UK dividend growth may be about to turn negative in a manner reminiscent of the declining payouts seen between 2001-03 and 2008-10, according to Troy Asset Management’s Sebastian Lyon.
Mr Lyon, manager of the £2.6bn Troy Trojan fund, said a recent spate of cuts from the likes of Glencore, Standard Chartered and some food retailers may mark the start of a “downwards cycle” for UK dividend growth.
Such growth last turned negative during the crisis period of 2008-10, the first time payout increases had reversed since the opening years of the century, Mr Lyon noted.
He pointed to the declining level of dividend cover for FTSE 100 firms as another indication that a third downwards move may be underway.
Dividend cover for both the FTSE 100 and the FTSE 350 – pre-tax profits divided by dividend payouts – stands at 1.2 times, well below recent peaks.
“Some companies are now paying out 100 per cent of their free cashflow to shareholders, and some have resorted to using debt to fund payouts. Dividends are now arguably more vulnerable and less permanent than they have been for many years. There is little room for error,” he said. “High yields, in the commodities and energy sectors in particular, indicate further cuts may be coming over the next 18 months.”
Capita Asset Services said last month it expected dividend growth in 2016 to be 3 per cent, down from 6.8 per cent in 2015.
“A [dividend] cut from a large FTSE 100 company may push dividend growth into the red for the first time since 2010,” Mr Lyon said.
He also warned the business cycle could be reaching a peak, as deteriorating profits – which correlate strongly with dividend cuts – are a sign of cyclical maturity. “Company managements have been rewarded by investors for increasing dividends and stretching payout ratios. A fall in profits leads to reappraisals of the sustainability of those payments.”
Corporate earnings are in part coming under pressure as an unintended consequence of years of ultra-loose monetary policy, he said: “Zero interest rates have encouraged overcapacity. This is evident in various sectors, including energy.”
But he warned: “The invisible hand of the free market is beginning to make its presence felt after being handcuffed to non-market forces for so long.”
FTSE All-Share 12-month trailing earnings have been steadily falling since April 2014, including sharp falls in early 2015, the manager said. Recent equity market drops have not been enough to create value in the market, but this may change in the event of a more serious slump, he added.
“Should a material fall in the market occur, it is likely to call time on the end of the secular bear market that began 15 years ago. The best investments are made during apathy and despair, not ebullience and complacency,” said Mr Lyon.
The manager’s relative performance suffered in 2012 and 2013 as his bearish stance contrasted with the ongoing equity market rally, but has improved as markets grow more nervous.
