“I think we ought to dial it back.” Unfortunately, statements from Ben Bernanke have been less straightforward. Clarity of expression is not a prerequisite for central bankers.
One thing, however, is clear: the US Federal Reserve is walking a tightrope. When it first embarked on QE, it was starting something that it did not know how to finish. It now wants to tell the market that QE will end at some point. But no one knows when – perhaps not even the Fed itself. So, if we can not be sure when QE will end, how can we be any more sure what its withdrawal will mean? And what would a spell of cold turkey mean for investors who look to global stockmarkets for an income?
Ending QE on this scale has never been tried before, so it is impossible to predict the impact it will have. But we can consider the market’s reaction to the Fed’s taper talk in the summer to have been a useful rehearsal. The prospect of tapering sent bond yields sharply higher. That, in turn, saw a lot of crowded carry trades – investments that had made a lot of money over the previous three-to-five years – being unwound. It is worth reiterating that QE had not been stopped at this point. And the world was fundamentally no different than it had been before investors began to discuss the ‘t’ word. Yet the mere suggestion of less loose monetary policy was enough to trigger a sell off.
Investors must therefore consider what will happen as bond yields return to more normal levels. And that is not just a matter for the bond market. It also concerns investors who look to the stock market for an income. What should they do? The good news is that the response to the tapering announcement suggested that monetary tightening will see equities outperforming bonds. But it also showed us that flexibility will be vital.
When conditions change, so should your portfolio. After Ben Bernanke hinted that the Fed might look to reduce stimulus, some managers moved quickly to reduce their fund’s exposure to ‘bond proxy’ holdings with high dividend yields and shifted towards cyclical dividend growth. They may have added to US and Asian growth stories and sold telecoms, utilities and Reits. Subsequent returns bore out the wisdom of these changes. If anything, they should have moved even more quickly than we did.
And, just as they must be ready to change their portfolios when stimulus is withdrawn, investors may have to work (even) harder on their stock selection. QE has helped to prop up asset prices over the past five years. As it is withdrawn, simply holding the obvious (and often overpriced) equity-income names may no longer be enough. There will, however, be plenty of less-recognised companies that will continue to offer their shareholders a high and growing income. The trick will be to buy them at the right price.
To do this, some managers are prepared to take uncomfortable investment decisions – such as owning companies in southern Europe. I am not suggesting that economic growth in southern Europe will be any stronger than the market expects. The structural adjustment in the periphery is far from over. But things are moving in the right direction. Production costs in the most depressed economies have fallen. The Spanish current account recently moved into surplus for the first time in 16 years. Ford and Renault have moved some car production back to Spain. Crucially, very few investors are prepared for any improvement in southern Europe – so any positive surprise could be profitable for those positioned to take advantage of it.
Take Spain, for example. In some parts of the economy, things remain dire. But there is good news from Madrid, where real-estate prices are no longer falling. It is posible to have exposure to a recovery in Madrid’s housing market via a holding in BankInter, a well-managed private bank focused on affluent urbanites.
As the summer showed, monetary policy is important. But it is only part of the equation. Companies pay dividends out of retained earnings, and their profitability is often a function of economic activity. And, on that account, things look good. Unemployment in the US has fallen and there are signs that China is ‘bumping along’ with growth of around 7 per cent. The Fed will only dare to stop printing money once it feels we have made our way out of the crisis. In that sense, tapering should be welcomed rather than feared.
Meanwhile, whatever direction monetary policy takes, there will be enough well-run companies focused on returning cash to their shareholders to assemble a diversified global portfolio. Companies that can boost shareholder returns through self help will be particularly important. German pay-TV company ProSiebenSat1 is just one example. As an over-leveraged, cyclical stock it hit tough times in the financial crisis. But it has since worked hard to reform itself. It sold its Nordic broadcasting assets and spent some of the proceeds paying down debt, with the remainder being returned to shareholders through a whopping 23 per cent special dividend. The de-leveraging of its balance sheet has removed a lot of the risk in the stock.
We can not, of course, control the fluctuations in share prices that result from shifts in monetary policy. But we do have visibility over future dividend payments. Fund managers communicate with the management of the companies in which they invest to help them assess the strength of their businesses and their dividend growth prospects. This vigilance reassures managers that the fund’s distributions are safe. So, if they are prepared to look for the right stocks, the conditions are in place for investors in global equities to continue to enjoy a high (and perhaps even rising) income from their investment. But one thing is clear: they will need to work harder than ever to avoid the turkeys.
Jacob de Tusch-Lec manages the Artemis Global Income Fund.
Key Points
When the Federal Reserve first embarked on QE, it was starting something that it did not know how to finish.
Investors must therefore consider what will happen as bond yields return to more normal levels.
Whatever direction monetary policy takes, there will be enough well-run companies focused on returning cash to their shareholders to assemble a diversified global portfolio.
