BNY Mellon Investment Management: Global equity income: will history repeat?

“History doesn't repeat itself but tends to rhyme” – the adage often used when comparing market events, past and present. Newton¹ senior portfolio manager Jon Bell believes we are at a juncture when history can indeed teach us about what’s in store for global equity markets.

Key points

• The global economy is experiencing two key macro themes: ‘big government’ and ‘great power competition’, which are inflationary.
• The era of zero interest rates and quantitative easing is over, altering the dynamics for valuing growth stocks.
• Long-term returns from equities are driven by dividend compounding, especially in times of higher inflation.
• Much of the market is trading at over 20 times earnings, highlighting the importance of starting valuation in determining future returns.
• High valuation and concentration risks mean that there may be a significant change in the dominant sectors of the market, with income stocks potentially offering pockets of value.

Inflation transition

Bell notes two key macro themes at play in the global economy:

• Big government: the intervention of governments in economies with increasing use of fiscal policy to drive growth; witness recent announcements in Europe and central bankers manipulating asset markets.
• Great power competition: the shifting balance in relationships between countries, as seen in the US/China dynamic, Russia and Ukraine conflict, and more recently, US and Europe trade tensions.

Bell believes these two themes can contribute to increased protectionism, tariff wars, higher defence spending and deglobalisation – all inflationary forces. Added to this is the global energy transition which Bell says is also inflationary.

As a result, he says the era of "free money" characterised by zero interest rates and quantitative easing is over. This, he argues, has altered the dynamics for valuing growth stocks, creating a more challenging outlook for high-valuation companies that have dominated equity markets in recent years.

“The world is transitioning from deflation to inflation,” says Bell. “That is important because it means the era of free money is over – that long period where interest rates were at zero and we had quantitative easing policies. That was fantastic for investing in growth stocks because when you value a growth stock by discounting its future cash flows at the bond yield and the bond yield is zero, the valuation can be whatever you want it to be.”

Compounding dividends

Looking to history, Bell notes long-term returns from equities are driven by dividend compounding, with reinvested dividends playing a major role in wealth accumulation. Bell notes while investing in the stock market since 1900 would yield US$575 by 2022 if relying on capital appreciation alone, reinvesting dividends would have resulted in a cumulative value of US$70,000 (see chart below).

This is especially pertinent in times of higher inflation, he believes, because income stocks have the potential to raise dividends, cushioning investors from higher prices.
 

The importance of valuation

Bell also observes that much of the market is trading at over 20 times ernings on a price to earnings (P/E) basis. This is especially the case in the US, where the top 10 stocks are trading on over 30 times earnings². Additionally, he notes 65% of the MSCI World index is trading on over 20 times earnings, compared with the 25-year average of 40%³.

Despite this concentration risk, Bell believes pockets of value can be found with income stocks, particularly those with above average yields, trading at discounts on both a P/E and a price to book (P/B) basis relative to below average yielding stocks⁴.

Starting valuation is vital, Bell argues. Again, looking to history, he notes in the decade after the Nasdaq bubble burst, the Nasdaq 100 companies grew their earnings at just under 8% while the rest of the market only grew at 1.4%. Crucially, however, this earnings growth didn’t match expectations and as a result the multiple that the market was prepared to pay fell by 13.5% compared with a 4% fall for the rest of the market. Coupled with limited dividend growth, that led to 5.5% underperformance from Nasdaq over the next 10 years⁵.  What this demonstrates, says Bell, is that the starting point for a stock’s valuation is key to its future returns.

Overall, Bell argues there is an ongoing shift in market leadership due to high valuation and concentration risks, signalling a potential change in the dominant sectors of the market. “Is history about to repeat itself? It certainly feels like we might be in the process of a significant change in equity market leadership,” he concludes.

The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed.

¹ Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds.

² Source: SG Cross Asset Research/Quant Research. FactSet, 30 November 2024. Based on forward looking price-to-earnings multiple of stocks in the S&P 500.

³ Source: SG Cross Asset Research/Quant Research, FactSet, 30 November 2024.

⁴ Source: Société Générale Global Income Investor, 29 March 2024.

⁵ Source: Stifel, SRC Chart Books (various issues), Standard & Poor’s, Bloomberg, Univ. of Alabama Bruno Library historical financial reports database. 31 December 2009.