24th August 2016
Mark Wharrier, co-manager of the BlackRock UK Income fund, on the dividend outlook for UK companies and why market volatility caused by the UK’s vote to leave the EU brings some investment opportunities.
“The Referendum result is now known, but uncertainty will influence the political and economic outlook for the near-term. The history of such events is that they create opportunities for the medium term investor who can hold their nerve during a period of stress.
“Market volatility always brings some opportunities where fundamentals are unchanged but the share price has moved lower on sentiment grounds. For example, in our portfolio we have reflected this uncertainty by reducing exposure to financials, while adding to existing holdings with more international exposure and selectively to domestic cyclicals which have priced in a significant recession. We consider a more defensive tilt appropriate in this environment.
“The banking sector was hit hard and indiscriminately following the outcome of the Referendum. In contrast, some of the consumer staples companies, such as Unilever and GlaxoSmithKline performed strongly in wake of the vote, gaining as much as 10%. The contrast in fortunes for these two areas has now levelled out somewhat. The banking sector has since recovered some of its lost ground, though share prices are still below pre-referendum highs. The rally in the more defensive, international stocks has since slowed.”
Distinguishing between those companies with the ability to grow dividends and those with a high initial yield is important
“The Referendum has had an important impact on interest rate expectations. Mark Carney chose to cut interest rates to 0.25% on 4th August, and Brexit is likely to defer an interest rate rise for some time with the markets currently not expecting a rate rise until 2019 and beyond. This has implications for the stock market. It means that the higher valuations on some of the so-called ‘bond proxy’ stocks may persist. However, we consider discernment to be very important. The market will, we believe, start to draw a distinction between those companies with the ability to grow their dividends and those that simply have a high initial yield. This distinction is likely to be particularly important if inflationary pressures start to emerge, either from a weaker sterling raising import prices, or from higher commodity prices.”
Earnings are still the key to long-term out-performance
“The next year is likely to be a challenging one for equity investors, with uncertainty on the outlook for China, technological disruption and negative interest rates. However, while the domestic economy clearly faces near term challenges, it is important to remember the FTSE All Share Index is a collection of international companies, with some 70% of revenues generated outside the UK.
“The same corporate characteristics essential for investing before this Referendum are likely to be just as important in this new environment. Earnings remain the key to long term outperformance when seeking UK companies that deliver a sustainable income. We are still focused on picking companies where we see sustainable free cash flow generation with strong balance sheets and exposure to compelling structural trends.”