In an inflationary environment with low, but rising interest rates, income producing equities could become a more dependable investment in 2022, according to Erik Knutzen, multi-asset chief investment officer at Neuberger Berman.
While the story of value’s underperformance versus growth is well known, Knutzen said that, as a subset of value, income stocks have fared even worse over the past decade.
“There are three sources of equity returns: multiple expansion, earnings growth and compounded dividend income,” he said. “Multiples appear stretched, and earnings have been growing above trend – which suggests to us that income may be more reliable over the coming year.”
EM headwinds
For Knutzen, the expected inflationary expansion this year is also likely to support cyclical over defensive sectors, value over growth stocks, smaller over large companies and non-US, versus US markets.
“That pattern was interrupted after Treasury yields hit their peak in March 2021, but could reassert itself as yields start to edge up again—particularly if this is accompanied by a weaker US dollar,” he said.
“This environment would normally bode well for emerging markets, but substantial headwinds mean we tend to favour only specific opportunities, such as leading companies in India’s innovation sectors.”
Policy changes
Indeed after 18 months of unprecedented fiscal and monetary stimulus and rapid asset price appreciation, Knutzen said investors have found themselves at an inflection point at the start of 2022.
“We are past peak growth and across most of the world, central banks are beginning to fade their ultra-accommodating policies, albeit by different means and speeds,” he said. “Where QE was employed, the rate of asset purchases is either already being reduced or will be soon.”
Elsewhere, led by emerging market central banks, he said the normalisation of policy rates has begun. With fiscal support being withdrawn in many places, he noted the end result is that policy risk is growing.
As result, Knutzen believes investors should reorient portfolios for an increase in volatility and a more two-way investment environment that will likely emerge in 2022.
He said: “Though we maintain our emphasis on finding yield with limited duration risk—which largely means focusing on credit—this may mean taking some profits, tilting toward higher quality credit exposures, and maintaining liquidity to deploy as volatility-driven opportunities arise.”
Bringing it back to the case for income, Knutzen noted that over the past 50 years, income has accounted for about 30% of equity total returns.
“Moreover, in an inflationary environment with low but rising rates, equity income is also a way to get short duration and inflation exposure into portfolios at relatively attractive valuations,” he said.
