Outlook for income investors
2019: the good, the bad and the surprising
Mark Whitehead, Portfolio Manager and Head of Income at Martin Currie, provides his thoughts on the major investment themes for income investors to keep an eye on
What opprtunities are on your radar?
As income investors, we’re naturally always looking for sectors that can generate strong dividend growth.
Income as a style may well have lagged the tech-led bull market for the last two to three years, but we are now starting to see signs of improving prospects for dividend-producing sectors, such as utilities, telecommunications and healthcare.
Healthcare is a particularly interesting area of focus for us, and one where we should see solid dividend growth in the coming year.
The near-term political outlook for the sector is fairly benign and this lends itself to earnings visibility for healthcare companies. In 2019, we will be looking for pipeline delivery and on-market drug sales momentum, as well as continuing strong cash flow generation.
We will, however, be keeping a close eye on who emerges as the likeliest Democrat Presidential candidate, as well as Democratic prospects for gaining a clean sweep across Congress and the White House.
A healthcare reformist in the White House along with a Democrat Senate and House would likely have negative ramifications for the sector.
Banking and interest rates
Banking is another sector we are keeping a close eye on in the coming year. While US banks have been an excellent place for income investors to be positioned over the last two years, we are now more cautious on their outlook.
It appears that the ‘Goldilocks’ trifecta of high volumes, expanding margins, and very low provisioning is coming to an end in the US.
By contrast, Europe is yet to experience this sweet spot in the cycle, and whilst uncertainty remains, we see scope for a significant improvement in the banking environment there in FY19.
...the next wave of motoring – mass electrification and autonomous driving - is another fascinating area of focus.
For example, Europe’s first interest rate rise could come at the end of 2019, which would significantly benefit banks in rate-sensitive geographies within Europe.
Also this year, we expect to see some of the exciting long-term trends where we have been focusing our research continue to develop and present opportunities.
Changing global dietary patterns is one. In developed markets, for example, there is a big push on the health & wellness theme and treatment of dietary issues.
For instance, in response we are seeing food & beverage producers finding technical solutions to significantly reduce the calories in what they offer consumers.
Meanwhile, the next wave of motoring – mass electrification and autonomous driving - is another fascinating area of focus (despite some short-term weakness in the autos sector).
As the technological requirements for the next generation of vehicles become more complex, exposure to these developments should lead to structural growth and sustainable yield in the long term.
This is already creating opportunities in sectors such as the auto-supply companies – although original-equipment manufacturers (OEMs) could see margins suffer in the short term and their competitive moats seriously eroded.
What are the potential risks on the horizon?
In 2018, we saw the ‘three peaks’ of liquidity, earnings and macroeconomic activity.
In 2019, tightening labour markets, rising wages and reasonably strong economic activity in the US, will continue to lead the Federal Reserve (Fed) to increase rates.
There is, of course, a risk that the Fed will tighten too quickly, and that the combined effects of balance-sheet reduction and conventional rate hikes may contract economic growth much earlier than expected in 2019; while this is not our central forecast, it is a risk we remain acutely aware of.
Higher rates are not going to be good news for some expensive equities out there (especially for the stocks of companies which have gorged on cheap liquidity for the last decade), as among other things they mean higher borrowing costs. As such, we expect to see volatility persisting in equity markets for some time to come.
...valuations are looking cheap and we could see a bounce in these equities in 2019.
Political instability will also remain at a heightened level. The ongoing Brexit process in Europe will undoubtedly be a cause of investor uncertainty in the run up to the 29 March departure date, but once we are through that (and on the basis that some sort of trade deal is ratified), companies should start to get back to normality and begin to spend capex once again.
In emerging markets, the risks include the rising dollar, with the effects exacerbated by high oil prices.
However, valuations are looking cheap and we could see a bounce in these equities in 2019.
What is the market missing?
It might sound unlikely in an age when sustainability issues feature so prominently in the headlines, but we believe ESG factors are still greatly underestimated– or missed completely – by the market.
We spend a lot of time with corporate management teams, trying to get to grips with a company’s culture and the approach to capital allocation within the business.
Research shows that companies with better sustainability practices tend to demonstrate better operational performance, which ultimately translates into cash flows and dividends.
There are some very good examples out there of companies which are making real strides in embedding sustainability into their day-to-day operations and long-term strategies and reaping the benefits of this approach.
Engagement on sustainability issues
Conversations we’ve had with firms in 2018 have included engagement with a global science-based firm on how it is maintaining its focus on sustainability issues along the full length of its supply chain – recognising the benefits in terms of its reputation (among its customers and its shareholders) and ultimately how this enhances its economic value.
We also conducted in-depth discussions with an energy company on how technology improvements were helping reduce energy use and therefore its carbon emissions.
Sustainability and ESG will, as ever, be a large part of our company engagement in 2019 providing us with unique, forward-looking insight on companies’ abilities to maintain returns over the long term.
Important information and key risks
Past performance is not a guide to future returns.
This information is issued and approved by Martin Currie Investment Management Limited. It does not constitute investment advice or represent an inducement to invest.
The opinions contained in this document are those of the named manager(s). They may not necessarily represent the views of other Martin Currie managers, strategies or funds.
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