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The Decade of Dividends: U.S. Equities

Outlook: Our primary concern with regard to the S&P 500’s earnings outlook for 2023 is that banks are indicating a buttoning up of their lending standards, an occurrence that sometimes indicates corporate profit trouble. Nevertheless, the “bank walk,” whereby deposits flow out of banks due to sub-1% yields, has been more of a “bank crawl."

Stocks with exposure to AI have been dominating in 2023, but this may subside as the market digests the excitement. We believe a Value cycle kicked off during the 2022 broad market sell-off.

• What We Like: The market has been rallying since October 2022, yet valuations are more reasonable than they were before the market peaked in last year’s opening sessions. Still, we are concerned that some parts of the market are trading on hype, which may be fine in a zero percent bond market world…but not so much when overnight money yields 5%. Fortunately, skepticism abounds; memories of 2022’s wounds are still fresh, aiding a “wall of worry” thesis.

• What Could Go Wrong: The value cycle turns out to be just a value trade—a shorter term run for dividend concepts that ended last autumn. Additionally, continued levitation from zero-yielding Silicon Valley giants would be troublesome. This year has been horrible for value-oriented mandates, along with most everything that was not mega cap growth. Stocks that can demonstrate durable profitability and reasonable valuations were the type that held up during the 2022 sell-off; we suspect they are opportune in 2023’s second half.

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The Decade of Dividends: International Developed Equities

Outlook: Like others, we are concerned that the war in Ukraine may not find resolution anytime soon. Nevertheless, we have eyes on two major components of developed market equity baskets—Britain and Japan—both of which are showing valuation appeal and potentially some newfound competitiveness because of the multi-year collapses in the British pound (GBP) and Japanese yen (JPY).

• What We Like: Many single-digit price-to-earnings multiples pervade across numerous developed nations. In terms of diversification, developed markets’ lighter exposure to Tech may round out a more even keel approach than allocations that are U.S.-heavy. Not yet appreciated by the market is the opening up of a large wage arbitrage between developed markets and the U.S. Americans find themselves with notably uncompetitive compensation dynamics relative to peers in Europe and developed Asia.

• What Could Go Wrong: An acceleration of the war in Eastern Europe, and/or the U.S.- and Swiss-centric bank headlines become more global. The Japanese bond market remains at risk amid continued central bank tightening elsewhere. Additionally, stickier inflation in Europe than in the US could upset visions of a quick resolution to that issue.

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The Decade of Dividends: Emerging Markets Equities

Outlook: We continue to believe China is investable, though the central government’s further concentration of political power breeds risk in equities. However, there’s significant inefficiency in the market’s pricing of China risk; overreactions to both good and bad news are common. We continue to assess very low risk of U.S.-China conflict over Taiwan.

• What We Like: Many deep value and even quality-oriented value mandates have dividend yields that are near double digits. Emerging Markets Value is also contrarian play, owing to years of historical underperformance.

• What Could Go Wrong: China cozies up closer to Russia, Taiwan headline risk rattles markets, firm-specific risk in companies that have close ties to the Chinese Communist Party grab more attention and a possible continuing of tightening credit conditions.

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Fixed Income: A Return to Normalcy

Outlook: During the first half of this year, fixed income markets have posted a moderate rebound from arguably their worst year on record in 2022. The era of negative and ‘zero’ interest rates appears to finally be a thing of the past. We expect rates to be ‘higher for longer’, with volatility continuing to remain a part of the broader bond market investment landscape.

This development has created an interesting phenomenon: there’s “income back in fixed income.”

• What We Like: Yields have risen to (normal) levels that a generation of advisors and investors have never seen before, returning fixed income to its more traditional role in portfolios.

• What Could Go Wrong: We could see no recession, with inflation remaining ‘sticky’. As a result, the Fed (global central banks) either continue to raise rates more than expected, or don’t cut them until mid to late 2024.
Or we could see a deep recession where the U.S. economy (labor market) rolls over and the Fed cuts rates sooner than expected. Other concerns include geopolitical developments (such as Ukraine or a China/Taiwan escalation).

Actionable Ideas:

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