More of the same?

Protectionism may be on the rise but the world is so interconnected today it may not be as far-reaching as some expect and many global companies remain well-situated to maintain delivery of sustainable income in 2017, says Newton global income equity manager Nick Clay.

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The year ahead looks beige – a year in Nick Clay’s opinion likely to follow the same trend of the past few: a continuation of uncertainty, market and asset class volatility, low growth and central bank interference. It will be an environment, Clay says, where although there appears to be less risks, in reality there are plenty. Against such a backdrop, the sustainability of income remains vital, he says.

There is much talk in markets today that the coming year will likely see more political divergence and an upswing in protectionism manifesting itself as rising trade barriers. However, Clay says much of this is noise and argues many companies are still well placed on the global stage. “The world is too interconnected to be dismantled easily – especially among those companies that have intellectual property. For capital-light companies strong in this area, trade barriers become harder to impose.”

Clay points out that money gravitates to those companies with intellectual property, something that is causing a widening wealth divide, creating discontent and leading to political and trade upsets. “The share of global wealth among the top 1% of the world’s population is back to levels last seen around 1929. This isn’t a result of trade agreements.” In 2015, it was reported the richest 1% of the world's population now owns 50% of its total wealth.1

Citing the US jobs market as an example of the structural changes leading to political upsets, Clay notes that virtually 95% of all US jobs created in the past 16 years have been in sectors such as healthcare, education, restaurants and social assistance. “Not only do jobs such as these pay less than average, they also feature fewer work hours, meaning take-home pay in these new jobs is some 40% below average; the incidence of those holding two jobs has concurrently been on the rise. The effect of this shift on total US earnings is a reduction of around 3%. The US may have improved employment figures but in fact many are now worse off.”

Among the 10 jobs projected to grow the fastest in coming years, half pay less than US$25,000 a year and three-quarters pay less than the typical annual US wage of US$35,540, according to US news reports in April 2016.2   Meanwhile in September 2016 it was reported that multiple US job holders rose to 7.8 million, representing 5.2% of all those employed, up from 4.9% in September 2015.3

Partly this is the result of a shift in the US away from manufacturing jobs and more towards technology and other areas that are more led by intellectual property, says Clay. “Companies such as Uber, AirBnB, Amazon – where does the wealth end up? With a very few.”

Although many companies might consider the current pace of technological change as a threat, for those whose product or service is embedded in everyday life, this is less of a problem.  Incumbent systems, such as Microsoft, for example, are so entrenched it is difficult for competing companies to derail them.  Likewise, another company Clay cites as an example is Computer Associates, a leader in software for mainframes used by global banks. “If you started from scratch today you likely wouldn’t have or need a mainframe computer system but for legacy businesses it is too deeply-rooted,” he says. The same thesis can be applied to a company like Western Union. “Many think of it as just a bricks-and-mortar cash transfer company that can be disrupted by the uptake in online transfers and smart phones. Yet some 80% of all transfers conducted via Western Union are in cash and around 85% of those that receive the transfer do not have a bank account – even if they may have a phone. Increased regulation around such businesses also means few entrants are competing in this space Western Union is not without an online presence either – it’s now one of the largest online cash transfer businesses.”

Meanwhile, the nature of the current globalised economy means for developed markets there will be a greater focus on capital-light companies featuring strong barriers to entry, providing them with the protection to fight off potential competition and disruption.

Clay believes these types of companies look positive for the provision of sustainable dividends over the year ahead, even as market valuations and volatility remain high. “One approach to likely volatility is to hide from it – but where? Now is not about hiding, it’s about surviving.”

Markets were fairly resilient through 2016, much of which Clay attributes to what he terms the “blind faith” of investors that central banks will intervene in times of great difficulty. He points to the somewhat short-lived downturn in the UK following the Brexit decision as evidence that a reliance on intervention by the authorities has become almost Pavlovian.

This support – or even just the appearance, or expectation of it – will continue to feed through to asset prices and valuations in 2017, Clay notes.

So is this the year when the support will stop working or a new central bank intervention tool will have to be created? Clay doesn’t think so. Ultimately, he says the question is more who will pay for it. “Quantitative easing isn’t a free experiment:  somewhere, someone will pay. Ultimately, it’s baking in low returns for the next 10 years. In this environment, every asset class looks expensive and correlations increase. ”

The ability of companies to put up prices in this environment is zero, Clay argues. “So who is going to take the margin hit? It’s not the consumer.”

Since dividend growth in this environment may be under pressure and lacklustre, sustainability of shareholder payments will be ever more important. As such, Clay believes capital-light business models – and those with discernible intellectual property - will likely fare best.    

What to watch in 2017

  • Global capacity and productivity levels.
  • Politics – internally in Europe.
  • Forthcoming European election results.

1. Fortune: ‘The top 1% now owns half the world’s wealth’, October 2015.
2. CNN: ‘5 of America's fastest growing jobs pay less than $25,000’, April 2016.
3. USA Today: ‘The job juggle is real. Many Americans balancing two, even three gigs’, October 2016.

This is not investment advice. Regulatory Disclosure