Any seasoned fund manager knows macroeconomic event risk is a perpetual feature of long-term investing.
But the present environment does not feel like the common garden variety of top-down upheaval.
Since the Global Financial Crisis, we have undergone an unprecedented historical experiment in monetary policy, seen a meteoric rise in global populists led by a mercurial US president, and endured an interminable Brexit saga.
This before we even consider the ongoing trade war that could jeopardise global growth.
Certainly, central bankers have had the greatest impact on markets. Decades of traditional market thinking has been turned on its head.
Who would have predicted institutional investors would be queuing up to buy negative-yielding government paper that holds a cast-iron guarantee it will lose money at maturity?
Fixed income may well still be fixed, but it no longer produces much of an income.
Stocks are bonds and bonds are stocks
Such is the extreme age in which we live that investors are accessing equities for income and fixed income for capital return. But whatever the current anomaly, equities cannot replace fixed income.
The risk profile is not the same. However, blending bonds with income-producing equities can provide a dependable long-term diverse source of income.
The question is, how can investors navigate global equity markets during a time of macro complexity and heightened valuations?
A gloom-laden confluence of factors and recent data points signalled a clear cyclical slowdown. So far, this has been partly suspended due to monetary intervention.
This layer of additional complexity explains why markets have been jittery and why we have seen such a prolonged period of outperformance by quality growth companies.
Indeed, low growth, low interest rates and uncertainty create the ideal conditions for quality stocks to thrive.
And so we have experienced a huge premium on defensive and quality stocks. The reasoning for a flight to quality appears obvious, but the picture is more nuanced.
While the risk of recession has increased, it is also more anticipated by the market.
Moreover, the depth of the recession is unknown. Our view is this excessive pessimism implies markets have further upside.
For this reason, investors should consider a more balanced exposure outside traditionally defensive industries.
Attractive entry point
We have increased our exposure to select high-quality cyclical companies, including French auto parts firm Valeo.
Auto parts are the epicentre of cyclicality, a sector that has been subdued by consumer gloom and a retrenchment from spending on big-ticket items.
Yet despite headwinds, there are some strong underpinnings for the European economy. For example, new figures suggest unemployment in the EU is at its lowest level since January 2000.
The current valuation chasm between beaten-up cyclicals and quality defensives is also at a historical extreme, even if the value rotation that started in September reduced the gap.
We believe, despite some ongoing cyclical headwinds, this is a good entry point from the perspective of a long-term investor.
In the current environment, to generate a stream of income above 4%, we have blended three classes of stocks.
The first, the ‘anchors', are quality defensives such as Nestlé, Merck or Nextera. These are classic quality stocks that compound cash over time and offset costs due to pricing power and operational excellence.
Deeper value opportunities
In the second group are the ‘accelerators'. These are innovative companies that can deliver a higher level of dividend growth over time.
A good example is Indian IT outsourcing and consulting firm Infosys. The current yield is 2.69%, but it has substantial potential to grow the dividend as it expands its footprint in the world of digital services.
In our view, a recent whistleblowing scare has created a good entry point.
The third group are more special situations stocks. These remain quality companies that may have been victims of indiscriminate selling due to prevailing macro, sector or style pessimism.
Valeo, for example suffered from both an aversion to value stocks and gloom over cyclicals, but remains a high-quality company trading on strong fundamentals.
It has an attractive forward P/E ratio of 12.4 and dividend of 3.89%.
Niche market-leading companies, such as recreational sports vehicle company Polaris, have also been hit by consumers shunning expensive goods, but we believe this firm has strong dividend growth potential and capital return upside.
As the three groups perform differently through the business cycle, the blending process creates a dynamic effect where performance can be smoothed over time and underpinned by steady high income.
The equity market may still be more inherently risky than fixed income, but it is a highly complementary bed for diverse income ideas.
Roberto Magnatantini is portfolio manager of the OYSTER Global High Dividend fund at SYZ Asset Management