Inflation to boost global income
Newton’s global income team expects inflation to remain elevated and a brighter outlook for dividends this year, which it believes will drive a rotation into income stocks.
Higher volatility and inflation in the year ahead are set to drive a rotation out of growth stocks and into cyclical income-paying names, according to the Newton Global Income team.
Before the pandemic, an environment of deflation and low volatility led investors to favour long-duration growth stocks. Low bond yields further benefitted these stocks due to the falling discount rate used to value growth businesses.
However, Newton’s global income team, headed by Ilga Haubelt, says as central banks start to taper bond purchases and raise interest rates, lower-valued income stocks are likely to be less vulnerable to inflation. This is because of the close correlation between inflation and rising dividend payments.
“We have seen in 2021 that periods of higher inflation and interest rate fears favour income stocks as the valuation of growth stocks comes under pressure and the relative attractiveness of income stocks increases,” Haubelt says.
Last year saw one of the fastest-ever global dividend recoveries to follow a recession thanks to fiscal and monetary stimulus and the re-opening of economies, according to Newton. Global dividends bounced back to pre-pandemic levels in 2021 and Newton expects continued dividend growth in 2022, albeit at a lower rate than last year.
The team observes sectors hardest hit by the pandemic in 2020, such as materials and consumer discretionary, benefitted most from the rebound, with companies in Asia and Europe leading the way. Dividend restrictions were also lifted in the financials sector, while technology and healthcare companies continue to show strong growth.
Dividend sustainability improved during the pandemic, according to the Newton team, as certain companies adopted a cautious stance by reducing payout ratios. “This provides an extra buffer for any potential future economic slowdown and means that the probability of companies having to cut their dividends has decreased,” Haubelt adds.
Looking ahead, the team expects earnings and dividend growth will remain healthy in 2022 but thinks it will revert to more normal historic levels as the pace of global economic recovery eases. Meanwhile, the team believes humanity is better prepared medically for any new wave of Covid-19 which means the most likely outcome is recovery “to a world more reminiscent of 2019”.
It also flags the possibility companies start to favour dividends over share buybacks, particularly in the US where President Joe Biden’s Democratic party has proposed a 1% surcharge on buybacks.1
“With market valuations elevated and dividend payout ratios and yields below their historic medians, we believe that should the proposed legislation be enacted, it will make it relatively more attractive for companies to return cash to shareholders through regular or special dividends,” Haubelt says.
The team notes demand for income in the market is high due to the general decrease in bond yields since the global financial crisis and negative real rates across fixed income, while meaningful income alternatives are scarce.
In the year ahead, the team expects the rotation between growth and income stocks to continue and remains bullish on the latter as valuations remain attractive versus the broader market.
“With dividends recovering and offering an attractive spread over the yields from fixed-income assets like government, corporate and high-yield bonds, their attractions are enhanced, and we are very encouraged by the more sustained outperformance from income stocks we have seen since the beginning of December,” says Haubelt.
1 Wall Street Journal. Biden Stock Buyback Tax: What to know about the latest proposal. 28 October 2021.
853979 Exp: 11 August 2022