Newton’s Jon Bell on the outlook for income stocks
Dividends have rebounded strongly and much faster than normal following a recession. While the dividend recovery of individual companies varies, most regions, with the exception of the UK, should see 2021 dividends exceed pre-pandemic levels. The recovery has been especially strong in cyclical sectors or sectors that have seen the biggest impact from the lockdown of economies. Sectors like health care and technology, which benefit from strong secular growth trends, have also continued to grow.
As long as the economic recovery continues, we expect dividends to benefit from the tailwind created by the strong positive improvement in company earnings that goes hand-in-hand with the economic upturn. Indeed, thus far, the earnings recovery has been ahead of the dividend recovery. As a result, dividend cover has increased, suggesting that there is scope for further upside in distributions and certainly implying that current dividend levels are sustainable. What is more, it means there is a larger buffer in place than there was pre-Covid in the event that economic recovery stalls.
Inflationary pressures, which have been building as a result of increased state intervention and the unification of monetary and fiscal policy, have been exacerbated by lockdowns, leading to supply shortages. Price pressures in commodity, raw materials and goods sectors should diminish as supply shortages ease, but others may be permanent - for example, with regard to wages - and we therefore expect inflation to settle at a higher rate than we have become used to. This is likely to lead to higher bond yields, and the US Federal Reserve has been clear that it will look to taper its bond purchases and ultimately to raise interest rates. This might be thought of as a negative backdrop for income stocks, but we would note that dividends tend to grow with inflation, providing a degree of protection.
We expect the pattern of rotations in leadership between income/value and growth equities to continue, but we are very positive on the longer-term prospects for income stocks, as we believe valuations remain attractive versus the broader market. With dividends recovering and offering an attractive spread over government, corporate and high-yield bonds, we see their attractions as being only enhanced.
Many defined contribution investors approaching retirement will be seeking a consistent, predictable income stream over the long term, and we believe the current backdrop offers plenty of good reasons for them to keep faith in income-paying equities.
Jon Bell is portfolio manager, equity income team, at Newton Investment Management
Important information: These opinions should not be construed as investment or any other advice and are subject to change. This article is for information purposes only. Any reference to a specific country or sector should not be construed as a recommendation to buy or sell investments in those countries or sectors. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England No. 01371973. Newton Investment Management Limited is authorised and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation.