BNY Mellon Investment Management: Incoming: is a value renaissance on the cards?

A memorable decade for dividends?

“We are at a pivotal moment for central banks. Should they cut interest rates? What does this mean for leadership in equity markets?

“We think in the current environment it is hard to believe central banks will aggressively cut interest rates. Two macro themes of big government and great power competition are at play, and both are inflationary. We see examples of these themes in action through central bank intervention, Covid lockdowns, and the influence on energy and food prices. Then there is the battle between liberal democracies and autocracies, the tech war, and conflicts in Ukraine and the Middle East.

“In our view, the might of these themes outweighs global disinflationary forces at play such as challenged demographics, high levels of debt and technological disruption. As such, we think the inflation genie has been released from its lamp.

“We had a long period after the financial crisis characterised by quantitative easing and lower interest rates that was good for growth stocks but not so good for dividends. But that era of ‘free money’ is over. The return to a more normal economic environment, we think, could prompt change in equity market leadership.

Newton global income portfolio manager Jon Bell

“For one thing, dividends become more significant to returns in an environment of higher interest rates. Dividend returns tend to be less volatile than capital returns and what’s more, the compounding of dividends is key to long-term equity returns.

“The importance of dividends has been evident when growth stock bubbles have burst, such as in 1930 after the stock market crash of 1929 and in the 2000s. Also, in the 1970s, the last time that inflation was a significant factor in economies. The pivot away from ‘free money’ could change leadership in equity markets and we think it’s likely we’ll reflect on the 2020s as a decade when dividends were critical to returns.” 

Newton US equity income portfolio manager John Bailer

Valuation spreads present opportunities

“For me, the biggest pivotal moment in the last 10 years was in late October 2021 when Federal Reserve chairman Jay Powell accepted that higher inflation was not ‘transitory’. From then short-term interest rates moved up significantly. This returned us to a more normal interest rate environment compared with the post global financial crisis (GFC) period.

“But in 2021, before Powell’s comments, companies were telling us they were raising prices because costs were moving higher. We could see then that inflation was not going to be transitory.

“I have a strong belief that you should throw away the playbook for what happened over the 10 years since the GFC. That is not what is likely to happen over the next 10, even 20, years.

“What happens to certain companies in a more inflationary environment? As Warren Buffett once said: ‘Only when the tide goes out, do you discover who has been swimming naked’. You saw that in early 2023 when the higher interest rate environment hit certain US regional banks. We think more companies could come unstuck, especially those that benefitted from so-called free money.

“When the S&P 500 gets overvalued or undervalued it has nothing to do with the cheapest stocks – they are always cheap – it has to do with the most expensive. When the most expensive group widen out from the cheapest, we argue it is worth focusing on potential multiple compression versus earnings growth. That is why we look for companies with good intrinsic value, improving business momentum and strong fundamentals.”
 

Attractive risk/reward characteristics

 “Investing in Asia has historically been about tapping into growth, given the commonly held view of Asia as a play on both GDP and export growth. But we think it is a fallacy to only focus on capital growth. We would argue better risk/reward characteristics can be had from a blend of growth and income in the region.

“We suggest that taking a dividend focused approach in Asia aligns investors with the right type of company. Essentially, those with resilient growth, quality franchises and strong governance and capital allocation. At the end of the day, we want companies that have cashflows to pay dividends.

“In the new interest rate regime, there is likely to be more volatility. Looking ahead, we expect more down markets than up markets. In this environment, Asia’s growth powerhouse China is seeing its growth dynamic and economy change. We think this could present a pitfall for investors focusing purely on growth strategies in the Asia region. China’s internet platform companies have become a large part of the benchmark but face headwinds, including the country’s uncertain macroeconomic situation, as well as regulatory risk.

Newton Asian income portfolio manager Zoe Kan

“We think the capital growth component of a portfolio’s total return is more volatile and less dependable than the income component - especially in Asia. Rather than trying to target just capital growth, we think by harnessing the potential of dividends and dividend growth it is possible to compound total returns in a more consistent fashion.

“Asia is a critical supply chain hub for technology products for the whole world. It supplies many of the nuts and bolts for the artificial intelligence (AI) theme. There are lots of opportunities for income investors to benefit from the AI wave, not least through Taiwan’s technology companies. We also see opportunities in Singapore where there are companies with good governance, strong balance sheets and high payout ratios. Plus, a lot of wealth and trade passes through Singapore from neighbouring regions.

“Investors might want to think more carefully about how they access Asia in the next decade and beyond. We would advocate looking beyond growth-only strategies and towards those that invest in quality companies that pay dividends that can be compounded over time.”