Day: 26 June 2020

The coronavirus pandemic could shape how UK businesses think about dividends going forward, says Franklin Templeton UK Equity’s Colin Morton. He shares his on-the-ground thoughts on the UK economy, and how it measures up against the last global economic shock.

As investors continue to navigate through the unprecedented global health crisis we have experienced this year, we’ve seen governments and central banks worldwide deliver extraordinary policy responses. These include large reductions in interest rates and substantial quantitative easing (QE) programmes, which have supported the bond market.

In the short term, we are currently considering what the exit strategies for these policies are—we’ve seen a few encouraging signs from the easing of lockdowns across some European economies. The United Kingdom is a few weeks behind other European economies in terms of a phased-in economic re-opening. For example, non-essential shops re-opened on 15 June after a three-month closure. The concern is whether we’ll see a resurgence in infection rates as people start going back to some level of normal activity.

An Unparalleled Global Economic Shock

Concerns hang over the foundation of some of these government or central bank policy responses. For example, the United Kingdom enacted a job retention scheme, which allows employers to furlough workers on 80% of their salary. The furlough scheme has undoubtedly protected a large amount of jobs in the country.

Many think tanks estimate that one in three people in the United Kingdom are currently furloughed. Questions remain what will happen when companies have to start funding payroll themselves after the furlough scheme winds down between August and October of this year. It may be that the UK government will have only temporarily saved the jobs companies were planning to let go.

The charts below show the course—and the speed—of unemployment claims in both the United States and the United Kingdom. Some investors might be numb to the word “unprecedented” at the moment, yet COVID-19 truly is an unparalleled global economic shock. We’ll be watching events in the United States closely as the economy gradually opens up.

Another aspect we’re monitoring closely in the United Kingdom is public sector borrowing. Over the last 10 years following the global financial crisis, annual net borrowing (i.e. budget deficit) to gross domestic product (GDP) ratio was reduced to about 2% of the economy. Given the UK policy response leading to more government borrowing and a potentially shrinking economy, we think the United Kingdom could reach as much as 15% net borrowing to GDP in 2020, clearly a huge increase as seen in the second chart below.

What’s counterintuitive is that we have a situation where government finances are in a worse situation than they were three months ago, yet they can borrow money at a cheaper rate, since those that are buying bonds are driving bond prices down. Despite the current financial situation, the UK government is able to take advantage of very low interest rates.

Three Potential Scenarios Face UK-Listed Companies

As we previously discussed in March, just when some companies were starting to forego dividend payments, we recognised some UK-listed companies, particularly those in consumer-facing sectors, have had to adjust their dividend policies in the wake of the pandemic.

While it’s hard to predict how long this crisis will continue to weigh on company balance sheets and dividends, it is becoming clearer that dividend policies are still up in the air for many UK-listed companies.

Against this backdrop, companies have split into three camps: those that have suspended, cut or cancelled dividends.

There are companies that have so far delayed dividend payments—they haven’t cancelled them, and they haven’t cut them. Some companies in industries where the virus generally hasn’t impacted as badly are hoping the outlook will improve over the next three to six months. And if they do, there’s a chance that they will pay the dividend that they’ve delayed. So, we may see some element of catch-up.

Meanwhile, other companies have completely cancelled dividend payments, and generally speaking, the pandemic has had a negative impact on companies dependent on consumers. It would be extremely difficult for them to pay dividends at this point in time. Companies that do not have much (if any) revenue at the moment, and have taken advantage of government schemes and cancelled dividends, probably won’t be paying them at all this year.

The Future for Dividends

Ultimately, we don’t think the pandemic will fundamentally break the concept of a steadily rising and consistent dividend story in the United Kingdom. What will likely happen is a refreshed approach—it will make businesses think differently about how they pay dividends.

Some people have argued in the past that companies with a model wherein earnings are very dependent on elements that are out of investors’ control i.e., oil prices, should have more of a payout ratio system rather than an absolute level of dividend. We’ve seen a gradual move towards this system from some oil businesses, for example, in the last three or four years. Some will pay between 40%-60% of their earnings out as a dividend, rather than committing to a progressive dividend policy.

