Compelling yield opportunities in 2018 for equity income investors

22.11.2017

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Alex Crooke, Head of Global Equity Income, believes that investors will focus more on valuations in 2018, rotating towards more cyclical areas of the markets, and that dividend yields remain compelling.

What lesson have you learned from 2017?

One of the key lessons we have learned in 2017 is that rising interest rates do not mean the end of equity market gains. We have seen the US gradually push up interest rates and, at the end of the year, the UK being one of the first European markets to increase rates. Despite this, share prices have continued to rise with economic growth overriding the impact of tightening liquidity.

Secondly, politics are perhaps not as important for markets as the media suggests. There has been a lot of noise around the European elections and US tax changes but focussing on the fundamentals driving markets has been more important. We have seen earnings recover very strongly into 2017 and this has been driving a lot of the equity market’s performance.

What are the key themes likely to shape the markets in which you invest in 2018?

Looking into 2018, the key themes of this year should carry on in terms of a focus on economic activity and growth. We are seeing a more co-ordinated environment; Europe is growing, Asia is growing and the US continues to deliver some steady growth numbers. That’s leading to better conditions for corporate earnings, which is driving share price performance for those companies that have had strong earnings upgrades.

What we should expect to see as we go into 2018 is that valuations become more important, with investors beginning to focus less on the highest growth stocks. We expect investors to be thinking more about where the attractively valued stocks are within markets. We also expect to see a broadening of market leadership as interest rate policies are tightened a bit further, with markets rotating away from some of the more expensive premium growth and defensive stocks into cyclicals – companies that benefit from economic activity and growth, such as financials and industrials. Hopefully, companies themselves will begin to invest for the future, so we should also see capital expenditure investment plans pick up, with a number of companies poised to benefit from any increases in this area.

What are the key questions for 2018 and beyond?

We believe that investors will begin to question some of the valuations of the highest growth stocks. The debate has not yet been had about what the correct tax charges are for these companies and what the profit margin potential is over the next three to five years? At the moment earnings upgrades are driving share prices but we think valuations will become increasingly important.

Where do you currently see the risks within your asset class and where are the most compelling opportunities?

In terms of the most compelling opportunities, firstly I think it’s the dividend yields available in equity markets. Markets around the world on average yield between 2% to 2.5%* and it is very easy within those markets to find the higher-yielding stocks that yield 3% to 3.5%. Markets in Asia and parts of Europe yield towards 4%*. Those levels of dividend yield look very attractive when compared to credit and government bond yields. The absolute level of dividend yields remains very attractive to investors when compared to other asset classes. We feel that financials, particularly banks, look to be very interesting investments from here. We are seeing the level of loan losses beginning to moderate and we are seeing bank margins improve as returns on equity increase. In the best quality banks the return on equity generated is increasing to double-digit levels of between 10-15%**, while valuations look compelling. This combination of cheap valuations and improving levels of return looks very attractive for investors and we believe should lead to increasing share prices.

Another sector that we like, which is a little unloved, is the oil sector. We’ve seen the oil price increase into the latter part of 2017 and although it might ease back a little into 2018, the companies within the sector have been reforming. We are seeing cashflow increase and capital expenditure moderate. If we see that reform continue into 2018, we should see dividends very well underpinned; dividend yields of between 5% and 6%* can be found in the sector on high-quality assets. We believe that those yields could be nearer 3% to 4% (which implies the companies are undervalued) so there’s potential for share prices in the oil sector to rebound strongly in 2018.

Source: *Thomson Reuters Datastream as at 31 October 2017, ** Bloomberg as at 17 November 2017.

Glossary

Bond – A debt security issued by a company or a government, used as a way of raising money. The investor buying the bond is effectively lending money to the issuer of the bond. Bonds offer a return to investors in the form of fixed periodic payments, and the eventual return at maturity of the original money invested – the par value. Because of their fixed periodic interest payments, they are also often called fixed income instruments.
 
Credit market – A marketplace for investment in corporate bonds and associated derivatives.

Defensive (non-cyclical) stocks – Companies whose performance is not highly linked to the overall state of the wider economy.

Fundamental analysis – The analysis of information that contributes to the valuation of a security, such as a company’s earnings or the evaluation of its management team, as well as wider economic factors. This contrasts with technical analysis, which is centred on idiosyncrasies within financial markets, such as detecting seasonal patterns.

Tightening of interest rate policies – Central banks may attempt to control their country’s economic expansion and inflation by increasing interest rates to encourage saving.

Tightening of liquidity – In the context of this article, a reduction in quantitative easing (see below) has resulted in a reduction in the level of money in circulation.

QE (quantitative easing) – A measure whereby a central bank creates large sums of money to purchase government bonds or other securities, in order to stimulate the economy by increasing the supply of money.

Yields – The level of income on a security, typically expressed as a percentage rate. For equities a common measure is the dividend yield, which divides recent dividend payments for each share by the share price. For a bond, this is calculated as the coupon payment divided by the current bond price.

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Die Wertentwicklung in der Vergangenheit ist kein zuverlässiger Indikator für die künftige Wertentwicklung. Alle Performance-Angaben beinhalten Erträge und Kapitalgewinne bzw. -verluste, aber keine wiederkehrenden Gebühren oder sonstigen Ausgaben des Fonds.

Der Wert einer Anlage und die Einkünfte aus ihr können steigen oder fallen. Es kann daher sein, dass Sie nicht die gesamte investierte Summe zurückerhalten.

Die Informationen in diesem Artikel stellen keine Anlageberatung dar.

Zu Werbezwecken.


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