Outlook 2023: playing the field for yield

2022 was a bruising year for investors. The adjustment to a new interest rate regime saw major bond and equity markets fall sharply. This is likely to impact risk appetite in the year ahead, with investors seeking out the comfort of a reliable income in the face of continued uncertainty.

While markets have substantially adjusted over the past 12 months, there is still plenty to worry about in the year ahead. Global growth projections are falling in the wake of significant interest rate hikes and squeezed household incomes. Oxford Economics projects subdued global real GDP growth of 1.2% in 2023, well below the 2.9% estimated for 2022.

This is likely to put pressure on corporate earnings as companies and individuals rein in spending. As it stands, the consensus estimate is for aggregate earnings per share growth of 3% for the MSCI All Country World Equity Index. However, there are risks to these estimates as the global economy weakens.

There are also plenty of geopolitical concerns. While the ongoing war in Ukraine and China’s manoeuvring over Taiwan are the most pressing problems, there are other signs of tension. Technology protectionism is increasing with the US government imposing an effective ban on US companies exporting high-spec chip manufacturing equipment to China. This followed the CHIPS and Science Act in August, which sought to bolster the US’s semiconductor capacity.

That said, there are tailwinds to lift equities higher. Inflation is set to peak around the globe, giving central banks room to ease off from raising interest rates. Our analysis shows that US stocks can recover following a pause by the Federal Reserve (Fed) however, we are focusing on yield to help minimise the risk.

Nevertheless, given the recent volatility in financial markets, we expect investors to be cautious in the year ahead. It is likely to be a year where investors remain defensive and seek income-yielding securities backed by reliable cashflows to protect against potential further falls in markets.

Excluding the pandemic, the silver lining is the sell-off has led to the widest dispersion of global stocks by dividend yield for 13 years [1]. In other words, dividend yields are high and there are more companies paying attractive yields. Assuming dividends are not cut – and they have recovered quickly from the pandemic and remain resilient – investors have a good choice of higher yielding options.

Some sectors offer notably higher dividend yields than others. Our analysis finds the highest one-year forward dividend yields can be found in the energy sector at 3.9%. The sector also generates significant cash supported by continued high energy prices and spending discipline.  The mining and material sectors are in a similar position.  In addition, defensive areas of the equity market (such as consumer staples and utilities) and materials also score well on this front.

This is in stark contrast to the low yields available from the information technology, consumer discretionary and communications services sectors — which all pay dividend yields of less than 1.6%. We believe there is a significant opportunity cost for sticking with such low-yielding stocks with bonds now offering relatively high yields and inflation still high.

There is also a gap between different geographic regions. The UK stock market has historically been a source of high and stable dividends and continues to have the highest dividend yield of all major markets. It sits at 4.3%, and is supported by strong positive cashflow.  The US, by contrast, is the lowest dividend-yielding market at 1.7% with a much lower level of cashflow generation. While the US market has been in favour for much of the past decade, areas such as UK large-caps may have more appeal in the year ahead.

Income investors can also look to the bond market again after a decade where bond yields have been negligible. Once the Fed stops raising interest rates, it may provide an opportunity to reinvest in government bonds, where yields are up from a year ago and economic growth is slowing.

A lot of bad news is baked into global stock market valuations today. Nevertheless, we believe investors are likely to be reassured by income-generative investments in the year ahead, which provide some protection against inflation and against an uncertain environment. Income is a tool to cushion market volatility as the global economy nurses its way through an inflationary hangover.

Sources:

All figures stated are sourced from Refinitiv, Evelyn Partners unless otherwise stated

[1] Bloomberg, Evelyn Partners

Yields are historical and represent the latest reported full year dividend expressed as a percentage of the price.