In this article, we discuss why the UK has lagged behind other developed markets in recent years, the factors contributing to the changing sentiment towards the market and outlook for UK dividends in the months ahead.
To describe the events of 2020 as extraordinary might constitute the understatement of this still very young decade. In weathering the COVID-19 storm, most global equity markets proved to be hearteningly resilient – something of a surprise in and of itself. The S&P 500 Index and Japan's Nikkei 225 Index have climbed 40.8% and 31.3%, respectively, whilst the FTSE Euro 100 Index has gained 31.2%, over the last 12-months. Meanwhile, the FTSE 100 has lagged behind with an 18.0% return.1
This underperformance may be noteworthy, but it's not a departure from recent experience. The UK has fallen behind other world markets by a huge margin: the FTSE 100 has grown by under 20% over the last 10 years whilst the S&P 500 has grown by over 200%2, a sobering disparity. Hope springs eternal, however. After years of inferior performance, the most compelling argument in favour of the UK is current valuations. Brexit-related perils imposed large discounts on UK stocks, such that no developed world market was cheaper; the pandemic then drove value stocks globally to near-record lows relative to growth stocks.
More recent developments are forcing a rethink, however. COVID-related shutdowns have not led to widespread bankruptcies; the 'no tariffs, no quotas' Brexit trade deal has meant that UK businesses are now in a position to function with markedly reduced uncertainty; the UK is amongst the world's leaders in terms of the success of its vaccine rollout; the release of substantial pent-up consumer demand is imminent; and there is increased optimism about the prospects for the UK economy. The Organisation for Economic Co-operation and Development projects UK economic growth in 2021 and 2022 at 5.1% and 4.7% respectively, which compares well with global growth forecasts of 5.6% and 4.0%.3 The Bank of England also expects the UK economy to grow by 7.25% in 2021, up from its previous forecast of 5.0% in its February report.4
Amidst all the talk of a return to normality, one further aspect in our view, casts a positive light on the case for investing in the UK: 'normal service' being resumed with regard to the payment of dividends. For most of the last 12-months, dividend payouts have been front-page news for all the wrong reasons. In 2020, UK dividends fell 44% to £61.9bn on a headline basis, the lowest annual total since 2011. Underlying dividends (which exclude special payments) fell 38.1% to £61.1bn and two thirds of companies cancelled or cut their dividends between Q2 and Q4 2020.5
It's an acutely relevant facet, given that the UK market has traditionally been a happy hunting-ground for those in search of yield. At over 3.5% at the end of 2020, it tops the pile of the major world equity markets as illustrated by the chart below. The yield is particularly attractive relative to cash, which is virtually zero (until recently, UK monetary policy makers were openly discussing negative interest rates), and bond yields which in some cases – particularly sovereign debt – have fallen into negative territory.
Source: Siblis Research, as at 31.12.20
Moreover, dividends may provide a critical stabilising impact on otherwise volatile equity returns. In the last four five-year periods, dividend income has provided more than half of the total return from investing in the UK equity market – see the chart below.7
Source: DataStream, Allianz GI Global Capital Markets & Thematic Research
Link Group's latest UK Dividend Monitor (Q1 2021) expects UK underlying dividends to rise by 5.6% in the best-case scenario, whilst headline dividends are expected to increase by 11.1% in a worst-case scenario and 17.2% in the best-case scenario.8 In the previous quarter, it was anticipating a worst-case decline of 0.6% on an underlying basis but, as businesses have increasingly been declaring dividends in line with best-case predictions over the first quarter as the economy re-opens, the gap between the low and high forecasts has narrowed markedly. After significant dividend cuts last year, the payout ratio of the average UK company is now below where it has been for some time – even taking into account a depressed earnings base – which leaves significant headroom for dividends to grow at a healthy rate as cashflows and profitability recover.
The trajectory of the UK's dividend is very much front of mind for Laura Foll, co-Portfolio Manager of Lowland Investment Company, part of the Janus Henderson stable of investment trusts, although Laura is keen to stress that she treats income as an 'output' of the investment decision-making process. If used as a starting point, one can very rapidly end up chasing one's tail, with higher yielding shares often acting as 'value traps' where challenged fundamentals merit low valuations.
