The Case for Low Volatility and High Dividend Equities in International Markets

There are reasons to be cautious in many markets, but low volatility and high/sustainable dividend stocks can help mitigate risk while providing income and equity exposure. The Franklin Templeton Investment Solutions Team weighs in.

We recently wrote about potential opportunities to be found in US small-cap and emerging market stocks. These areas of the market have historically been more volatile than developed market mid- and large-cap stocks,1 but we find them compelling at this time.

As a rule, we have always been selective in our risk budgeting; this is perhaps even more important when the macro environment is as uncertain as it is today. At the asset allocation level, we still prefer a defensive posture. And with a less-sanguine view on international developed markets in general, it may make sense to favor defensive equities, which could also help neutralize risk from other portfolio selections. There are certain factors we prefer to help buttress relative performance should things turn south or even trudge sideways. These include the low volatility and high, sustainable dividend factors. Further, hedging foreign currencies against the US dollar can help improve returns when the dollar appreciates (relative to those foreign currencies).

A challenging macro environment

From a macro standpoint, there are reasons to be cautious throughout international markets. Uncertainty abounds when trying to forecast central bank policymaking.

For instance, determined to cool inflation (which has been sticky in services), the European Central Bank raised interest rates in September, despite a dismal growth outlook. The eurozone manufacturing Purchasing Managers’ Index (PMI) level is very low compared to the world’s (43.5 vs. 49.1).2

The story is a bit different in Japan, as the Bank of Japan has expressed conviction that inflation is transitory and has so far avoided raising rates. But with inflation high and stickier than anticipated, it may have to tighten over the coming quarters. This is unfortunate timing, as Japan’s manufacturing PMI is at a seven-month low and currently in the contractionary territory (48.5).3