Secure yield
Over the past months the equity performance has been rather erratic driven not only by shifting expectations with regards to the fundamental outlook but also by big swings in investor sentiment and positioning. Turnarounds were often concentrated around central bank policy setting events. We observed higher volatility around central bank meetings and the Yellen testimony to Congress Mid-February. The latter coincided with a turnaround in the US eco-nomic surprise data and represented the bottom of the market. Also for cyclical commodity prices this was the start of a prolonged period of rising prices whereby Brent oil rose from USD 30 to USD 40 and industrial metal prices increased 8%.
Interesting is the fact that even with perfect central bank forecasting skills it has not been easy to predict market movements. Who could have imagined a soaring JPY and hence falling Japanese equity market once the BoJ cut rates into negative territory? Or what to think about the gyrations of the European equity market immediately fol-lowing the latest ECB meeting? Only the market reaction after the dovish outcome of the last Fed meeting was in line with what one could have expected: a lower USD, higher US equities and EM outperforming DM equities. We adapted our regional allocation accordingly by upgrading US, UK and EM and downgrading Japan and the Eurozone.
Given all this short term volatility, it might be interesting to focus on one of the more stable parts of the market: Dividends. Not pretending that making dividend forecasts is easy, but at least these are less volatile than earnings.
In addition, it is possible by looking at some cash flow and balance sheet metrics to get an idea of the sustainability of the dividend on a global sector and regional level. In this respect, we looked at the following elements: The pay-out ratio relative to history and to the market, financial leverage, the dividend cover, free cash flow and past divi-dend policy (growth rate, volatility and maximum drawback since 1985). Finally, we integrated the IBES consensus growth EPS numbers for the next two years. Based on these elements we ranked the 10 sectors from high to low risk with their current dividend yield.
Not surprisingly, there looks to be a trade-off between the yield and the safety of it. For example, the global energy sector has a trailing dividend yield above 4% but the safety of this dividend is low.
The Health care, Staples and Industrials sector on the other hand both offer high dividend safety but this yield is relatively low. Nevertheless in a generally low yield environment a 2%+ safe dividend yield could still be attractive. Technology is an interesting case. Based on the used screening factors, the dividend safety is only average. We think this is overly cautious given the low pay-out ratio (26%) and very strong balance sheets of technology compa-nies. It is also the sector that witnessed the third highest dividend growth (7.9%) over the past 30 years (Staples and Health Care are the number one and two).
We made the same exercise for the regional dividends. The lowest risk is perceived for the Japanese market. This is driven by three elements. First, the average payout ratio is below 30%. Second, the financial leverage of the corpo-rate sector is low and thirdly there is a structural shift towards more shareholder value creation.
The region where we think dividend growth will have more difficulties to keep up with earnings growth is the Euro-zone. However, an element that could be supportive is the ECB program to start buying corporate bonds. This will push down the risk premium for corporate bonds which makes it attractive for companies to push up EPS through financial engineering (debt financed equity buy backs).
