Eugene Philalithis, Portfolio Manager, Fidelity Multi Asset
Economic data is finally reflecting the impact of economic lockdowns, and markets have seen a meaningful risk rally. But given the extent of the economic slowdown and the unknown duration of the crisis, is it too early to move to a risk-on posture?
Key points
- Given the extent of the economic slowdown and the still uncertain duration of the crisis, we think it is too early to move to a risk-on posture.
- Income investors have hit headwinds in dividend-paying equities, but our equity research analysts are still seeing dividends being maintained in 70%-80% of our exposure.
- The economies of North East Asia and Singapore have the potential to recover lost growth quicker as their government’s management of the Covid-19 outbreak facilitates a quicker rebound in activity supporting internal demand within the region.
Given the current environment, we maintain our bias towards positions higher up the capital structure, and we have strong conviction in some areas of the credit markets. As the worst of the sell-off hit, credit spreads widened meaningfully and significant indiscriminate selling led to more attractive valuations, even in corporates with strong balance sheets and cashflows. While we turned constructive on investment grade in March, the Fed’s policy support has provided the catalyst for our view to become positive on high yield in the US, where we had been cautious until recently. In addition, we have shifted exposure from emerging markets local currency debt into US, Asia and European high yield. We don’t think ‘fighting the Fed’ or other major central banks is prudent, and until we see a meaningful turnaround in the economic backdrop, our preference for adding to risk is likely to remain for debt over equity securities.
Dividends are a bump in the long and winding road to recovery
As income investors, we are of course acutely aware of the headwinds for dividend-paying equities as earnings are likely to struggle throughout the year. The recession is also likely to drive greater dispersion among current dividend payers, while the overall level of equity income falls. This view certainly feeds into our bias to credit overall, and highlights how a multi asset approach to income investing offers up the flexibility needed to navigate the challenges of this market environment. But behind the dreary headlines on dividends lies a lot of nuance, and we work closely with our colleagues in equities to gain some clarity on the high levels of dispersion within the universe of dividend paying equities. Even given the bleak forecasts for the global economy, so far dividend cuts have occurred in the areas hit hardest by the economic shutdown and Fidelity equity researchers still see 2020 dividends being maintained in 70%-80% of our exposure. But there could be meaningful regional differences.
Looking to Asia for guidance
The economies of North East Asia and Singapore have the potential to recover lost growth quicker as their government’s’ management of the Covid-19 outbreak facilitates a quicker rebound in activity supporting internal demand within the region. Companies there may not need to adjust dividend pay-outs or any that do may be able to return to previous levels quickly. Asian companies showed how nimble they could be after the Great Financial Crisis, reducing dividends in 2009 but returning to previous pay-outs in 2010, in contrast to European companies that have yet to reach pre-2009 dividend levels because of economic stagnation. Also, the longer the recession the higher the chance of insolvency and then regulation becomes a key factor. The US government’s bailout program under the CARES act requires companies that receive help to stop paying dividends and buying back shares. France will take the same approach. UK and European regulators appear to have been more aggressive by recently requesting that banks and some insurers stop paying dividends for a short period. Importantly, these are dividend deferrals and not necessarily permanent cuts.
