Emerging markets companies tend to have more robust commitments to dividends, in sharp contrast to the US where dividend yields and payout ratios are among the lowest globally.
In fact, approximately 25 per cent of the US market pays no dividend at all.
Emerging markets countries have grown dividends at a multiple of the rate in developed countries over the past decade and are likely to do so again over the next decade.
The reason investors are able to buy such companies at substantial valuation discounts is due to the strong consensus opinion on the impact of tighter US Federal Reserve policy on emerging markets. But this view is based on events from the 1990s, when emerging markets countries were at a very different level of development. The practice of an emerging market pegging one’s currency to the US dollar, which caused such turmoil in the past, is also largely gone.
In fact, emerging markets have performed well during many periods of Fed rate hikes, particularly when the developing world is as attractively valued as it is now. There is increasing talk of ‘decoupling’, with the US economy rebounding strongly while the remainder of the world languishes.
The use of the term ‘decoupling’ is ironic as the term first became popular during 2010. Then it was the emerging markets that were going to rebound strongly due to the region’s structural growth drivers, including low and falling government debt-to-GDP ratios, growing consumer spending power and the limited impact of the financial crisis on the banking system.
Of course, in an increasingly integrated global economy it was hard to imagine the emerging markets growing strongly while the developed market consumers were under severe pressure. Similarly, it is difficult to envision the US rebounding strongly and this having no impact on emerging market economies, particularly those that are export-oriented.
Many of the characteristics of the emerging markets that made people think they would decouple during 2010 remain relevant. Government debt-to-GDP ratios remains low and stable, below 50 per cent in aggregate across the emerging markets, while government debt soared across the developed world during the financial crisis, with most large developed economies at roughly 100 per cent debt-to-GDP – a level typically associated with slowing growth.
Emerging market economies have grown much faster than developed market economies for decades, often for structural reasons, and while the spread in growth between the emerging markets and developed markets has shrunk as the US recovered, the emerging markets continue to grow faster and this is expected to continue.
The macroeconomic environment clearly improved in 2014, with the US showing signs of a true self-sustaining recovery from the financial crisis, albeit in a relatively slow manner. However, the valuations of global equities overall are not nearly as attractive as they were two years ago, following a nearly 30 per cent rally in global stocks, particularly in the markets that have led the rally.
Also, stresses in markets appear to be increasing, particularly over the decline in oil prices. Liquidity is constrained in the bond markets as dealers have reduced inventory and staff. With income limited in the bond markets and extended stock prices calling into question the potential for further broad-based price gains, a robust and diversified income stream has the potential to support total returns even if price gains falter.
We live in uncertain times, amid a slow and fragile recovery from a global financial crisis. With equity prices broadly elevated, an unconstrained, income-focused global equity strategy that is skewed to attractively valued companies operating in faster growing regions remains an attractive option.
Pat Ryan is fund manager and analyst on the Lazard global equity team
KEY FIGURES
25%
Approximate percentage of the US market that pays no dividend at all
2%
The Federal Open Market Committee’s (FOMC) inflation target for the US
5.5%
The unemployment rate in the US in February, deemed an important factor in the FOMC’s decision to raise rates
