Strong cash generation driving a positive dividend outlook

In the first half of this year, things that we were concerned about were interest rates being higher and the impact that might have on companies and also inflation.

We positioned ourselves to be cautious on sectors and companies that have used significant, amounts of leverage when debt was very cheap. And we’ve largely seen that playing out. So most companies are coping well with this higher inflationary environment, with higher debt costs. But we’ve seen some notable exceptions within the areas of US regional banking and real estate.

Positive dividend outlook remains

In terms of dividend trends, we’ve seen strong dividend growth this year. We’ve seen a higher level of special dividends coming back this year and buybacks returning as companies have proved quite adept at generating cash through the last few years. Areas that have been particularly strong have included some cyclical areas such as automotive companies, financial services companies, including banks, and also the oil and gas sector. We’ve seen some moderation in earnings from the commodity sector and they’ve moved to more variable dividends.

So that’s the area of negativity we’ve seen. But it’s not so much caused by economic sensitivity rather than just the pricing of commodities. The outlook for dividends remains strong and companies are generating a lot of cash. And in general, large listed companies are able to pass through inflation, which again is helping them generate higher levels of cash.

Whilst there has been significant uncertainty coming into the year on the effect of certain things like energy prices and the ongoing war in Ukraine, we’ve actually seen very strong dividend growth from European companies. Generally although interest rates haven’t gone up significantly across Europe and actually the energy prices have been much more modest than people expected.

Interest rate and inflation expectations have moderated

Generally, we’ve seen interest rates increasing, but the rate of increase is moderating and as we predicted and expected, companies that are able to pass on pricing to consumers are coping with it. Our position remains very similar for the second half. We don’t have any strong expectations around interest rates falling anytime soon and actually inflation is still there and so quite embedded within supply chains, although it is moderating.

On the positive side, at the start of the year, it wasn’t clear quite what would happen with China in terms of COVID and opening up. And we’ve actually seen the pace of policy change there being much faster than people expected. We’ve seen much higher levels of movements around the region, including in Japan and other areas of the region where they shut down for longer periods around COVID.

And that’s been positive for activity, although it’s not fully recovered. We remain of the view that the Asia-Pacific regions will continue to recover through the end of the year and actually the valuations there don’t reflect the opportunity set.

Opportunities from rising infrastructure and technology spending

Looking forward, one of the interesting things outside of the macroeconomic trends is we’ve seen generally quite a lot of policy initiatives over the last few years from governments, to try and increase spending on infrastructure, whether that be aiming to reduce carbon output, whether it’s about increasing security of supply for certain strategic industries, and actually recently the increased interest in artificial intelligence.

Whilst we don’t know exactly how that’s going to play out, what we can see is that it’s going to increase and necessary investment in technological areas, semiconductors, but also infrastructure around that, (eg.) data servers. So actually while there was some softness within the consumer in areas, we are seeing that being picked up by increasing capital expenditure trends for certain parts of industry and society that haven’t seen enough investment for the last few years.

Importance of diversification and balance sheet strength in challenging markets

So, we would remain relatively cautiously positioned in terms of risks that we’re monitoring or that we’re cautious about for the rest of the year. Interest rates have gone up significantly. Whilst we don’t expect them to go up significantly higher from here, we do expect that impact to come through on the economy as we go through the next six to 12 months. Primarily we would be expecting that to be felt within either leveraged companies or within the consumer.

And the other area that is ongoing is geopolitical concerns. The war in Ukraine is ongoing and there are other geopolitical issues around the world. And so remaining diversified, we think is important. And also kind of keeping a close eye on companies to make sure that they’ve got strong balance sheets so that we can endure any volatility that may arise.