In the current situation of uncertainty, taking a slightly more defensive stance with high dividend generating equities, along with higher yielding fixed income is a good compromise.
Global Market Strategist
Recently, the market is facing worries on multiple fronts. The macroeconomic outlook isn’t as certain as it was only a few weeks ago, with the COVID-19 Delta variant causing a resurgence in infection rates across a number of countries, weighing on recovery prospects. Inflation has remained at levels that continue to spawn speculation on how soon supportive monetary policy will end. Volatility and uncertainty continue to reign in these times of mixed messaging, but there are rarely ever times when we can expect a smooth path upward for markets. Instead of looking at investment opportunities through the lens of themes such as growth versus value in equities for example, an income theme is a consideration to invest in, given the current recovery stage of the business cycle.
Income generation has long been a popular theme for investors. Yield is still very much an attractive feature by offering another stream of dependable proceeds in the form of interest rate payments from fixed income holdings, or dividend yields from equities or adding to total returns. Economic trouble, and through it a combination of high inflation and low cash returns, has driven real interest rates lower. This has further encouraged this theme for investors to seek income. Where central banks have forced rates lower, investors have been driven to seek better alternatives outside of traditional sources such as government bonds for more yield.
In the current situation of uncertainty, taking a slightly more defensive stance with high dividend generating equities, along with higher yielding fixed income is a good compromise. Growth stocks currently face the issue of an expectation in interest rates shifting higher, putting greater stress on future prospects. However, value stocks also see some pressure, because while we are still positive on the recovery and re-opening story, the Delta variant spread will also weigh down on this theme as our original timetable for re-opening will be delayed. Income investing would provide a less risky option between these two major ideas. Historically, higher-yielding stocks have generally outperformed the broader market and done this with less volatility. While there is no guarantee this will always continue to happen, in this current situation with positive earnings growth, dividend growth also tends to follow. Earnings growth for high yield equities had previously been hit hard, but now the outlook strongly favors them.
Investors also shouldn’t ignore other asset classes that offer yield in fixed income. Our forecast of major central banks to begin tightening next year could possibly push price returns for bonds into the negatives and while rates are expected to rise, they are rising from historic lows, making the yield offered by various government bonds still less attractive than they might have been in the past. This means investors should look for short duration, high yield opportunities instead of writing off fixed income completely. Higher yield might mean higher risk, but given the stage of the business cycle we are in, we think default risks are low.
EXHIBIT 1: DIVIDENDS ADD APPRECIABLY TO INVESTMENT RETURNS
Investors are facing uncertainty and volatility from many different directions. Equities remain volatile on regulatory concerns emanating from China and a shaky recovery threatened by the still present COVID-19 issue. Shifting to an income focused theme offers a more defensive stance that might suit investors more than merely trying to participate in the reflation trade or value theme investing in the short run.
Not all investors have the ability or the risk appetite to take aggressive positions when it comes to asset allocation. For those who are more conservative, an income strategy is an interesting way to navigate this current environment. High dividend equities offer both dividends and growth potential, with dividend opportunities existing across sectors, giving exposure to multiple themes. Combined with higher yielding fixed income they offer diversified returns from a range of assets that will help add to returns or provide a steady source of cash.