Olly Russ, fund manager at Liontrust, shares his views in a short article below.
Although 2020 will likely prove to be a year to forget for income investors, 2021 should see companies free of restrictions and awash with capital to return to shareholders.
It is said that predictions are difficult, especially about the future, and never more so than now. An epidemic itself is not out of investors’ experience – we have seen SARS and Swine Flu in recent times, for example. Never though have we seen countries deliberately shutter their entire economies in this fashion. What effect this may have had on viral transmission will no doubt be debated for years to come, but the effect on economies has been severe.
Without doubt, the world is looking at the most severe recession in modern times, with all that this entails in terms of destroyed jobs, wealth and businesses. The fiscal damage caused by varying personal and business bailouts will dwarf the global financial crisis. The corporate response to a downturn in demand has to be to lower costs, which unfortunately means unemployment will rise sharply. This reduced personal spending power will have a long-term negative effect. This excess debt is forecast to take the UK and Europe to around 100% debt-to-GDP ratio.
On the more positive side, as the recession itself was to a large degree artificial and self-inflicted, the bounce-back should be relatively swift once restrictions are lifted. Nonetheless, it seems as if it will be the end of 2022 before European economic output once again reaches the level of January 2020.
Unlike the 2008 global financial crisis, this current recession is not the result of a credit crunch. Banks entered this downturn in relatively good shape, having accumulated capital over the last decade, albeit not necessarily due to prudent management but rather under government orders. As a result, and aided by various government guarantee schemes, there should be no shortage of available funding during the recovery phase.
More than ever, investors need to focus on companies with secure balance sheets and the financial robustness to weather the immediate storms and survive into the potentially more profitable and less competitive landscape beyond. Dividend-paying companies are normally at the forefront of this, but the signalling power of dividends is reduced in this crisis.
European dividend season is very heavily focused in the spring, when payouts are made from the previous year’s earnings. Unfortunately, this coincided with peak corona-panic this year. Dividends were cancelled, reduced, postponed or suspended with varying reasons, including ECB or government suasion, the impact of falling earnings or simply prudence on the part of companies’ management teams.
The net effect of all this will be to reduce the dividend-paying ability of Europe temporarily, in common with the UK.
Looking at those income stocks that have so far been able to navigate the crisis relatively well, it is unsurprising that healthcare stocks feature prominently. Whatever happens in the future, it seems health budgets will rise worldwide, and stockpiling of medical equipment and medicines will become more prevalent, as politicians give the stable door a good slam. Swiss company Roche has hit the headlines with its testing kits for coronavirus, which will no doubt see brisk demand for the foreseeable future. It paid its (increased) dividend as usual in March, as did Novartis and hopeful vaccine contender Sanofi in May. All three companies are expected to raise payouts again next year.
By contrast, with the ECB effectively forbidding capital distributions until at least October, banks have been rather frustrated at not being allowed to pay dividends when they regarded themselves as ready, willing and able to do so. For example, ING announced that the 2019 dividend it expected to pay this year has not been added back to capital, showing that it still intends to distribute it when allowed.
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