US growth remains resilient, and most analysts expect interest rates to be higher for longer. Economists are talking about a soft landing for the US economy. The macro data remains strong despite high energy prices, elevated interest rates, and geopolitical instability.
Inflation is starting to recede, suggesting rates are at or near their peak. None of this is happening quickly, and with rates forecast to be higher for longer, we see a possible US recession on the horizon, albeit potentially shallow.
The S&P500 has continued to rise, with growth outperforming value. But this was driven by a handful of stocks. We expect higher-for-longer rates to lead to a slowdown in global growth, with value and dividend-paying stocks starting to outperform. Under this backdrop, investors should consider equities for income rather than bonds.
Traditionally, investors have turned to bonds for income. But when you buy a bond, you receive a static coupon that doesn’t grow with inflation. Records show that dividend income has been resilient to inflation.
Remember, quality companies continue to pay dividends whether markets rise or fall. If they fall, you can receive income payments, and if they rise, you can benefit from capital growth potential while still receiving income. Dividends have grown 5.6% annually over the past 20 years, and we’re forecasting 7% annual dividend growth for the MSCI AC World Index next year.
We think equity income makes sense for 2024 for three reasons. Firstly, leading companies can raise dividends despite inflation. Income from equity dividends has some specific well-known advantages compared to income from bonds. Albeit with more risk, equities typically offer greater upside potential from price appreciation. Also, unlike most bonds and other investments that pay set interest rates, companies can increase their dividend payments over time. Companies that increase dividends in inflationary environments can provide inflation-hedged income opportunities.
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Another reason is income stocks look currently cheap on a relative and historical basis. In 2023, equity markets experienced limited leadership, with the “Magnificent Seven” taking the lead and the “dividend aristocrats” recording their most significant underperformance since 1999.
Various indicators signal a potential shift away from the narrow dominance of a handful of mega-cap tech stocks, with an expected slowdown in economic growth. Transitioning from a growth-oriented economic environment to a more value-driven one could benefit companies that pay and grow their dividends. Equity valuations generally look reasonable, particularly away from US markets.
Finally, firms that grow dividends outperform those that don’t in the long term. Dividend investing strategies have a reputation for providing attractive long-term returns, particularly risk-adjusted ones. Substantial evidence across global equity markets shows dividend-orientated investing strategies outperform the broader market over the long run.
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Over the last 20 years, companies that have initiated or consistently grown their dividends ("Dividend Growers and Initiators") have comfortably outperformed the broader global index. Dividend Growers and Initiators have also outperformed companies that have paid but without growing them ("No Change Dividend Payers") and companies that don’t pay dividends ("Non-Dividend Payers").
Two-tier approach
So, how can investors build a global equities portfolio to enjoy sustainable income and capital growth? One method is adopting a two-tier approach, seeking premium yield and capital growth opportunities. We favour companies we think can grow their dividends, and unlike many peers, we do not use derivatives to help generate income.
For example, we analyse company fundamentals to find the best dividend-payers and actively manage a portfolio of 80-100 stocks. This makes up the core part of the portfolio.
Additionally, the portfolio could set aside a tactical trades account to rotate into dividend and special dividend events to enhance yield. Investors could gain exposure to these stocks to capture their dividends before selling out.
Unlike traditional dividend strategies, which may focus on high-dividend sectors, a dynamic dividend strategy can diversify across sectors and countries and is style-agnostic regarding value or growth. That gives investors more scope to invest in businesses offering attractive total returns over the long term. We look to understand a company’s competitive positioning and ability to sustain and grow dividends.
As the US economy demonstrates resilience amidst challenging conditions, investors are advised to consider equity income as a strategic choice for 2024. With its ability to combat inflation, offer attractive valuations, and deliver long-term outperformance, equity income presents a compelling alternative to traditional bonds.
By adopting a two-tier approach focusing on premium yield and capital growth opportunities, investors can build a diversified global equities portfolio that aims to provide sustainable income and capital growth.
Navigating the dynamic economic landscape requires a forward-thinking investment strategy, and equity income offers a viable path to help secure financial success in the future.
Josh Duitz is head of global income, abrdn
