Bill Jamieson: Your dough can rise while the UK stock market holds its nerve

Published on Friday 26 November 2010 21:16

Why has the stock market not plunged in panic and blind despair? Heaven knows the implications for Europe's banks, governments and taxpayers are scary enough. And stock markets may yet plunge if the debt contagion is not stopped soon and other countries in the euro periphery are sucked in.

But amid prospects of bank bondholder write-downs and even an ultimate break-up of the eurozone, the UK stock market has broadly held its nerve, slipping just 1.1 per cent last week. It is still showing a gain of 9 per cent on its level 12 months ago. Why have shares been so reluctant to do what conventional wisdom expects?

That the market rarely does what conventional wisdom expects is the main reason why the purveyors of conventional wisdom are still toiling at their desks this morning and why so few are stretched out on Seven Mile Beach, Grand Cayman. But the equity market's evident resilience may be due to something more than perversity.

One reason is obvious: Government bond markets do not now have the same sure-fire appeal that they have held for the past two years. By October, yields had been driven down to ultra-low levels, offering a return that would not protect investors from current levels of inflation. Investors are now casting round for an asset alternative that does not look so vulnerable and which offers a better prospect of inflation beating returns.

Look no further than blue-chip shares. Amid the raging storm in eurozone sovereign debt markets, many companies have not only been turning in better-than-expected results, but they have also been able to replenish their balance sheets. There may be a business investment problem as confidence is currently so fragile, but there is not a corporate liquidity problem - companies are cash rich. And those better-than-forecast earnings have enabled companies to maintain, if not improve, their dividend pay-outs to shareholders.

Dividend income is the principal component of long-term total returns. A portfolio of equities where dividends are re-invested soon starts to rise above those dependent only on capital growth. And even in conditions such as those prevailing over the past year, with government spending retrenchment and real worries over prospects for economic recovery, a portfolio of blue chip shares with a higher than average dividend has not done at all badly.

Take, for example, those generalist investment trusts - my collective investment vehicle of choice for transparency, low management fees, ease of dealing - and performance. Out of 25 investment trusts focused on "UK growth and income", no fewer than 14 are yielding more than 4 per cent. And within that 14, all but one have risen by more than 10 per cent over the past 12 months, and eight by more than 20 per cent.Over the same period, in the increasingly popular "global growth and income" focus, all but one of the eight investment trusts in this space have gained 10 per cent or more, while four have risen by more than 25 per cent. Top performers here are Baillie Gifford-managed Scottish American Investment Trust (up 39 per cent over the past 12 months and still yielding 4 per cent); Edinburgh-based Julie Dent's British Assets Trust (up 31.7 per cent and yielding 4.6 per cent) and Aberdeen Asset Management's Murray International Trust (up 26 per cent, yielding 3.23 per cent).

You don't have to move out of Scotland to get a range of easily accessible collective investments for the discerning retail investor, or some of the best returns available in global markets.

There is a third reason for sticking with blue-chips in the period ahead, in that they stand to benefit from the turmoil in this sense: it further embeds low official interest rates for the forseeable future, and government focus on policies to secure recovery.

There is of course the inflation risk. But equities tend to benefit in the early stages of an inflation rise - and this I do expect next year.

Finally there is the improving prospect for growth. US data last week, overlooked in the euro imbroglio, pointed to a pick-up in employment and in consumer confidence. By the end of next year an international economic recovery should be in view if not firmly established. This is not yet built into equity valuations.

On the reckoning of analyst Darren Winder at Oriel Securities, the UK market currently is on a price earnings ratio of just ten with a prospective yield of 3.5 per cent.

These are turbulent times and all this, as I say, does not preclude a sharp sell-off if the euro turmoil worsens. But any such fall would be more of a reason for opportunistic buying than selling everything and fleeing to the hills with a bag of wheat futures and a primus stove.