Mike Bell
Tilmann Galler
Vincent Juvyns
Hugh Gimber
Maximilian McKechnie
Natasha May
Zara Nokes
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