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Outlook for equities: Time to pursue all-weather investing
Jared Franz
Economist
Diana Wagner
Equity Portfolio Manager
Chris Buchbinder
Equity Portfolio Manager

With economic storm clouds obscuring the outlook for global growth, investors may want to prepare their portfolios for ongoing market volatility.


Powerful trends have transported the world’s major economies back to where they stood just before the pandemic: firmly in late-cycle territory. “The environment is changing rapidly and significant headwinds have emerged,” says US economist Jared Franz.


Although rays of light are shining through the clouds, the risks are clear. Inflation is elevated and pricing pressures are broadening, keeping the US Federal Reserve and other major central banks locked the course of increasing interest rates. Supply chain disruptions and rising costs are eroding corporate profit growth. Geopolitical pressures including the war in Ukraine and COVID lockdowns in China magnify these risks.


What does that mean for investors? “Late cycles are not predictive of recessions, but they do tell you that the economy’s ability to bounce back from shocks is reduced,” Franz says. “I view this as a time to pursue all-weather portfolios built to withstand a variety of risks.”


Here are three equity investment themes to consider for the remainder of 2022 and beyond:


1. Rising dividends can counter inflation 


When market volatility is rising, boring is beautiful. That’s why many dividend paying stocks today are compelling, if dull and dependable, investment opportunities.


Indeed, investors are starting to recognise the importance of dividend investing. As markets tumbled in the first half of the year amid fears of slowing growth and broadening inflation, investors shifted their attention from the fast-growing tech companies and their elevated valuations toward more modestly valued dividend payers. Thus far in 2022, as at 31 May, dividend payers have significantly outpaced the broader market.


Global dividend payments rose 20% to US$1.9 trillion in the last year

Dividends paid by MSCI ACWI last 12 months (USD billions)

Past results are not a guarantee of future results.

Sources: Capital Group, MSCI, Refinitiv Datastream, Refinitiv Eikon, RIMES. Dividends paid represent total cash dividends in the trailing 12-months as at 31/5/2022. Dividend yield is for MSCI ACWI as at  31/3/2022. MSCI All Country World Index (ACWI) is a free float-adjusted market capitalisation-weighted index designed to measure equity market results in the global developed and emerging markets, consisting of more than 40 developed and emerging market country indexes.

And after a couple of years of pandemic related cuts and suspensions, dividends are making a comeback. Global companies paid out a remarkable $1.9 trillion for the 12 months ended 31 May 2022, as measured by the MSCI ACWI (All Country World Index). That represents a 20% jump from the prior 12 months.


"Today I am finding no shortage of opportunities to invest in companies restoring and even increasing dividend payments,” says equity portfolio manager Diana Wagner. “With profit margins recently near peak levels, companies are able to increase dividends despite inflationary pressures."


Proven dividend growers can help bolster investment returns when inflation is rising. “Dividend growth commitments are a critical signal by management about their confidence in the future earnings growth potential of their company,” adds equity portfolio manager Caroline Randall.


Companies paying growing dividends can be found across the financials, energy, materials and health care sectors, among others. 


2. US healthcare innovation is alive and well


The health care industry captured the world’s attention in the early days of the COVID pandemic, as several companies produced vaccines in record time. But observers today may be overlooking one important consideration in an unsettled environment: health care companies appear attractively valued relative to the broader global stock market and their own history.


“Some market leaders are particularly appealing, given the prospects for growth of their pipelines,” says portfolio manager Alan Wilson. Across the sector, drug developers, device makers and service providers are transforming health care and improving patient outcomes.


“Drug discovery is in a golden age that would not be possible without the combination of efficient genetic sequencing, computational power to analyze massive datasets and precise biochemical tools.” One recent advancement is antibody-drug conjugates (ADCs), which empower the immune system to target cancer cells while leaving healthy cells alone.” The global market for such treatments is expected to grow from $3.18 billion in 2020 to $20.01 billion in 2028.


Examples of companies that are seeking to tap into this opportunity include oncology pioneers Bristol Myers Squibb, Merck and Roche, which are developing ADCs that combat various tumors. Of, course not every ADC will be a success, so the key for selective investors is to understand both the science and business opportunity.


Health care companies are undervalued relative to the broader market

Sources: MSCI, Refinitiv Datastream. Relative valuation is the ratio between the forward 12-month price-to-earnings ratio of the health care sector of the MSCI USA Index to the overall MSCI USA Index. As of 5/31/22.

3. Tech stocks are down, but cloud growth is sky high


Fast growing tech companies found themselves in the eye of the storm during the first half of 2022, and many saw their shares decline steeply as the market neared correction territory.


But patient, long-term investors should not be discouraged, says equity portfolio manager Chris Buchbinder. “Rising interest rates and inflation have certainly clouded the longer term earnings picture for many of these companies,” Buchbinder explains. “But there are also well-run software companies in fast-growing segments with favourable prospects.”


The cloud services business, as an example, has rapidly expanded as businesses move their traditional enterprise IT functions to the cloud. “A few years ago, when Amazon Web Services was introduced, it was really a new business segment,” says Buchbinder. “It’s no longer new, but we are still in the early days of this transition.”


Microsoft was not the first mover in this market, but it has grown a larger cloud revenue base than both AWS and Google Cloud thanks to its strong legacy enterprise relationships. As of April 2022, the cloud services division of Microsoft achieved 32% quarterly growth from a year earlier, putting it on a path to reach nearly $100 billion in annual revenue. “It is not a certainty that all cloud businesses will realize the profit growth to justify high valuations,” Buchbinder says. “That is why selective investing through fundamental research is essential.”


While markets are unsettled, cloud revenue remains strong


Sources: Capital Group, company filings, Refinitiv Eikon. Years above refer to calendar years. Cloud revenue is represented by segment revenue for Intelligent Cloud Services (Microsoft), Amazon Web Services (Amazon) and Google Cloud (Alphabet). Data as of 12/31/21.

Bottom line for investors: Maintain balance


With growth moderating and risks rising, maintaining a balanced, diversified, all-weather portfolio is particularly important. Stocks that pay rising dividends can help temper volatility and counter inflation, as can companies with pricing power. On the other hand, although technology stocks have been battered, select digital companies have grown cloud revenues.


“In this environment of slower growth and inflation, I am going to be looking for companies that can make their own growth,” Wagner concludes. “That might include some old-economy companies that make tangible things, but also some leading digital companies.”


 



Jared Franz is an economist at Capital Group, responsible for covering the United States and Latin America. He has 16 years of investment industry experience and has been with Capital Group for seven years. He holds a PhD in economics from the University of Illinois at Chicago and a bachelor’s degree in mathematics from Northwestern University.  He is also a member of the Forecasters Club of New York and the National Association of Business Economics. Jared is based in Los Angeles.

Diana Wagner is an equity portfolio manager with 23 years of investment experience. She holds an MBA from Columbia Business School and a bachelor’s degree in art history from Yale University.

Chris Buchbinder is an equity portfolio manager with 25 years of investment experience. He holds bachelor's degrees in economics and international relations from Brown University.


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