Mark Whitehead analyses the impact of interest rate rises and the recent volatility in markets and gives his general outlook for 2018.
What is the impact of rising rates on equity income?
It is our view is that lower bond yields are here for longer. The income from a global portfolio of equities chosen for their high yield and potential for dividend growth is likely to be higher than that from an equivalent portfolio of bonds for some time yet. Investors that want more yield from a bond portfolio have to take credit risk and a good equities manager should be able to produce better risk adjusted returns over the long term from a high-quality equity portfolio targeting dividend growth.
However, central bank policy error (by raising interest rates and withdrawing quantitative-easing stimulus too quickly) could lead to a disorderly sell-off in bond markets – causing a de-rating of equity markets. In such a correction, investors in stocks that have higher dividends are likely to lose less as a higher proportion of their total return over the long term comes from income than the market in general.
Income from global bonds and equities
Volatility is returning to markets. How do income stocks respond in this environment?
We feel sure that this period of volatility at the closing stages of a record bull market will not be the last, but we are not entering a sustained market reversal just yet, so the markets are going to have to get used to it. Investors are likely to slowly realise that they need to be in higher quality companies with sustainable dividends as more volatility hits the markets.
What are the other biggest risks to your markets in 2018?
There are a number of key risks which investors will be aware of, including politics, the risks of terrorism and tensions on the Korean Peninsula. Donald Trump’s destabilising influence on the world stage does concern us. His decision to move the US Embassy in Israel to Jerusalem, for example, was widely condemned (and could fan the flames of geopolitical rhetoric). In the UK, the Brexit negotiations moving into the second phase ahead of the final ‘divorce’, could be very tricky and cumbersome. There is much to work out in terms of trade treaties, healthcare, movement of labour and more, all of which will be very important for the UK’s economy and international standing for generations to come.
A slowdown in China (which could come from Chinese credit tightening) could potentially cause global growth to falter; and there is the risk of an earnings slowdown. At a company level, technology disruption continues to upset traditional ‘old-economy’ businesses. This could have a destabilising effect in a number of areas, including labour trends, inflation, social wellbeing and politics.
What do you think will be the key drivers for your markets in 2018?
Economic conditions were strong in 2017, and we expect this to continue this year. The US could accelerate the fastest with business activity rebounding, capital expenditure improving as corporate tax changes are implemented. This economic backdrop should bode well for corporate activity and thus earnings growth should remain positive.
China’s role will be vital, as it has been injecting huge levels of liquidity into its economy over the past year. While this has not increased its own economic growth, it was arguably responsible for much of the global upswing in economic activity in 2017. As a result, if Beijing's policies are reversed, this may well cause a wider slowdown.
Cyclical sectors, meanwhile, should continue to perform well, driven by the industrials, materials, technology and financial sectors.