For businesses where there might be a lot more cyclicality to their earnings, which is a lot more difficult to predict, perhaps we will see a similar type of dividend policy.

It largely depends whether businesses think a shock like we have seen with COVID-19  is something that could happen again or even regularly, which could encourage companies to run their businesses with stronger balance sheets going forward. Furthermore, companies which are more cyclical and consumer-dependent might want to make sure they have a stronger balance sheet and pay out less in terms of special dividends and curtail share buybacks going forward.

In a normal type of economic scenario, however, we think many companies with quality businesses and good long-term prospects should be able to keep growing their dividends, albeit from a lower base.

 

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John Husselbee, multi-asset manager at Liontrust, shares his views in a short article below.

 

A fixture in our presentations for many years, the investment clock is a useful way of showing how a business cycle typically develops over time and has proved as good a method as any of pinpointing ‘where we are’ in terms of markets and economies at any particular point in time.

While many have claimed its invention – and a number of investors have certainly evolved the concept over the years – the idea of the clock goes back to the 1930s when it was first published in the London Evening News.

Noise or sentiment (primarily those old classics of fear and greed) are typically the drivers behind short-term market direction; over the longer term, however, more fundamental factors tend to dominate and for us, the most important are the path of inflation and economic growth.

This is ultimately the thinking behind the investment clock, with these forces peaking and troughing at different points: if you plot it as a graph, economic growth is on the vertical axis, from bottom (falling) to top (rising), while inflation is on the horizontal, moving from deflation on the left to rising prices on the right.

The investment cycle moves through waves, with central banks usually inflating or deflating monetary policy to stabilise activity within the economy. Tracking the movement around the clock’s quadrants, reflation and recovery on the left, overheat and stagflation on the right, can give some guide to investment rotation across assets and sectors.

It is possible to include a lot more information on the clock ‘face’, drilling down into the types of bonds or commodities that will outperform at particular points, but we prefer to keep to the relatively simple model below. This shows inflation and growth and which of the four main asset classes (as well as which sectors of the equity market) is likely to be in the ascendancy during each period. Anecdotally, I typically describe the clock as heading North when the economy is expanding, South when contracting, East when inflation is rising and West when it is falling.

Source: Liontrust, January 2020

While there is no fixed term for a cycle, a full turn of the clock would typically be expected to last the best part of a decade. Long-term trends have been more muted over recent years, with persistently low inflation and anaemic growth during perhaps the slowest bull market in history. As we all know, however, that quickly gave way to one of the fastest bear markets when the implications of Covid-19 became clear, moving the clock into fast-forward mode and jumping to the dreaded bottom left-hand corner of recession and deflation.

Conventional wisdom would dictate this is typically a period that favours bonds and there could certainly be an argument made for this once again, with government intervention skewed towards fixed income and the asset class benefiting from its mandatory coupons as equity dividends suffer suspensions and cancellations.

Despite this, however, equity markets have already bounced back to a large extent and retraced most of their losses, nominally pushing us deep into the clock’s recovery zone. Financial markets are well known for their discounting ways as they price in expected future events, but given how fast things are moving, it is worth stepping back to take a good look at exactly where we are on the clock in reality.

If we go back to those two driving factors of growth and inflation, we can probably push any serious concerns about the latter into the future. Given the scale of government intervention during the current crisis, growing fears about higher prices are understandable, although talk of a spike seems premature.

During a previous period of government largesse, in the wake of the Global Financial Crisis, there were similar concerns that quantitative easing would spark inflation but, ultimately, the forces of globalisation and technology were enough to keep it in check. This time, however, we would suggest technology is more embedded than it was then, and perhaps less disruptive, and we might also see companies eschew global supply chains and seek more local suppliers in a post-Coronavirus world, both of which could put upward pressure on inflation longer term.

