Richard Macey, director of charities at M&G, looks at how 2016 has so far fared in terms of equity investment.

‘Alas, the storm is come again!’
The Tempest, Act II, Scene II (circa 1610)

These words, spoken by Trinculo, a court jester, seem rather apt given the somewhat tempestuous start to the year in equity (company share) markets, with its echoes of the global financial crisis that has left many near multi-year lows. Meanwhile, mainstream government bond*, or fixed income markets, such as those in the UK, US and Germany, which are generally regarded as expensive, have risen in value again so far in 2016 as investors have appreciated their ‘safe haven’ properties in uncertain times.

There may be some similarities to be drawn with the situation in 2007-08, as the banks are in the spotlight again, especially in Europe. But these institutions are much stronger today, notwithstanding any concerns about the impact of negative interest rate regimes in Europe on their business models and doubts about their loans to oil companies, which, amongst the largest banks at least, are not particularly material.

Picking through all the market noise, the overriding impression is that investor sentiment has changed, although the economic fundamentals have not. Indeed, the latter are quite positive. The US and UK economies are in relatively good health with strong consumer sectors, buoyed by low unemployment, decent wage growth along with near-zero interest rates. In both countries, company profits are also generally fairly healthy. The eurozone is showing signs of recovery too, finally.

On the other hand, the extent of the slowdown in China is an issue for commodity-producing countries, but these worries could be overdone. Another factor is whether central banks have any powder left in their armouries to prevent a global slowdown with interest rates at all-time lows. However, this underestimates the power of the central banks to use unconventional policy measures. In addition, the slump in the oil price this year, which is currently being interpreted as a sign of economic weakness, has more to do with oversupply of the black liquid than a lack of demand. Historically, falling oil prices have contributed to periods of improving economic activity.

I would like to highlight the important contribution that income makes to overall returns from equity investment. In 2015, the UK market, as measured by the constituents of the broad-market FTSE All-Share Index, delivered dividend growth of 8%. To put that in an historical context, since 1960 real dividends (after inflation) have grown at around 2% per annum. 2016 is unlikely to match 2015, although I still expect dividend growth to remain positive. The reason is that energy and mining companies make up a large percentage of the top dividend payers in the UK and, reflecting the steep fall in commodities prices, a number of them have begun to announce cuts to their future payouts, or their intention to maintain them at the same level as last year. However, there are other drivers of dividend growth in the UK that could mitigate the commodity effect to some extent, such as the strength of the US dollar and the level of special dividends – the latter accounted for 7% of total payouts last year.

This year’s referendum on the European Union is a hugely important decision for the UK with enormous ramifications for the economy and the domestic political landscape, including the possibility of initiating a second Scottish referendum.  A worry is that headlines about migration and terrorist atrocities will play to the public’s emotions. The run-up to the referendum is likely to increase volatility levels in financial and currency markets, and to some extent, the genie is already out of the bottle. In addition, inward-investment will be curtailed and the City will undoubtedly be affected in the event of a Brexit vote in view of the uncertainty it will create.

While bonds continue to provide diversification and an element of mitigation against the full effects of stockmarket falls, UK gilts look relatively expensive. On this basis, our preference for our charity fund portfolios remains equities on mid- to long-term valuation grounds.

Please note that past performance is not a guide to future performance. The price of shares and the income from them may go down as well as up and a charity may not receive back all its original investment.

Richard Macey 
Director of Charities
E-mail: [email protected]

With thanks to M&G Investments for their support with this blog.

Notes:
*Bonds – A loan in the form of a security, usually issued by a government or company, which normally pays a fixed rate of interest over a given time period, at the end of which the initial amount borrowed is repaid

All past performance statistics are quoted with income reinvested unless otherwise stated.

This Financial Promotion is issued by M&G Securities Limited. Registered in England No. 90776. Registered Office is Laurence Pountney Hill, London EC4R 0HH. Authorised and regulated by the Financial Conduct Authority in the UK.