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Dividends signal value in equity markets, says Standard Life Investments

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Standard Life Investments believes that the current level of dividend forecasts is pricing in too pessimistic an outlook for equity markets.

Standard Life Investments believes that the current level of dividend forecasts is pricing in too pessimistic an outlook for equity markets.

In the latest edition of Global Perspective, the global fund manager has utilised its "Focus on
Change" investment approach to argue that analysts’ forecasts of further cash dividend cuts over the next two years are overdone.

Standard Life Investments stress tested an extreme scenario3 within the UK stock market and concluded that dividends will not fall more than 35 per cent in total over the period 2009-11. In contrast, the market currently suggests dividends could fall by up to 50 per cent.

Standard Life Investments also argues that dividends have an important equity market signalling function. It suggests that in the context of the last 100 years, the current level of dividend yields over cash indicate equities are undervalued. Such valuation signals in the past have resulted in equities outperforming cash by typically five to ten per cent a year in the UK and US, and up to 25 per cent in France, over a number of years.

More recently in the UK after similar dividend signals in 1973-74 and 2003 equities outperformed cash by 20 per cent per year over two years.

Richard Batty, global investment strategist at Standard Life Investments, says: ‘After examining future dividend prices and severely stress-testing the dividend outlook, we think future dividends are priced too cheaply. We believe buying dividends as an asset class offers a ten to 12 per cent per annum return in the medium term, suitable for example to include in an absolute return portfolio. At a market level, the equity signalling function of dividends also suggest that UK and US equity markets are cheap. This supports the heavy positions in UK and US equities in our House View portfolio.’

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