Rate hike could destabilise income from equities

Russ Koesterich, global chief investment strategist at BlackRock, observes that stocks “advanced sharply” in August, while equities gained roughly 2.5 per cent, with the US and emerging markets posting the strongest returns. He warns, though, that daily volatility was roughly 15 per cent higher in the month than in the previous three months.

Mr Koesterich says: “To the extent that strong economic data continues, one side effect is likely to be a heightened focus on an initial rate hike by the Federal Reserve. Marginally tighter monetary conditions are likely to support the trend towards somewhat higher volatility.

“In addition, geopolitical risks are still festering. Although investors are increasingly turning a blind eye to the escalating conflict in Ukraine, to the extent the situation continues to deteriorate, this is likely to produce an abrupt reversal in momentum for stocks.”

The UK Equity Income sector continues to top the IMA’s ranking of top-selling retail funds by region. In July, the UK was the best-selling region for equity funds with net retail sales of £678m, boosted by net retail sales of £1bn through the UK Equity Income sector.

There has been some positive economic data coming out of the UK, with the FTSE 100 reaching a 14-year high in September.

Paras Anand, head of European equities at Fidelity Worldwide Investment, says he is encouraged to see UK shares making progress. “Over recent years, UK companies have coped well with a period of subdued end demand, not only domestically, but across the globe and the improving economic news augurs well for share prices looking forward,” he notes.

“It is also worth remembering that UK shares offer good exposure to overseas markets, including the US, and particularly developing markets, where sentiment continues to be subdued but where longer-term prospects remain compelling.”

Aside from geopolitical risks, Mario Draghi’s unveiling of an asset-buying programme at the European Central Bank (ECB) meeting on September 4 may be one of the more pressing issues for equity income investors.

The ECB is to start purchasing asset-backed securities in a bid to stave off the threat of deflation in the eurozone. But Tim Hartch, co-manager of the Brown Brothers Harriman Global Core Select fund, cautions that in the current market environment where developed markets’ central bank policy is diverging, equity gains are running ahead of “economic realities”.

He says: “There is a tendency among investors to celebrate strong gains in the equity market and use them as a positive feedback mechanism in their assessments of the broader economic situation – in fact, this is one of the key tenets of monetary stimulus.

“But we believe this seemingly self-reinforcing effect has a natural limit because, at a certain point, investors are consuming future market returns, leaving little room for market upside beyond that which the economy can generate naturally through actual growth in cashflows.”

Mr Hartch adds: “In other words, even if a robust economic acceleration does eventually occur, the benefits may have already been front-end loaded into asset prices. ”

Ellie Duncan is deputy features editor at Investment Adviser