Asset Allocator: November 2015

The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only.

 Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment.

 This article has been published for marketing purposes and has not been prepared in accordance with those legal and regulatory requirements which are designed to promote the independence of investment research. There has been no prohibition on dealing ahead.  It was not subject to any prohibition on dealing ahead  prior to its publication on this website.

 


ASSET ALLOCATOR: November 2015 

 

In last week’s monthly asset class review we looked at the prospects for US equities. Overall I’d be very cautious about US shares at the moment, especially given poor fundamentals and arguably over optimistic sentiment. Nevertheless we also concluded that US equities might still move higher driven by insatiable demand for quality stocks – and a rather counter intuitive reaction to interest rates which might be based on the notion that a quarter per cent increase was a sign that the US economy was normalising. 

But my cautious tone shouldn’t nevertheless blind investor’s to the real opportunities within the US market – I just think you need to be very selective about your fund or stock choices. In this short weekly note I want to pick up on three very different recent research observations to highlight some possible new ideas. The linking theme is that point about focus – my sense is that dividend orientated stocks, especially in the financials sectors might represent good value as might some, higher quality parts of the energy spectrum.

The first observation based on a recent note comes via fund management business Henderson who track global dividend streams via something called the Henderson Global Dividend Index. I find this an excellent tool and latest numbers from this index are very positive for US shares. Last week (16 November 2015) the asset manager released numbers that suggested that Global dividends rose 2.3% year on year on a headline basis in the third quarter, rising to $297.0bn, an increase of $6.8bn.

The increase follows three consecutive quarters of declines, and was nearly all due to rapid growth in the US, and a huge special payment from Kraft on its merger with Heinz. Underlying growth, which strips out exchange rate movements and other lesser factors, was an encouraging 9.0%, in line with the first half of the year. US dominates the quarter, with dividends soaring 23.4%; a large special payment from Kraft boosted the total – in fact Henderson suggests that US has experienced double digit growth for seven consecutive quarters, with expansion across almost all sectors.

Looking in detail at the US market the UK based fund management business concluded that overall payouts soared 23.4% (headline) to $107.9bn, “comfortably a new record for the US. Kraft’s $9.8bn special payment following its merger with Heinz accounted for almost half the increase. 10.0% underlying growth was also impressive, and marked the seventh consecutive quarter of double digit increases. Every sector except mining and tobacco increased its payout”.

Back at the global level Henderson has now trimmed its forecast for 2015 by $10bn, expecting total dividends of $1.15 trillion this year, which is down 2.0% (headline), though it expects underlying growth of 9.5%. Looking forward into the coming year the asset manager expects Japan and North America still set to be the fastest growing regions, while emerging markets lag behind.

One potentially substantial source of dividends might be large US financial institutions, notably the large national banks. It’s notable that on the day that excellent numbers came out for US Payrolls, bank stocks strengthened – investors have assumed that rising wages will encourage the US Federal Reserve to increase interest rates which should benefit the big banks.  Banks have also been the best performing sector in the last month. The conventional logic is that banks have been struggling to make profits in the low rate environment of the last seven years, a rate rise (and higher yields) could be good news for them.

Yet these impressive recent performance numbers are slightly undercut by the fact that in relative terms bank stocks are relatively good value. On some measures the banking sector is the third cheapest equity sector within the S&P 500. What will happen next ? Will US bank stocks continue to rise or has the recent uptick in share prices already made the sector expensive? Researchers from Source ETFs recently decided to investigate the relationship between rising interest rates and bank stocks. Citing figure 1 below the fund manager’s researchers observe that “US financials tended to outperform in previous rate hike periods (by a median 5% annualised) and that they did so in 71% of cases (5 out of 7 cycles). Consumer-related sectors and technology (including telcos) also did well, while materials were less predictable.”

What’s likely to power change in the value of bank stocks in the future ? Source analysts looked at a range of underlying metrics drawn from macro-economic data. According to the note last week the team “ran a multiple regression analysis with six independent variables: 10-year Treasury yields, the trade-weighted US Dollar index, the yield curve (10-year minus 2-year yields), WTI oil prices, copper and gold prices. Based on the coefficients of determination, two variables stand out when it comes to influencing sector valuations: 10-year yields and the yield curve.”

The Source analysis could be used as an argument AGAINST investing in banks in a rising rates environment.  Other factors may also be at work though according to the ETF firm not least that  “maybe in the early stages of Fed tightening cycles, the anticipatory rise in long bond yields causes a temporary steepening of the yield curve, the positive effect of which on financials outweighs the negative effect of the rise in yields. However, that is far from proven. More encouragingly, banks are currently the third cheapest sector in the S&P 500 index (only telecoms and basic resources are cheaper). Perhaps the negative effects of Fed tightening are already priced in (the valuations of banks and financials appear to be in line with what our regression models would suggest, whether we look at current or predicted levels of the explanatory variables)".

My latest observation this week focuses on the energy sector and especially the huge income orientated master limited partnership space within the US equity markets. Master Limited Partnerships (MLPs) generate income through their ownership of US energy infrastructure, and its fair to say that they have had a terrible year. The broad MLP index has lost roughly a third of its value so far in 2015, inexplicably underperforming oil producers that are directly linked to commodity prices. 

Over in the US these MLPs have been a popular source of income with many private investors. But they’ve come up against the perfect storm: a halving of oil prices, sell-off in the broader energy sector and concern about rising interest rates. Although revenues from infrastructure are not directly correlated with commodity prices, and their fee-based contracts remain intact, the market has reacted to uncertainty by slashing share prices as investors panic about a massive contraction in supply. But in a note to media a few weeks back Alan Higgins, UK Chief Investment Officer at private bank Coutts argued that US investors have over-reacted. 

Looking back at a previous crisis – in 2009 – Higgins suggests that “at the height of the crisis, MLPs couldn’t raise capital through the equity and bond markets. Distributions fell by 2% in 2009, but were not wiped out and returned to growth the following year. In effect, concerns about MLP sector destruction in 2008 and 2009 turned out to be overdone.” He reckons the current crisis might be no different, with annualised yields running at over 8.5% - the Coutts CIO also reckons that “distributions that will be announced during the coming earnings season look likely to be about 11% higher than a year earlier. Oil prices below $50 a barrel are definitely a challenge for MLPs, but our analysis suggests that distributions are largely sustainable even if oil prices remain at this low into the middle of next year. If they do, distribution growth will slow, but MLPs appears to be already pricing that in. Though raising capital in the equity markets is difficult at the moment, bond markets remain open, even for sub-investment grade (poorer credit quality) MLPs". 

On balance the UK based private bank reckons that there’s still a good long term case for investing in income orientated MLPs. “Energy independence is a high priority in the US, and shale technology and production are unlikely to be abandoned. MLP infrastructure is needed for all this shale oil to get to market. Lastly, a return to crude oil exports is an option in the medium term. Though the past is no guarantee of the future, we believe prices will eventually revert to reflecting the underlying fundamentals, as they have done before". 

 I’m inclined to agree both with Coutts and earlier with the analysis by Source. There are ETFS tracking the MLP space and more generally some sector specific energy ETFs for the US market. I would be keen to still have significant exposure to US equities within a portfolio but I would weight more holdings towards trackers and funds focused on high yielding US equities, energy (more specifically MLPs) and financials. 

PREVIOUS ASSET ALLOCATOR REPORTS  


The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes  responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.

INDEX DISCLAIMER

The indices referred to herein (the “Indices”) are not sponsored, approved or sold by Societe Generale. Societe Generale shall not assume any responsibility in this respect.


version : 4.38.0-SNAPSHOT