UK p/e ratios favour gilts and equities

Chris Iggo, senior strategist, UK, observed the p/e ratio of the UK market excluding resources had dipped even further below 10 times earnings than during the slowdown of 1990-92.

He pointed out after the 1970s the UK equity market has enjoyed compound annual returns of 14 per cent or more whenever the p/e ratio has slipped below 10.

Single-digit p/e ratios also indicated real compound annual returns from gilts of more than 5 per cent over the same period, according to the strategist.

From a value perspective, however, Mr Iggo said equities looked more attractive than straightforward gilts. To counteract the effects of inflation, he recommended a portfolio of high-quality equities and inflation-linked debt.

Andrew Merricks, head of investments at Hove-based IFA Skerritt Consultants, said inflation should be a concern for the next two to three years, so index-linked gilts looked attractive. But beyond that he said beyond that the power of inflation was up for debate.

He said: "If inflation is still going to be a problem in a few years' time, you're asking wheat, corn and oil to double again in the next 12 months, and I don't think that's going to happen. If house prices are going down, that won't be inflationary either."

Mr Merricks also expressed concerns at the ability of equity income streams to keep pace with inflation. "I can't see them increasing the dividend against a background of lessening profits."