Stock selection
In terms of how to address the issues from the perspective of stock selection, Stick’s co-fund manager at Rathbones, Alan Dobbie, says: “It is noticeable that in recent months, defensive stocks have started to outperform against some cyclical shares. This is because of the nature of the inflation we have, with supply constraints.
"But the general picture is that the market is shunning the steady-eddie type stocks, such as pharmaceuticals, and maybe those stocks that usually underperform when bond yields are rising because of strong demand in the economy are actually an opportunity now because they have been out of favour with the wider market.”
The types of stocks referred to by Dobbie often underperform when bond yields are rising as their predictable income stream looks relatively less attractive when compared with the income from a bond.
But in their latest macro outlook, analysts at Bank of America’s wealth management unit revealed they are switching towards those types of equities, as they feel bond yields may have peaked, and so the income from those equities will have an increased appeal.
Richard Saldanha, global equity income fund manager at Aviva Investors, is less keen on those stocks, often called compounders, because while the dividends are consistent, and relatively high, those businesses are often not growing much, and so the dividends are not growing in line with inflation.
Instead, Saldanha is targeting companies that may have lower yield now but are growing their yield at faster than the rate of inflation.
One area he finds particularly interesting is DIY stores. He said the pandemic pushed the share prices very high, and made the yields look relative meagre, but the shares subsequently fell as the market moved away from "pandemic winners", but Saldanha says hybrid working means those companies, usually viewed as very cyclical, are now on a longer-term growth path, and this is reflected in dividend growth.
Pyle says that while equity markets could not, right now, reasonably be called “cheap”, valuations are “reasonable”, but his favoured way to generate the income required from equities right now is commodities. Those tend to rise in price whenever inflation is rising, regardless of the type of inflation or its origin.
He says: “At the sector level you want to own those where prices are generally aligned with inflation or are defensive. Commodities benefit from rising prices and demand in a typical inflationary period, banks from rising interest rates and healthcare and luxury goods generally have the ability to pass through inflation effectively.”
