By Rebecca Chesworth, Equity Strategist at State Street Global Advisors SPDR ETF business UK.
Rebecca Chesworth, Equity Strategist for SPDR ETFs, State Street Global Advisors.
The equity market rally witnessed over the past few years has been characterized by an unusual pattern of sector leadership. Stocks traditionally considered low-beta, and hence more defensive have, thus far, led the rally.
This is particularly true of long-duration sectors where cash flows are more bankable, dividend yield pay-outs high, and the risk of a cyclical drawdown in earnings low. The consumer staples, utilities, and health care sectors very much fit this profile.
Valuations in these sectors have, consequently, become extended. On the other hand, more economically sensitive sectors have registered less emphatic shareholder returns and market ratings.
There has also been a significant shift in the dividend pay-out profile across global sectors in recent years. The dividend contributions from traditionally more defensive sectors such as telecoms and consumer staples have been on the wane, whilst more cyclical sectors such as information technology, consumer discretionary, and energy have seen their contribution to total market yield rise.
The appearance of high dividends is not, however, necessarily indicative of actual delivery of yield, or indeed of dividend yield growth.
Scrutiny of the sustainability of yield is important. For example, the high dividend yield seen in the energy sector in the ‘Global Sector Dividend Yield’ chart opposite is partly a result of depressed valuations.
Sustainability is very much in question given the moribund nature of energy markets in the short term. Investors need to zero-in on earnings-to-dividend coverage ratios to assess sustainability of yield.
Excessively cyclical sectors will carry some risk of a weakening in earnings power as the economic cycle progresses, with the attendant risk of a cut to dividend pay-out ratios.
We see more sustainable dividend yields in the resources, industrials, and information technology sectors, whilst more heterogeneous sectors currently present interesting opportunities. Ultimately, investors must weigh the yield opportunities in shorter duration stocks against the maturity of the current economic cycle.