Neil Woodford explains how his long-term strategy is set for the challenges of the ‘new normal’ economic landscape.
Anyone listening to the governor of the Bank of England, Mark Carney, at November’s Inflation Report press conference could be forgiven for thinking that they’d been caught in some sort of time warp. Carney hasn’t been the governor for long, really; but much of what he said, particularly his comments about the UK labour market and real incomes, could have come from the mouth of his predecessor, Mervyn King, at practically any point since we emerged from the financial crisis.
By way of example, the November 2011 Inflation Report stated: “Real take-home pay should gradually begin to recover after a period in which prices have grown faster than wages.” Three years later, we are still waiting. The latest Inflation Report stated: “Real take-home pay growth is in prospect… The MPC expects annual real pay growth to pick up from around zero now to around 2% by the end of next year.”
This time round, although it is by no means assured, perhaps real pay growth actually does have a better chance of increasing. However, this is unlikely to occur as a result of a pick-up in wage growth but instead it may come through disinflation or, worse still, deflation. This is hardly something to celebrate, as it brings with it a very different set of economic problems.
The key problem for policymakers appears to be that they continue to live in the hope that a return to more normal economic conditions lies just around the corner. Unfortunately, I believe they are deluded. Any anticipation of economic ‘normalisation’ is misguided in my view, because we are already normalised. It’s just that the ‘new normal’ looks very different to the old normal!
The reality is that the economic landscape post-crisis is drastically different. Growth outcomes continue to disappoint, inflation continues to fall, productivity growth has evaporated, investment is inadequately low and real wage growth remains virtually absent from developed economies.
Much has been written elsewhere about the reasons why all this may be the case and I have a lot of sympathy for the ‘secular stagnation’ thesis which contends that changing global labour market dynamics, the substantial burden of private and public debt, rising inequality and unfavourable demographics have contributed to a permanent shift down in potential economic growth rates across the developed world.
Policymakers clearly don’t have any answers to these issues; but it would be helpful if they at least acknowledged them rather than relying on the rather wishful thinking that something will come along to improve our economic fortunes.
Perhaps something will come along but I’m not banking on it. Instead, I continue to set my long-term strategy with a difficult future in mind. And I remain absolutely confident in the long-term returns that this strategy can deliver. My view on UK interest rates has been consistent since the financial crisis, in believing that they would remain at ultra-low levels for the foreseeable future. This remains the case and, although this is clearly a reflection of the extraordinarily challenging economic environment that prevails, it is also the root of my confidence in the portfolios I manage.
Low interest rates and low bond yields pose a considerable problem for income-seeking investors but equity dividends remain one of the few remaining sources of attractive income. Remarkably, the most attractive yields in the UK stock market seem to be offered by the shares of companies that are best able to deliver growth in this challenging world. The likes of GlaxoSmithKline, Legal & General and Centrica all have starting yields of over 5% currently, with Imperial Tobacco, BAE Systems and Royal Mail all yielding well over 4%*.
That is why the portfolios I manage are focused towards these sorts of businesses. Not only do they tend to offer very attractive dividend yields, they are also capable of delivering sustainable long-term dividend growth. My long-term confidence in the portfolio is purely a function of these two factors: dividend yield and dividend growth. I expect these two factors to result in high single-digit annualised returns from the portfolios over the next three to five years. In fact, I hope to do better, but this is a realistic expectation, based on a realistic assessment of the fundamentals and, therefore, one in which I have realistic confidence.
*Source: Bloomberg, November 2014 – based on current year consensus forecasts.
The opinions expressed are those of Neil Woodford and are subject to market or economic changes. This material is not a recommendations, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.
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