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Recession comes: How can a dividend strategy help mitigate the investment risk?

Ross McSkimming
Ross McSkimming • 4 min read
Recession comes: How can a dividend strategy help mitigate the investment risk?
High dividend stocks tend to do better in high inflation environments / Photo: Shutterstock
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It is definitely a difficult time for the global economy in the first half of 2022. Most asset classes are down year to date, some by quite a lot, and even within some of the bright spots, such as commodities, some of these areas are also down year to date.

In most economies, inflation is very high. Not just headline rates, not just because energy and food price inflation is high, but across the board. The consensus that existed during last year that a lot of this inflation would prove transitory has evaporated very quickly. And central banks have quickly got the message that they have to act quickly and aggressively to rein in inflation.

When underlying inflation is very high and labour markets are extremely tight, demand has to be destroyed one way or another to bring inflation under control. So in our view, recessions is likely to occur across the major economies within the next two years.

In some countries, these risks are probably already materialising. In the eurozone, which is at the epicentre of the shocks caused by the war in Ukraine, the energy price shock and the food price shock are proving particularly acute.

However, what is not being reflected in the fall in equity markets is the impact of the recession on profits and cash flows and therefore dividends. The earnings seasons that we approach will be watched very closely to see what the underlying effect of the changing global economy is having on corporate cash flows. And probably most importantly, what chief executives and chief financial officers are saying about the outlook. We feel that the potential risks to earnings are not reflected in many equity markets.

We expect appetite for high dividend stocks to remain robust in particular, as history tells us that high dividend stocks tend to do better in high inflation environments. Moreover, those companies that can grow dividends are even better placed. Based on this, a focus on high dividend and dividend growers may be favourable in the rest of 2022.

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At the same time, a cautious outlook for bonds also means that equities continue to be attractive to many investors from an asset allocation viewpoint. Given rates are rising, this presents headwinds to the performance of bond portfolios.

Thankfully, dividends are in abundance. The outlook for dividends is very positive and the current dividend environment is one characterised by steady recovery and resilience. The global economic recovery has resulted in an earnings recovery which, of course, is favourable for dividend payouts. In the 12 months ending March 31, the companies in the MSCI AC World index paid in excess of US$1.3 trillion ($1.8 trillion) of dividends, so there are plenty of dividend opportunities for us to take advantage of.

Nine out of 11 sectors saw dividend growth so it is a broad-based recovery for dividends. Cash on balance sheets are at historic highs, so this also provides a positive backdrop for companies to pay dividends. The earnings outlook for global equities is for double-digit growth and we expect global dividends to grow at a similar rate.

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Year on year, we have seen resilience of dividend payments by global companies as well as growth in the size of these dividend payouts. In particular, the energy sector, materials, real estate and industrials see strong growth. Following on from the latest reporting season in the US, the S&P 500 dividends shows a 13% increase y-o-y, demonstrating the resilience of dividends and challenging the talk about recession.

Looking at the cash piles available on a sector-by-sector basis, technology, consumer sectors, communication, healthcare, industrials and financials are relatively well placed to generate dividends. We scour the universe for dividend-paying companies and have identified steady dividend payers with strong fundamentals in other sectors like energy and materials.

Given the current broad base of economic recovery, the companies that stand to benefit will also be diverse by sector. Given the uncertainty over whether value or growth will do better in the future, it is important to adopt a strategy in global equities that is diversified across both value and growth stocks, and also is diverse by country and sector exposures. This approach is a neat hedge and provides investors with both structural growth and cyclical growth.

Ross McSkimming is a senior investment specialist at abrdn

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