UK investors have become more aware of the investment potential from US equities in the last few years. Broadening your portfolio to include US stocks also provides a level of diversification that UK investors cannot achieve from investing solely in UK markets.
This is particularly true for investors seeking equity income opportunities.
Within the US market, there is a broad spread of yielding equities across a diverse range of sectors such as financials, health care and consumer discretionary, and not just in the traditional areas such as utilities, materials and telecom.
Today, over 80 per cent of the companies in the S&P 500 pay a dividend and many are also increasing their dividend payouts. This is in contrast to the UK, where investors are dependent on a handful of large dividend payers concentrated in only a few sectors.
Not only is the US market more diversified in terms of dividend payers, but over roughly the last 25 years, dividend paying stocks within the S&P 500 have outperformed non-dividend-paying stocks and by a significant margin.
Performance of stocks
Source: S&P
So not only can UK investors get the benefits of diversification by looking to the US market, they can also get rewarded for that investment as well.
While dividends are important, so is the ability to pay the dividend. We also like our dividend payers to have a relatively low payout ratio as well.
A low payout ratio generally means that these well-managed companies can reward investors with a dividend today while leaving capital available to grow shareholder value and enhance the dividend for tomorrow. The best performing stocks over the past 20 years have been those with above average yields and below average payouts.
Navigating the pitfalls associated with those dividend streams means not being too greedy for current income and looking for diversification.
We recognize that dividend paying companies could come under pressure as rates begin to rise. Our goal is to invest in a broadly diversified set of companies that pay dividends, yet simultaneously have the ability to invest in the future via M&A, capex, and buybacks.
By doing so, we believe our portfolio should fare better than equity income strategies that focus more heavily on yield in a rising rate environment (as has been the case in the past).
Looking ahead
Investor fears of an upcoming US recession have most certainly been reflected in the market action over the past several months.
Performance of indices over 1yr
Source: FE Analytics
Our base case remains that the US avoids recession. Moreover, market volatility and statements by Fed officials (in response) have convinced markets that four increases to the federal funds rate this year is highly unlikely.
At this stage, we think 1 to 2 rate increases in 2016. However, the pace of the rate move is still very accommodative to the markets.
Corporate profitability should, overall, do better this year as the headwinds from the dollar and energy prices moderate. There is still plenty of growth in the domestic economy. In addition, strong cash flows should support another year of higher dividends and buybacks too, although higher borrowing costs may be a restraint here.
Valuations are reasonable overall at about 15.6 times forward P/E, with cash flows strong and dividends rising faster than earnings.
Reasonable returns are probably what investors can best expect for the year ahead but with, at least, average levels of volatility, as investors grapple with the same issues that preoccupied them for much of last year.
At the moment it feels like the election is weighting on parts of the market, particularly the health care names. Although the ability of the candidates to make changes is at best a few years, rather than a few months away.
As for the likely outcome, I have always been somewhat reluctant to make specific predictions about these things, as we think our talents lie in analysing and selecting specific stocks and building a portfolio from the bottom up, rather than making macroeconomic forecasts.
Clare Hart is manager of the £2.8bn JPM US Equity Income fund. All of the views expressed above are her own and shouldn’t be taken as investment advice.