As for economic growth, equity markets appear to be rising on the assumption that the damage caused by the pandemic will be offset by massive monetary and fiscal stimulus. But forecasts show real global GDP in 2020 falling by 4.5% to 5%, with developed markets expected to shrink by 6.5% to 7%, and there is huge uncertainty as countries move out of lockdown: how will unemployment affect consumer-led economies like the UK and US, for example, and should the world brace for another wave of the virus in the winter or earlier?

We would not expect markets to collapse again as they did in March, given the level of state intervention and the prevailing ‘whatever it takes’ narrative. But as previous recoveries have shown, there are often several chances to invest on the way up and we would caution against the assumption we are already out of the reflation stage and heading towards recovery and a new bull market. As has been the case many times before, we are perhaps not as far around the clock as those giant discounting machines in the shape of equity markets are signalling. For us, the global economy is still around the 8pm mark, based on fundamentals, while equities have rushed ahead to 10pm – and with tough times ahead, patient investors might do well to reset their watch.

 

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The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Issued by Liontrust Fund Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518165) to undertake regulated investment business. This document should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.  

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By Preston Caldwell, equity Analyst, Morningstar.

Fiscal stimulus is already substantially boosting economic activity. 

After several months of dour data rolling in for the U.S. and global economies, the surprisingly positive U.S. jobs report on June 5 and retail sales report on June 16 have given investors a glimpse of the recovery from the coronavirus. For the United States in particular, an economic recovery from trough April levels is clearly underway, thanks to lessened social distancing plus unprecedentedly large fiscal stimulus. These factors should continue to play out in the second half of 2020, though there will be some bumps on the road to recovery.

We expect broad vaccine availability in the first half of 2021, clearing the way for a full normalization of economic activity in the U.S. and abroad. In the meantime, fiscal stimulus is playing a crucial role in limiting the knock-on economic damage from the virus. Private income has actually surged thanks to the stimulus. A good deal of the extra income is supporting spending, but the saved portion is bolstering household and firm balance sheets, which should lay the groundwork for a robust recovery. So far, signs of long-run economic damage appear small, as evidenced by the rapid rebound in employment in hard-hit industries in May. We expect robust catch-up growth in the years following 2020. By 2024, we think that the U.S. GDP level will recover to just 1% below our pre-COVID-19 expectation.

Even with May’s surprise rebound in employment and retail sales, broad indicators of U.S. economic activity point to a double-digit GDP decline in the second quarter. Activity was down sharply for key indicators through April, and total employment in May was still 13.5% below January levels.

Source: US. Bureau of Economic Analysis, U.S Bureau of Labor Statistics, Morningstar.

The overall drop in activity has far surpassed the peak-to-trough decline during the Great Recession. This is especially the case for personal consumption. The 19.4% drop in (nominal) personal consumption from January to April 2020 dwarfs the 3.9% drop from June 2008 to March 2009; in fact, this year’s drop is by far the largest in the post-

World War II era.

Source: US. Bureau of Economic Analysis, U.S Bureau of Labor Statistics, Morningstar.

Among the components of consumer expenditure, consumer services has created the bulk of that disparate impact. In a typical recession, spending on consumer services (which accounts for about 70% of total personal consumption) is largely unscathed. This time, the need to social distance has caused many consumer services to be among the hardest-hit parts of the economy. While the monthly data doesn’t cover the components of consumer services spending, the industry-level employment data suggests that restaurants, hotels, air travel, and personal services (for example, hair salons) have seen the greatest declines.

The thundering rebound in retail sales in May points to rapidly improving consumer sentiment. However, overall personal consumption probably didn’t recover as strongly in May, given that retail sales don’t incorporate consumer services spending. If we assume that services spending was still down around 12%-14% in May (versus January levels), then overall personal consumption was still down about 10%, even incorporating the surge in spending on goods.

Retail Sales Came Roaring Back In May
Following a sharp rebound, retail sales (excluding restaurants) in May are now merely 4% below January 2020 levels. Excluding gas station sales, retail sales are down merely 1%.

