Equities, even traditionally reliable income stocks that investors have come to rely on for divided payments, look unlikely to be a source of investment income for some time. Even when dividends do return, it is now forecast as taking a number of years for pre-pandemic levels to be returned to.
With cash interest rates at new record lows, down even from the recently set records now replaced, savings also show little to no hope of producing an income any time soon. They don’t even look likely to run particularly close to inflation levels.
So where can investors look for income, either now or in the months ahead? There are still income investment options but investors may have to be ready to venture outside of their usual approach.
Dividends Are Doomed
This week the UK’s major banks announced that dividends would not be paid out for the foreseeable future. That was a major step considering that the dividends already announced were those due on the 2019 financial year and some of the shares were already post dividend. In total, income investors holding London-listed banking shares lost out on almost £8 billion in already announced dividends.
Investors hoping that dividends would only be postponed until later in the year were left disappointed. No dividends will be paid out in 2020. Nor planned share buybacks that would have helped support share prices to at least some extent.
While the banks publically supported the command issued by the Bank of England’s Prudential Regulatory Authority (PRA), whose reasoning was the need for an additional financial buffer and flow of funds to businesses in the shape of loans over the coming months, there doesn’t seem to have been unanimous agreement in boardrooms. A number of HSBC directors reportedly reacted by mooting reopening the question of reverting the bank’s domicile back to Hong Kong.
Insurance companies, also under the regulatory gaze of the PRA, were not, like the banks, banned from issuing any dividends. For the former the ultimatum was clear, with the PRA’s statement reading that it stood – “ready to consider use of our supervisory powers should your group not agree to take such action.” But they were told firmly to exercise extreme caution.
Even utilities like British Gas owner Centrica, who might strike as the kind of companies who wouldn’t suffer from the Covid-19 lockdown, have already announced they will not be issuing any dividends this year. The company told investors that while domestic power consumption has risen in recent weeks as people stay at home, it is nowhere near enough to offset the drop in consumption from commercial sites.
Sector by sector, company by company, dividends are being announced as having been written off entirely in the short to medium term. And it’s not just in the UK. Over in the USA, where regulators are usually as hands-off as possible, a major chunk of the dividends that would have been paid out will evaporate. Any company taking government loans during the coronavirus pandemic shutdown will not be allowed to pay dividends, nor conduct share buybacks, until 12 months after the debt has been repaid.
Some analysts believe stock markets may have already dropped to, or near to, their Covid-19 lows after average declines in the region of one third of valuations. However, other believe valuations still don’t take account of a drop off in earnings over coming months and years.
Equity analysts at Citi Bank are estimating European companies will see earning per share and dividends halve this year. The investment bank expects earnings per share of S&P 500 companies to fall by around 25% and dividends by 30%. However, after the last crisis it was 3 years before US dividends returned to their previous levels. S&P 500 dividend futures suggest this time it could take until towards the end of the decade.
For investors who will continue to look for income from equities, the bank believes that in Europe sectors such as utilities, telecoms and healthcare are the best bets and in the USA, consumer staples and utilities. BNY Mellon macro strategist John Velis commented for the Financial Times:
“We expect the next few years to see dramatic cuts in cash returned to shareholders via dividend payouts.”
What Are The Options For Income Investors Other Than Equities?
So if equities look unappealing from an income perspective for the foreseeable future, where can investors try to turn for income? We’ve already discussed why cash savings will practically lose value over coming years. High quality central bank bonds were already offering income levels running below inflation before the Covid-19 crisis. Many are now essentially offering a close to zero or even negative return.
However, the huge asset-buying programmes that are being initiated by central banks do offer a clue as to where income investors could go – high quality corporate bonds. The cash flowing into bond markets from stimulus programmes means large companies with healthy balance sheets should be safe.
And there is plenty supply of high-grade corporate debt, with companies keen to take advantage of current market conditions to build cash reserves. That’s demonstrated by the record $261 billion of investment-grade debt sold in the USA in March. That’s expected to continue this month as institutional investors hunt for low risk yields that are an improvement on government debt.
Higher quality companies may also stand to benefit from the current crisis, which is likely to evolve into a recession deep enough to kill off some of the weaker competitions, giving those left market share to claim.
The main argument against fixed-price debt is the potential for higher levels of inflation to result from the unlimited debt purchases that have been authorised by central banks. But if that does eventuate it is likely to take a few years to manifest itself.
With that in mind, investors could do well to look to high grade corporate debt with a maturity date of up to four years. That could coincide nicely with the right time for portfolios to be shifted back towards equities for growth.
On the other hand, there is a scenario in which income investments could remain attractive for longer. If companies and investors, shocked by the speed and depth of the current economic crisis, prioritise higher levels of cash savings and fixed income investments for a number of years ahead, that could mean a slow path back for equities as less money is directed towards stock markets.
For more adventurous investors hunting growth, post-crisis periods typically offer rich pickings as a new generation of start-ups emerge. Airbnb, Uber, Pinterest, the fintech challenger banks and countless more now well-known brands were forged in the hubris of the 2008 collapse.
The last decade has shown the value of holding a combination of strong income-paying and high growth investments. That could also be a good move over the one ahead.