Staring down volatility and deflation

Economic news in the US and abroad continues to have significant influence on domestic stock and bond markets, triggering inconsistent market behavior and leaving many investors wondering about the direction of the US economy.

While we dislike higher volatility in the short term, we believe the economy is headed in the right direction and volatility can open up opportunities for the long term.

At the moment, we are finding opportunities in a more balanced strategy as we have shifted from a greater focus on credit late last year to a more even composition of asset classes, including higher allocations to dividend-paying common stocks and convertibles.

For example, the utilities sector is currently a significant part of our strategy, with a focus on high-yielding, dividend-paying utility stocks.

We recognise the sector lagged a bit earlier this year as investors had been focusing on sectors that were viewed as more economically sensitive and tied to economic growth and recovery.

In the last couple of months, however, we have seen the utilities sector outperform the broader market.

In the regulated utilities business, we believe prospects for growth in the underlying rate base may lead to earnings and dividend growth.

Dividend growth potential is a big theme for investing in utilities, and we remain very optimistic about this sector.

In addition, we have found select opportunities in other sectors, including health care, energy and telecommunications.

Here again, dividend yields and dividend growth prospects play an important role in our evaluation of an investment opportunity.

One somewhat unique feature of today's low interest-rate environment is that for several companies, the dividend yields offered on their stock exceed the yields offered by their long-term corporate debt.

We currently find several of these stocks attractive, including several health care names, an oil company and a global mobile communications company.

While we believe equities are likely to play a greater role in positive market performance going forward, we continue to find value in the fixed income space.

We have seen strong appreciation in high-yield bonds over the last few years and have been able to take some profits in bonds trading at a premium to par, redeploying them into equities to position ourselves for a potential rise in stock valuations.

Yet we have not lost sight of high-yield bond opportunities, and they remain an important asset class for our strategy.

Our focus remains on where we think value is in the market and where the opportunity is to meet our objective of maximising income, regardless of whether it is in fixed income or equities.

On a final note, a financial topic we have been hearing about lately is deflation, and it is one to address and put into perspective.

Fears of deflation are tied into a number of different factors, including excess capacity in different segments of the economy, continued high unemployment and a weak labour market.

Within equities, we believe high-quality stocks with attractive dividend yields and strong balance sheets could potentially do well in a deflationary period.

Within fixed income, we believe the yields of our intermediate-maturity corporate bonds are likely to remain attractive and perform well in a deflationary scenario where rates stay low for a long period of time.

Overall, we focus more on how each individual security can help us meet our objective and less on the macro dynamics at play.

The writer is Senior Vice-President, Director of Core/Hybrid Portfolio Management, Franklin Equity Group

Follow Emirates 24|7 on Google News.