The aftermath of the Covid-19 pandemic and a tightening of global supply chains have unleashed an inflationary wave which looks set to drive greater corporate discipline, boost income stocks and increase the importance of dividends to investor returns, says Newton portfolio manager Jon Bell.
After years of low interest rates and low inflation, the economic tide is turning. Post the Covid-19 pandemic, Newton Investment Management’s Jon Bell says an injection of pent-up savings has introduced a fresh flood of liquidity to the market. This, in turn, has helped fuel a sharp spike in inflation across major markets – just as supply chains contract.
While the initial rise in inflation was at first considered a transient blip by some economists , Bell believes higher inflation levels are now here to stay, with major implications for global investors.
“Post-pandemic, we believe we are now seeing a regime change from a disinflationary world to one which is more inflationary,” he says.
“In recent months markets have seen growing evidence of deglobalisation and increased protectionism which will further support this. In our view, we will have to get used to the fact we are living in a more inflationary world than we were.”
All of this, says Bell, means change for both equity investors and the companies they invest in. In a post-global financial crisis (GFC) environment, where the corporate operating cashflows of some of the largest US technology companies and many others rose significantly, corporate excess and a general lack of focus on shareholder returns became more common. In some extreme cases, this led some companies to focus more on devising workplace gimmicks than delivering shareholder value.
For Bell, changing market conditions mean it is now payback time for investors, with some investment managers now looking to subject the companies they invest in to much greater scrutiny, demanding more capital discipline and higher dividend pay outs.
“Although corporate margins have improved over time, many companies have given less back to shareholders in the form of dividends than they did historically. In our view, that needs to change. As we go into a different, more challenging economic environment, corporates need to offer more value to shareholders,” says Bell.
“The days when companies could spend as much as they like on whatever they want are behind us and we expect to see them begin to tighten their belts. The age of extravagance is over.”
Bell believes investment managers can play a key role in shifting corporate thinking, influencing management teams and encouraging them to change behaviours in order to generate greater shareholder value.
He says, “Ideally, we want to see more corporate discipline and the return of a healthier blend of corporate reinvestment and dividend pay-outs to shareholders. In fact, companies have not been doing a very good job of giving cash back to shareholders in recent years and, in many cases, we have actually seen pay-out ratios fall.”
Not all sectors are alike. While some US technology giants have a poor track record of rewarding their shareholders in recent years, some pharmaceutical and utilities companies have been far more responsive, with business models that do more to reward investors.
Against this mixed backdrop, Bell stresses the historic and ongoing importance of dividends in a world where slower economic growth can limit returns. The compounding of dividends from income stocks, can fuel a steady accumulation of income within portfolios. This strength of income stocks, he believes, was often overlooked during a long period of low inflation and heavy central bank intervention in markets, post the GFC.
“The 2020s started with a record low return from dividends, and an environment of zero interest rates and excess fuelled by quantitative easing. Yet when financial bubbles burst dividends, can become a very important factor in building returns,” Bell says.
“It may be that in 2030 we look back on a decade where dividends have been critical to investor returns. The last time inflation was a major problem, in the 1970s and 1980s, strong returns came from dividends and income stocks do tend to outperform during similar periods.
“In inflationary markets, we continue to believe dividends are key and that the compounding of dividends makes select income stocks some of the most exciting investments in the current market.”
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1572505 Exp: 05 April 2024