Low interest rates, low growth and memories of the 2008 crisis have understandably kept investors’ feet on the ground in recent years.
There have been times when value has rallied strongly, but overall quality companies have reigned supreme – particularly those providing investors with a consistent level of income.
Over a five-year period, the MSCI World Quality index has outperformed the MSCI World index by almost 30 percentage points. Consumer staples, typically seen as a haven for the highest-quality companies, have outperformed by even more.
Fears over a global recession have exacerbated this trend of late, with high-quality dividend-paying companies acting as a haven for risk-averse investors. The S&P High Yield Dividend Aristocrats index, which is made up of US companies that have grown their dividend for at least 20 years, has rallied by more than 8 per cent in 2016.
It would be understandable for income investors to keep buying these types of quality companies, and indeed having some exposure to them seems wise. However, as so often proves the case when an area of the market has had a stellar run, the risk/return profile at this stage is not as attractive as it once was.
Equities that can be dubbed dividend aristocrats have become much more expensive in recent years, and are now trading with more than a 30 per cent premium to the market. The strong performance they have exhibited has not been attributable to significant earnings upgrades, but can instead be ascribed simply to multiple expansion.
In some cases, there have actually been earnings downgrades but share prices have risen nonetheless. These companies are seen as the ultimate safe havens – a place for equity investors to hide as the storm clouds gather.
The likes of Nestlé and Unilever could of course get more expensive, but for even more expensive valuations to be justified, investors would have to factor in a doomsday scenario – one in which there was a global recession and possibly even a financial collapse.
But the falling oil price is less about falling demand and more about unprecedented disruption on the supply side.
China’s transition from a manufacturing to a service-led economy is problematic and it will need to weaken its currency further to stimulate growth; however, the authorities have the tools to ease the pressure. At the same time, the US economy goes from strength to strength.
Renewed optimism about the global economic outlook could see investors start to question the price they are paying for safety, which would put a lot of strain on valuations.
There remain a select few companies in this bracket that are still fairly valued – Japanese telecommunications company KDDI and Johnson & Johnson, for example – but more generally investors need to look off the beaten track for sustainable dividend growth.
