Monthly video update – June 2018

What Italy’s political uncertainty means for equities, and the impact of higher-for-longer oil prices on dividend growth. Alan Porter looks at the key points of interest for May.

14 June 2018

Securities Trust of Scotland - June 2018 Play Play Video
Alan Porter GIVES AN UPDATE on Securities Trust - June 2018

What caught your eye this month?

  • Italy dominated many of the headlines during the month, as the country’s struggle to form a government led to increasing political uncertainty.
  • Fears of an escalating crisis and that a populist-led Italy could follow the UK’s lead and decide to leave the European Union, prompted a sell-off in Italian equities.
  • However, from an economic perspective, the GDP outlook remains in positive territory and corporates are fundamentally strong. So, with sentiment at very low levels, many investors may be viewing this environment as a buying opportunity.

What currently interests you?

  • Alongside cheaper European valuations, following recent weakness, an area of interest for us is oil stocks, which have been strong in recent months.
  • This strength has been driven in part by expectations of higher-for-longer oil prices that are fueling large cash flow yields – which, in turn, are supportive of strong dividend growth. The market now looks to be discounting higher oil prices over the long term, but could go further to reward free cash flow generation.
  • In addition, the prospects for higher-yielding sectors less favored in recent years look to be improving, offering dividend sustainability and attractive growth.

What is the outlook for the next few months?

  • We expect volatility to continue to bubble up in Europe over the summer months, mainly driven by ongoing political uncertainties. Meanwhile, in the US, inflationary pressures look set to build as the economy continues to run at full employment. This will no doubt prompt further rates rises – with perhaps as many as three more this year and up to four more in 2019.
  • This would undoubtedly impact US corporates that have become highly leveraged on cheap debt. We increasingly see this as a potential threat to dividend sustainability, analysis of which forms a central part of our research.
  • Equities typically perform well during the latter stages of the economic cycle, which is what we believe we are currently experiencing. We expect this to continue for the rest of 2018.
  • As ever, we believe targeting high-quality companies, which exhibit lower balance-sheet leverage while sustainably investing into structural long-term trends is a compelling strategy.