Ben Lofthouse, Head of Global Equity Income, believes that, despite being in a rising interest rate environment, dividend growth expectations are good for 2018, buoyed by new tax legislation and the recovery in commodity prices.
Dividend-paying stocks were hit hard in the opening months of 2018. Is this a result of the rising rate environment?
Broadly yes, a rising interest rate environment can cause some sectors of equity markets to underperform. In the medium and long term, however, we would expect company fundamentals to be a more significant driver of total returns. Historically, higher interest rate expectations can cause defensive sectors to underperform the market alongside sectors with high debt levels. It is important to say that not all yielding equity sectors consistently underperform in a rising bond yield environment. Many financial services companies’ earnings actually benefit from interest rate increases, and commodity sectors, including oil and mining, are positively correlated to rising rates at some stages of the economic cycle.
It is not clear that the sharp fall in the oil sector in the first quarter of 2018, a sector with some of the highest dividend yields in the market, can be attributed to rising rates, and it was good to see it subsequently recovering in response to improving fundamentals post the initial sell-off. As ever in equities the starting point is important; we have long viewed some US yielding sectors as relatively expensive and have been avoiding exposure to them. These sectors have turned out to be some of the most negatively impacted, with examples including consumer staples and US utilities.
Global dividends recently hit a record high. What factors globally could drive further dividend growth in 2018?
2017 saw economic growth recover after faltering in 2016, and many companies’ earnings are growing again. Dividends tend to lag earnings growth (management and company boards like to see improving profits before committing to dividend increases) so we believe 2018 should see good dividend growth as a result of the still relatively benign macroeconomic environment. In addition, there are a few sector specific factors that might impact dividend growth in 2018. The first is the change in US tax legislation that reduces the tax on company earnings and the barriers to repatriation of earnings from overseas jurisdictions. These tax changes improve the cash flow cover of dividends, which might encourage management to make bolder dividend decisions, and the repatriation changes could free up significant amounts of capital, some of which may be returned to shareholders. Companies to watch include those with high levels of domestic US earnings, and the technology and pharmaceutical sectors, both of which have significant overseas earnings. The other driver of improved dividend trends is the recovery in many commodity prices, ranging from oil to iron ore and paper, which is improving the cash flow of many resource companies and subsequently their dividend paying potential.
In your opinion, which regions, sectors or industries now offer the best opportunities for dividend growth and why?
There are a wide range of opportunities for dividend investors. We are overweight energy on the basis that the improvement in cash generation has been underappreciated by the market. We are also overweight European equities, which look attractively valued and generally have not taken full advantage of the persistently low interest rate environment in many countries across the region. The level of buybacks is increasing, balance sheets remain lowly geared across many sectors, and the extent of restructuring activities to improve returns continues to positively surprise us.
Dividend – A payment made by a company to its shareholders. The amount is variable, and is paid as a portion of the company’s profits.
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.
Yield – 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.
Yield curve – A graph that plots the yields of similar quality bonds against their maturities. In a normal/upward sloping yield curve, longer maturity bond yields are higher than short-term bond yields. A yield curve can signal market expectations about a country’s economic direction.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.