Bill Jamieson: Euro crisis makes ‘dull’ stocks look attractive

Remote it certainly looks as we enter yet another week with our fingernails stretched on the eurozone window ledge. For most of the past year, markets have see-sawed dramatically with every twist and turn in the sovereign debt crisis.

This unnerving volatility, which at times has seen swings of 3 per cent and more in share values in a day, have shredded investor nerves and reduced time horizons to the briefest periods – with Wednesday being the current definition of “long term”.

In the process, investors, scrambling to protect their savings against an inflation rate of 5.2 per cent, have been driven into apparently “safe” government bonds. The yields on these bonds are derisory; the pay-back on UK government ten-year bonds is currently 2.53 per cent – before tax – while investors have been scared off the bucking bronco of the stock market.

The result is that the yield on the FTSE all-share index stands at 3.45 per cent and many FTSE 100 giants are offering a dividend yield substantially higher: Vodafone on a 6 per cent yield; Sainsbury on 5.7 per cent; Astra Zeneca on 5.5 per cent; and Standard Life on 6.8 per cent.

By any standards, this is an astonishing – and unsustainable – valuation anomaly. Blue-chip equities with strong balance sheets and reasonable earnings prospects are standing on yields that are more than double that on ten-year bonds. Financial advisers, scared to recommend clients anything other than the seemingly safest, “risk off” investments, steer portfolios into government bonds oblivious to a yield that is less than half the rate of inflation and the growing vulnerability of bonds to a reappraisal as the bond bubble keeps getting bigger.

Fortunately, it is the fitful recognition of this anomaly among the daily eurozone debt scares – the relative cheapness of defensive, income-generating blue-chip equities – that explains why the FTSE 100 has not gone down in a straight line to 4,000 and even lower in the face of all the worrying news hurled at it.

On Friday, ahead of the latest do-or-die, make-or-break, all-or nothing euro summit, the FTSE 100 closed at 5,488.65, more than 540 points above its autumn low and its highest closing level since early August,

“A triumph of forlorn hope over real experience”, I hear you mutter. Certainly there has been no lack of reasons to force share prices lower: a clear slowdown in western economic growth; America’s loss of its triple-A rating; an appalling sovereign debt crisis in the eurozone; a slowdown in China; continuing evidence of regulatory failure of investment banks, such as UBS; the rescue of Belgian bank Dexia; and a glaring failure of the eurozone’s political class to recognise either the scale of the sovereign debt problem they created or to agree timely action to deal with it. This is not, as those financial centre protesters have it, a “crisis of capitalism” as much as it is of a reality-denying political culture – here, in America and particularly in the eurozone.

I am grateful to Jim Wood-Smith, head of research at brokers Williams de Broe, for a perspicacious presentation to clients in Edinburgh earlier this month for some timely observations to which all investors should take heed.

The first was his checklist of what has not happened, including – as many have feared – runaway inflation, a Chinese hard landing, a collapse in corporate profits and a military coup in Greece, though whether this is a market plus or minus is debateable.

Markets have also tended to underplay better-than-feared data from the US, China’s soft landing, the near-term outlook for inflation, low interest rates for as far ahead as we can see – and relative valuations that are, in his word, “crackers”.

Second was an eyebrow-raising chart showing us how a dull-as-ditchwater stock such as Unilever – which business journalists rarely appraise as an investment – has dramatically outperformed the FTSE 100 index since the market peaked in 1999.

His key message, forcefully stated in the firm’s latest weekly digest, is that, if gilt yields are unlikely to rise much over the coming decade, “then the investment industry is bang on in its current insistence that equity dividend income has never been more important. We think that we are in for an extended period when supposedly safe assets yield less than allegedly risky ones, despite healthy dividend growth.”

The broad message to investors is that volatility presents opportunities as well as threats and that those blue-chip dividend yielders are not to be overlooked, however cloudy and impenetrable the present news flow and the difficulty of seeing through this fog to a five- to seven-year perspective.

And the secret of investment happiness? The re-investment of dividend income. There may be faster ways to secure gains when times are good, but these are not good times.

And the Greek debt crisis will persist and worsen long after Wednesday. Equity dividend income and its re-investment are for this moment, and I would say for most periods, the first choice game in town.