At the trough in April, retail sales were down 18%, exceeding the Great Recession drop. During a typical recession, durable goods spending falls sharply as consumers pull back on big-ticket purchases like autos, appliances, electronics, and furniture. Some of that has occurred in 2020, indicating that precautionary saving probably drove a good deal of the reduced spending in April. This is particularly the case for motor vehicles (accounting for over 20% of retail sales), where sales fell 35% from January through April. Given that auto dealers remained open in most states during the lockdowns, and that COVID-19 transmission concerns are relatively small in an auto dealership setting, most of the decline was probably driven by consumers’ heightened economic uncertainty rather than narrow concerns about social distancing. Motor vehicle spending recovered aggressively in May along with consumer sentiment.

By contrast, the massive declines seen among apparel, electronics and appliance, and home and furniture retailers were probably driven mostly by social distancing. Declines in these categories remain high through May, though rapid substitution to online retailers has probably curbed the overall impact on consumer expenditure on these items.

To what extent has the shift to e-commerce buffered retail sales from the impact of social distancing so far in 2020? Nonstore retailers (mostly online retailers) saw sales growth of 27% from January to May, increasing their share of total U.S. retail sales from 15% to 19%. While substitution to nonstore retailers was insufficient to offset the drop in other store retailers’ sales in April, the substitution proved more than ample in May.

Employment Losses Have Been Larger (And Different) Compared with Prior Recessions
The distress in U.S. labor markets has surpassed all post-WWII recessions. In April, the employment/population ratio fell to 51.3% and the unemployment rate surged to 14.7%, both the worst levels since the Great Depression.

The nature of the job losses has been quite different from recent recessions. Construction and manufacturing are typically the largest drivers of net job losses during recessions, and in the last two recessions they accounted for the majority of job losses. This is unsurprising, given that expenditures on consumer goods and private investment typically see the steepest declines in recessions. This time around, however, nearly all of the job losses have been in private services industries.

The more muted decline in manufacturing employment (only 8% through May) is a positive signal. U.S. manufacturing employment has generally failed to recoup its losses following recent recessions. These layoffs were generally associated with increases in labor productivity, mitigating somewhat the impact on sector-level GDP/output. Nevertheless, unemployed workers from manufacturing struggled to find new jobs, thereby dragging on the economy’s aggregate demand.

Of the job losses through May, 77% have been driven by a set of highly affected industries. The most viciously affected have been restaurants, other hospitality, and personal services, which accounted collectively for 41% of the job losses though constituting just 15% of employment in January. Encouragingly, jobs in these industries bounced back quickly in May as social distancing was relaxed, indicating that once the need for social distancing has expired entirely, these industries should be able to jump back to prior levels of activity.

The May employment rebound also likely reflected the effect of the Paycheck Protection Program, which essentially provides grants to small businesses conditional on their maintaining payrolls.

No Massive Disruption Of U.S Manufacturing Due To COVID-19
So far, we haven’t seen massive disruption to U.S. manufacturing as a result of COVID-19. Industrial production fell 16% from January to the April trough, actually less than the 17% peak-to-trough drop during the Great Recession. The 83% collapse in auto production through April is one prominent counterexample, owing to a shutdown brokered between the United Auto Workers and the Detroit Three. Given that vehicle sales are likely to be down sharply in 2020 due purely to lower demand, manufacturers may not have balked to the degree they normally would have at curtailing supplies with a temporary shutdown. In any case, auto production resumed in late May. Most other manufacturing segments have seen more modest declines, likely driven more by the prospect of reduced demand than by supply-side disruptions. Some segments (notably electronics and IT equipment) have seen no hit to production levels so far.

Breaking down industrial production into key categories, the defense equipment category probably best reflects the impact of pure supply-side pressures, given that defense expenditures are not likely to be curtailed. Production of defense equipment is down just 7% versus January levels through May, and the rebound versus April levels suggests that supply-side constraints are receding. Finally, producer prices excluding food and energy were flat in May versus April levels; given the recovery in demand, this would not be the case if supply were highly constrained. Overall, we expect industrial production to continue to rebound insofar as aggregate demand supports it; we don’t think supply-side constraints will hold back a recovery.

