High-yield stocks a good bet in slowdown

Investor: An insider's guide to the market Although there are still more than three months to go before the end of the year, it is clear that 2006 will go down as an exceptionally strong year for global economic growth. Attention is now beginning to focus on the prospects for 2007 as analysts and investors try to assess whether the growth momentum of 2006 can carry forward into 2007.

Developments in the US economy will be crucial and there are increasing signs that the US economy will slow next year. Indeed the consensus is that there will be a slowdown in the US in 2007; the question is by how much.

Trends in US leading indicators and a significant cooling in the housing market provide convincing evidence that an economic slowdown is on the way. The Conference Board's leading indicators are closely monitored and have proved to be a reliable signal of US recessions in the past. For example, the slowdown in the US economy in 2001 and 2002 was preceded by a sharp fall in the rate of change of this indicator.

Since May of this year there has been a similar decline, with the six-month rate of change going negative for three months in a row.

Another sign of a slowing economy comes from the US housing market, which has cooled in recent months as reflected in a recent downturn in residential investment. But lower residential investment on its own will not have a large impact on overall GDP growth.

Of greater significance is whether the softer housing market leads to a retrenchment by the US consumer. So far this year consumer spending has remained resilient in the face of the housing slowdown. The experience from the last downturn in the US from 2000 to 2002, when consumer spending slowed modestly, supports the view that a collapse in consumption demand during 2007 is highly unlikely.

Even if the US economy does slow sharply next year, it is unlikely to drag the rest of the global economy with it, according to a report issued by Merrill Lynch. The report expects US GDP growth to slow to 1.9 per cent next year from 3.4 per cent in 2006. Growth outside the US is forecast to decline by only half a per cent due to an ongoing steady European economy based on stronger domestic demand in the euro area. Asia, Japan, India and China should be capable of continuing to grow strongly even in the face of a US slowdown.

Economic forecasting is notoriously unreliable and very few investors base their investment strategies on such forecasts. Whatever about the detail of current economic forecasts, what does seem clear is that 2006 is likely to be the peak growth year of this economic cycle. Growth in 2007 will probably be good, but not as strong as this year. Higher interest rates and high levels of consumer indebtedness in many countries are bound to eventually dampen economic growth.

For investors, slower growth need not necessarily lead to poorer investment returns. If slower growth is accompanied by lower inflation and falling interest rate expectations, then bond prices could well rise. Within equity markets, stocks offering relatively high dividend yields could perform well in such circumstances.

The Irish equity market includes many stocks whose historic dividend yield is well above 3 per cent. Most of the quoted financial stocks offer dividend yields in excess of 3.5 per cent. Outside the financials, Independent News & Media stands out with a 5 per cent yield while the yield of 4.6 per cent on Fyffes is also attractive. A more stable company such as Viridian is trading on a yield of 3.6 per cent.

Those investors willing to take some currency risk will find a wide range of high-yielding stocks in the London stock market. Some research is needed to sift out those companies that may have difficulty in sustaining high dividend payments into the future. Nevertheless, many large-capitalisation British companies, with strong balance sheets offer attractive dividend payments that are likely to grow into the future.

This list includes many financial stocks although Irish investors may prefer to look at other sectors given the preponderance of financials on the Irish market. Two candidates from the teleco sector are BT, which trades on a dividend yield of 4.6 per cent, and Vodafone where the yield is an even higher 5.2 per cent.

Higher yielding stocks offer something like an each-way bet - they rise in a rising market, but in a flat or declining market high dividend payments limit the downside.