OCEAN CITY — When most U.S. investors search for yield, they only look to opportunities here at home, typically in defensive sectors such as utilities or telecom. However, the focus on domestic equity sectors can leave them with concentrated positions and the risk those holdings entail. Overall, however, yields and valuations are more attractive abroad.
Last year, with Quantitative Easing (QE) in full force in the U.S. and regions such as Europe delaying it, markets became wary of stocks in many other parts of the world. However, as the ECB has embraced full-fledged QE, most of those markets have stabilized while dividend yields have remained attractive. Given the diverging monetary policies, these high-dividend international equities also provide more of a cushion against rising rates than their counterparts in the U.S. We believe dividend yields outside the U.S. are likely to remain more attractive than domestic yields as central bank policies diverge. In the U.S., the Federal Reserve looks ready to begin raising rates later this year while policy steps in Europe and Japan have become increasingly accommodative and thus more likely to support equities. Prospects for economic growth outside the U.S. continue to improve as well, supporting the fundamental outlook for international equities. Look abroad for a broader set of options Outside the U.S., attractive dividend yields are found across a broader range of sectors than they are here. Even on a country or regional level, there is a greater set of dividend opportunities overseas.
This broader set of yield and income opportunities is in line with one of our core themes for 2015, “diversifying sources of income.” We favor the combination of yield and relative value, and some of the best values among higher-yielding stocks are found outside of the U.S. Historically, high-dividend stocks in the U.S. have traded at a significant discount to the market. Today, they trade at a premium in the U.S., and only in the U.S. For investors who are overweight U.S. stocks with high dividend yields, there is an opportunity to reallocate some of those holdings to the international counterparts.
A key focus for investors is the sustainability of dividends. Longer-term investors should target corporations with strong cash flow metrics and policies that support stable dividend payments. Another opportunity is in companies paying dividends that aren’t the highest in their sector or country but that show consistent growth, supported by ample free cash flow.
With attractive yields more scarce in the fixed income world, stocks with high dividend yields have been popular for crossover investors. Typically, bond yields tend to be higher than equity dividend yields, since equities provide a claim on the future growth of the business; the dividend can grow whereas the coupon will not. However, in many regions abroad dividend yields currently tend to be higher than corporate bond yields.
While yields on high-dividend equities abroad tend to be more attractive than those for fixed income, the risk is not the same, as equities with high dividend yields are more volatile than their fixed income counterparts. However these foreign stocks can complement portfolios with allocations to U.S. stocks with high dividend yields and new equity capital to deploy.
(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)