Fiscal Policy Is Providing Crucial Lift To Incomes And Spending
The U.S. fiscal policy response to COVID-19’s economic impact has been extremely impressive. As a result of the bills passed (including the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act signed March 27), the U.S. Congressional Budget Office projects that the U.S. federal deficit/GDP ratio will reach 17.9% in fiscal 2020 (ending Sept. 30). Combined with modest state and local deficits, we expect U.S. total government deficit/GDP to reach about 20% in calendar 2020, a 1,300-basis-point increase versus 2019. This would mark an unprecedented level of peacetime U.S. fiscal stimulus. This year’s stimulus will dwarf anything seen during the post-Great Recession stimulus or the New Deal era of the 1930s.

A good deal of the stimulus funds were disbursed in April and May, including the $1,200 one-time payment sent to most U.S. adults, federal supplements to unemployment insurance, and the Paycheck Protection Program targeting small businesses. This showed up clearly in the personal disposable income figures for April, which were up 11% versus January despite a 10% drop in labor income. The gap is accounted for by a fall in net taxes and transfers, which includes the effect of the fiscal stimulus.

However, despite the 11% jump in personal disposable income, personal consumption plummeted 19% through April. This means the personal saving rate surged to 33% in April. Does this mean that the stimulus is failing to prop up spending (and thereby aggregate demand in the economy)?

Even though much of the stimulus has clearly been saved so far, we think spending growth would have been drastically worse without the stimulus. One study examined household-level data from SaverLife, a nonprofit that helps families track income, spending, and savings. It looked at the effect of the one-time cash payments included in the CARES Act (around $1,200 per adult) and found that households increased their spending by $0.30 for each dollar in stimulus received in the first month. Unsurprisingly, the effect was much larger for liquidity-constrained families (those with smaller cash savings balances). Because the timing of receipt of stimulus checks varied substantially across households, identifying the causal effect of the stimulus is very credible.

Furthermore, we suspect that the stimulus will provide an even greater boost to spending eventually, once the social distancing concerns about shopping abate along with the virus. To some degree, this has occurred already in May and June as lockdowns have been lifted. According to aggregated credit card data from tracktherecovery.org, consumer spending has rebounded from a trough of down 33% (versus January levels) in April to down 13% in early June. Ultimately, the wide availability of vaccines that we project for the first half of 2021 should quell remaining COVID-19-related hesitations about shopping.

In the meantime, households and firms alike are building up an impressive pool of savings with which to eventually fuel spending growth. We expect that domestic private (aftertax) income will grow about 9% in 2020 despite the collapse in nominal GDP. Domestic private income is the sum of private expenditures, the government deficit, and net exports. Equivalently, it is nominal GDP less taxes net of transfers. Despite a collapse in private expenditure (and therefore GDP), private incomes will be supported thanks to a massive boost in government deficits.

In the short term, much of the income windfall will fuel higher savings. This extra savings should bolster household and firm balance sheets. Not only will this help curb the risk of financial distress (which threatens to weigh on economic activity well after the pandemic subsides), it also will encourage households and firms to spend more in the period once the pandemic is over.

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Since its original publication, this piece may have been edited to reflect the regulatory requirements of regions outside of the country it was originally published in.

The opinions, information, data, and analyses presented herein do not constitute investment advice; are provided as of the date written; and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this document. Except as otherwise required by law, Morningstar, Inc or its subsidiaries shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. It is important to note that investments in securities involve risk, including as a result of market and general economic conditions, and will not always be profitable. Indexes are unmanaged and not available for direct investment.

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This information has been accurately reproduced, as received from Morningstar, Inc. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or
solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your
investment return therefrom. Any decision to invest should always be based upon the details
contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta)
plc.