One of the clearest manifestations of a return to dividend normality can be seen in the banking sector. In December, the UK regulator gave banks the green light to resume dividend payments (with conditions attached), some nine months after it asked them to suspend shareholder payouts and preserve capital at the height of the COVID-19 pandemic. This resumption in dividends, combined with low valuations relative to history and exposure to the domestic economic recovery, meant Lowland has invested quite materially in the sector, having previously had relatively little exposure. The banking sector is in a very different financial position to where it found itself in the wake of the global financial crisis of 2008, entering this crisis with excess capital. The forced suspension of payouts meant that they were trading on particularly attractive valuations at the end of last year relative to their historical averages. Furthermore, and with the benefit of hindsight, the economic scenarios used to support their loan loss provisions in 2020 now look extreme. Financials as a whole currently represent roughly a third of the trust's asset base.8
Outside of the banking sector, Laura has been encouraged by the speed at which companies have returned to paying dividends. The majority of companies held in Lowland’s portfolio that suspended dividends during the pandemic have since returned to paying. Companies held that continue not to pay a dividend are either in the areas most affected by the pandemic (such as Johnson Service Group, which launders textiles for the hospitality industry) or did not pay a dividend prior to the pandemic. This could be due to their stage in the company lifecycle (for example solid state battery company Ilika, which is still at a stage of heavy investment in research and development and scaling up production). However, while dividends have in most cases resumed where they were previously suspended, company boards remain understandably cautious on dividend payout ratios at this stage in the economic recovery. This conservatism on payout ratios, combined with earnings that are still recovering from their lows during the pandemic, means that in Laura’s view there is a further ‘leg’ of dividend recovery to come. This further progress could come as earnings continue to climb and company boards become increasingly confident in the durability of the turnaround.
Over the last 12 months, performance has been impressive. Lowland's share price and net asset value on a total return basis – up 44.6 and 41.9% respectively – are both substantially ahead of the 21.5% growth for the FTSE All-Share benchmark.9 Data from the Association of Investment Companies also confirm that Lowland's one-year performance is well ahead of the UK Equity Income sector average.10
Patient income investors have been rewarded as UK companies begin the restoration of payouts to pre-pandemic levels. After a long, hard winter for dividends, the green shoots of late spring are sprouting. 2021 FTSE 100 dividends (excluding special dividends) are set to increase by 18% to £73.4 billion.11 It's a far cry from the levels of 2018 and 2019, but heartening nonetheless, and puts the 2021 forecast dividend yield for the index as a whole at 3.8% which is still at a significant premium to the yield on most other global equity indices. By way of comparison, the current yield on the US S&P 500 Index is 1.37% 12 - only just over a third of that anticipated for the UK.
1 Source: Bloomberg, as at 30.06.21
2 Source: Bloomberg, 17.05.11 to 17.05.21
3Source: OECD Economic Outlook, Interim Report March 2021
4 Bank of England, Monetary Policy Report May 2021
5Source: Link Group, UK Dividend Monitor Q4 2020
6 Source: Siblis Research, as at 31.12.20
7Source: DataStream, Allianz GI Global Capital Markets & Thematic Research
8Source: Link Group, UK Dividend Monitor Q1 2021
9Source: Lowland Investment Company PLC factsheet, 31.06.21
10Source: The Association of Investment Companies, as at 21.06.21
11 Source: AJ Bell, Q1 2021 Dividend Dashboard
12 Source: Ycharts, 30.04.21
|Discrete year performance % change (updated quarterly)||Share price||NAV|
|31/03/2020 to 31/03/2021||45.9||47.2|
|29/03/2019 to 31/03/2020||-29.8||-29.6|
|30/03/2018 to 29/03/2019||-6.3||-4.8|
|31/03/2017 to 30/03/2018||6.2||2.5|
|31/03/2016 to 31/03/2017||16.0||20.5|
All performance, cumulative growth and annual growth data is sourced from Morningstar
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