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I wrote earlier this week about the possibility that we might be at the beginning of a bubble in simplicity – in the kind of high-quality, dividend-paying stocks that everyone now appears to agree are the best things to invest in for the long term. The story is continued by Jane Fuller in the FT.
Investing for income, she says, has “not been so fashionable since the first half of the last century”, when the yield on equities was generally higher than that on government bonds (as it is now). These days, baskets of higher-yielding stocks are regular outpeformers and it is slowly becoming clear that the 1980s and 1990s were very unusual in the way that they provided most of their total return from capital gain rather than income.
The question, of course, is what happens next? Equity investors aren’t generally supposed to worry much about GDP growth: as Tim Bennett points out, “GDP growth and stockmarket returns do not have any particularly obvious relationship either empirically or in theory”. But we do need to worry about earnings growth. That’s where the problem might come in. Right now, says Fuller, the typical stock in a blue-chip high-yield portfolio will be either a huge international firm or a national champion of some kind.
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Both are vulnerable in profits terms – the first to macroeconomic forces such as the slowdown in China (I’m tweeting a lot on this @merrynsw this week) and the second to domestic slowdown (of the kind you’re seeing everywhere). At the same time they will be too diversified to be able to expect particularly high revenue growth, even at the best of times. They also will already have record-high profit margins and record low interest rates to work with. The upshot? Investing in quality is good and it’s “good to see a revival in the art of stock picking on a value basis”. But “this is as good as it gets for large income stocks”.
Ed Yardeni of US-based Yardeni Research is worried too. His latest note points out that, if you look at anything from consensus expected earnings per share in the US, to after-tax net income for S&P 500 firms and the profits coming into the States from abroad, “the earnings-led bull market in stocks is running out of earning power”.
We don’t think it’s time to move out of quality dividend-payers (perhaps it never will be). But we do think it’s worth noting that, given the environment, the profit margins of a good many firms are probably at risk one way or another. And the firm most at risk? Yes, it’s Apple. We don’t know exactly what margins it makes on what products, says Matthew Lynn. But “most analysts reckon that margins across its range are in the region of 50%”. They’re unlikely to stay that high. To see why and to find out why you should sell now, see Hidden dangers in the Apple hype machine.
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Merryn Somerset Webb
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