Blog: Weekend Wealth - Equities Update in a challenging week
Tim Wishart is a senior investment director at Psigma Investment Mangement
Last week was quite a week - England was dumped out of the Euros twice! To top it off, instead of the stockmarket getting trounced, as most doom-mongers forecast, it has rallied strongly – notably in the UK’s FTSE 100, the apparent provider of abject misery the world over.
Why? – the FTSE 100 is largely made up of international earners, with a high weighting in defensive sectors including healthcare, consumer staples and utilities. The importance of dividends and the weakness of the pound have played strongly into the hands of these parts of the UK market. Last week’s shock vote sent shivers through global markets and once again sent government bond yields the world over crashing to new lows that are barely imaginable. So as UK domestic stocks like housebuilders and retailers were getting annihilated, defensive stocks like Unilever, Diageo and Reckitt Benckiser initially barely budged and then began an inexorable rise, in the case of Unilever and Reckitt, to all-time highs. One week later these stocks and many like them the world over have had one of their best weeks in stock market history.
Part of the benefit of being a UK domiciled company as the pound comes crashing down around our proverbial ears (rather reminiscent of the collapse of the English defence in fifteen minutes of madness last week), is the translation effect into UK earnings for a UK domiciled business that has hardly any of its business interests in the UK and is barely affected by the traumas that may lay ahead for the UK economy.
More importantly, in my opinion, are the dividend streams those companies offer to investors in an era where income is difficult to generate without taking a higher degree of risk.
It’s not just UK companies that performed well because of their defensive characteristics and dividend yield support. Nestle in Switzerland and Johnson & Jonson in the US both enjoyed strong weeks, as investors gobbled up stock in order to find some way of generating a real return on their money.
Perhaps Nestle is the classic example of the recent flight to defensive stocks. Nestle shares currently yield 3%, and the company has consistently grown its dividend over a long period of time. It also looks expensive on a PE (Price/Earnings) ratio and the recent strength of the Swiss Franc will mean that it will have fx (foreign exchange) related downgrades. However, the fx issues only serve to disguise the fundamental strength of the company and it’s cash flow and balance sheet strength, which will see it through whatever dark days may lie ahead. Meanwhile, the 3% dividend yield compares to the prospect of investing in Swiss or many other Government bond yields with a negative yield over a period of ten years, or even buying UK ten-year gilts with a whopping 0.82% yield!
It’s little wonder then, that last week investors flocked to buy shares in Nestle, Reckitt Benckiser and Unilever. I often hear that these stocks are dubbed ‘expensive defensives’ and ‘crowded trades’. However, in such an uncertain world, it may well be that these stocks could get a lot more expensive and a lot more crowded.
Earlier this year, shares in Cisco Systems were languishing at just above $22. Management then announced a major increase in dividend policy and the shares have barely looked back ever since, rising above $29 to a return of nearly 30%, as investors clamoured for the dividend yield of over 3%. Will this be an era where many companies with strong balance sheets, cash flow and the potential to return more cash to shareholders, take the opportunity to materially increase or introduce a dividend to yield-hungry shareholders? Amazon, Alphabet and Facebook could all move from a zero dividend policy to using their considerable cash-piles and inherently cash generative business models to start paying dividends to shareholders. What better way for Tim Cook to regain investor confidence in Apple than to use the company’s considerable cash pile, which gets bigger by the quarter, to increase dividends and give investors the income they so desperately crave and can no longer get from the Government bond market?