2021: better income outcomes?

Investors should be mindful of structural challenges posed to income generation as a result of rapid thematic change.

• The development of effective Covid-19 vaccines is a pivotal moment.
• The vaccines will enhance management teams’ visibility.
• Improved visibility could lead to the reinstatement of both forward-earnings guidance and dividends.

After a year that has been dominated by the uncertainty generated by the Covid-19 pandemic, which has benefited growth stocks – given the structural tailwinds they benefit from, and the perceived earnings certainty they enjoy as a result – the announcement of three potentially effective vaccines marks a significant change in the outlook. There are still questions that need to be answered, such as how governments will roll the vaccines out and how long they will be effective for, but markets have been buoyed by the news. It should enable market participants to look through the pandemic-related disruption and focus on the economic recovery that is underway as a result of the enormous fiscal and monetary stimulus that has been applied to economies. This policy unification, whereby quantitative easing is no longer matched by austerity policies, represents a significant development of our ‘state intervention’ theme, a development that had begun ahead of the pandemic, but one that has moved forward dramatically during the crisis.

Enhanced visibility

The vaccines will enhance management teams’ visibility into the end of this recession and might also be the catalyst for a return in management confidence, leading to the reinstatement of both forward-earnings guidance and dividends, reversing some of the cuts that we have seen this year. In addition, economic normalisation should lead financial regulators in Europe to allow banks and insurance companies to resume dividend payments.

Overall, we are encouraged by the dividend trends that we have seen during the last two rounds of company results, with fewer cuts coming through, and several companies which had previously suspended their dividends announcing a resumption of payments. We believe that this will be the catalyst that brings investors back to dividend stocks and gives them the confidence to take advantage of the undoubted valuation opportunity presented by the dramatic outperformance of growth stocks.

Rapid thematic change poses structural challenges to income generation

The dividend distribution from the global index is expected to be down 16% in 2020 relative to 2019, but income will return. However, not all companies will be able to restore dividends to previous levels, as the pandemic has accelerated some of the key themes that were in already in place.

Trends identified by our ‘smart revolution’ and ‘Earth matters’ themes have clearly accelerated. The office environment may never be the same again, international business travel will surely be reduced in favour of technology-driven alternative methods of communication, and a number of major oil companies have accelerated their transition to renewable rather than hydrocarbon-based sources of energy. Income funds will need to be mindful of the structural challenges posed to income generation as a result of this rapid thematic change.

One key consideration is whether the unification of fiscal and monetary policy will help to end secular stagnation, and finally be the catalyst that shifts the world from deflation to inflation. There is no doubt that the pandemic has delivered a profoundly deflationary shock, but the scale of the response is also unprecedented beyond world wars. It is likely that, over the medium term, inflation will start to rise, and while central banks are likely to intervene to prevent bond yields rising dramatically, we may begin to see a change in the shape of the yield curve to the benefit of financial stocks. The financial sector has been one of the hardest hit by the pandemic, leaving some companies at levels we think are broadly attractive.

To navigate such a challenging backdrop, and with volatility likely to be elevated, we believe following an active, disciplined approach that emphasises quality and sustainable income should serve investors well.

Authors

Jon Bell

Portfolio manager, Equity Income team