The Federal Reserve (Fed) has resumed its rate-cutting posture after a lengthy pause. While we expect the easing cycle’s impact on the economy to be beneficial, lowering rates comes at a cost: many savers who depend on income-oriented financial instruments will have challenges meeting their living expenses.
The timing is particularly vexing when you consider that more than 10,000 Baby Boomers retire every day and that Social Security is not exactly in the best health. Outlays continue to exceed revenue, and the trust fund is headed for depletion in eight years. No one can say whether tax increases, benefit cuts or other adjustments to Social Security in the US will emerge to close that gap, but the problem is getting harder to just ‘kick down the road.’ At the same time that interest rates are declining, the number of retirees grows and Social Security looks less secure.
So where can investors find income opportunities?
Equity income can be an option for those with appropriate risk tolerance, bearing in mind that of course equity can have higher volatility than fixed income. It is true that in the market as a whole dividend income is near all-time lows. As the S&P 500 rises, dividend yields have been declining; currently, the S&P 500 yields just 1.15%. But that’s deceiving as it is driven by a few companies, mostly in the tech sector led by the Magnificent Seven. Not surprisingly, the last time yields were this low was the dot-com era. Like today, it was full of investor euphoria and driven by tech firms that prioritise growth above equity income. The aftermath of the bust saw value and dividend-paying companies outperform the previously unbeatable growth sector. Will history rhyme?
No need to wait for that. Outside of the Magnificent Seven, things may look better for the income investor. The utilities sector and its stocks offer the opportunity to earn yield while benefiting from the wattage needed for the AI buildout. Energy, another high-yielding sector (and also a beneficiary of AI power needs), is down for the year on the weak oil price, but as the saying goes, the cure for low oil prices is low oil prices. We expect oil to rebound—and lift energy companies’ stock prices too. Real Estate Investment Trusts (REITs) may stand to gain from lower rates as well.
Outside of the Magnificent Seven, things may look better for the income investor.
Another place to look for equity income is overseas, as dividend yields are often much higher outside the US, due to a more shareholder friendly mentality. For example, Germany and Canada have average dividend yields above 2.5%. In the UK and France that figure often exceeds 3.3%. You can find yields of almost 6% in Brazil.
Even as interest rates decline, we believe there are places in the equity markets, both in the US and abroad, where investors can derive attractive current income with the potential for future appreciation.
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