They argue that the downside risk is limited in that we are in a low inflation and deflationary environment already. They argue that a mere sniff of inflation may be enough to get investors thinking differently.
If we look at the UK market in more detail, this can give us an excellent view of the larger equity picture, particularly within developed markets. For instance, we have an emergency interest rate environment, an investor demand for yield, politically influenced markets and a weak currency. These are all dictating the fortunes for different parts of the UK stock market.
It seems hard to believe that since the UK’s momentous decision to leave the European Union this summer that UK stock markets would push near to record highs only months ago. While this rally provided some relief given the immediate concerns after the referendum, the outlook for the UK economy remains unclear. Only time will tell what Brexit actually looks like.
Since the Brexit vote, UK large cap global businesses have been the big winners. Many benefit from sterling’s weakness because these companies generate overseas earnings in US dollars. Additionally, the Bank of England’s recent interest rate cut and gilt purchase programme squeezed deposit rates and bond yields further. This has increased demand for dividend-paying blue chip companies, for which the UK market is traditionally known.
However, when seeking dividends, what route might investors go down? At present, there are lots of FTSE 100 stocks paying attractive dividends, but dividend cover remains a problem. With many large caps facing issues, such as increasing pension deficits and historically low commodity prices, dividend cover is likely to remain problem in the foreseeable future.
For example, income stalwarts, such as BP and Shell, continue to pay attractive dividends of more than 5 per cent, although dividend coverage is low and the ability to keep paying a dividend in the future with oil prices at suppressed levels is in doubt.
By contrast, consider Unilever, which is trading on a price-to-earnings ratio of just under 20x and offering a yield of little more than 3 per cent. Quality focused investors would argue this remains an attractive long-term investment given where interest rates and government bonds yields are at the moment.
The comparison is stark with a company such as Royal Dutch Shell, which is trading on 8.5x and is offering a yield of just under 6 per cent.
However, the market landscape could be shifting. As we have witnessed across global markets, not just the UK, value is showing the first signs of outperformance. The anticipation of some inflation (albeit small) is being priced in by markets. This is good news for the cheaper, cyclical areas of the market. Time will tell if it is a new era or one of the number of false dawns seen over recent years.
