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Home > Investments > UK

By Chris Murphy | Published Aug 21, 2012

Don’t let the doom-mongers twist market reality

Hosting the Olympics has taken years of meticulous planning and massive investment.

Yet as the great event approached, doom-mongers went into overdrive, speculating the transport system would collapse and the games would, in one way or another, be a disaster. Fortunately, the opening ceremony was a triumph, the transport system has held up well and UK made third in the medals table.

What lessons can be drawn? One is that if there were a gold medal for running itself down the UK would win. Another is that once the moaning gets under way, reality gets overlooked. A similar phenomenon has been in evidence in relation to the UK stockmarket.

For some time, commentators have been predicting the UK stockmarket would collapse as nervous investors, fed up with the lack of a resolution to the eurozone crisis and fearful about what is in store for the global economy, headed for the exit. And yet, in spite of these predictions, the UK stockmarket has just hit a three-month high.

Two things have brightened the market’s mood. First, European Central Bank president Mario Draghi’s insistence that the bank would do “whatever it takes” to preserve the euro bolstered confidence. Second, a stronger-than-expected US labour market report, showing a net 163,000 jobs were created in July, helped reassure investors that the world’s largest economy is unlikely to slip back into recession.

The recovery in the UK stockmarket has occurred in spite of mixed news on the domestic economy. While the annual inflation rate dropped to 2.4 per cent in June, economic output plunged 0.7 per cent in the second quarter. These lacklustre releases have triggered speculation that further monetary easing – either in the form of further quantitative easing or an interest rate cut – may be in the pipeline.

Although such measures would be unlikely to boost economic growth materially, the threat of them being implemented should help keep gilt yields low and move expectations of the timing of an eventual interest rate rise even further into the future. This suggests more pain for savers.

Currently, 10-year gilts yield 1.5 per cent, well below inflation, and returns on cash are nugatory. The FTSE All Share index, by contrast, yields 3.9 per cent. Although it may take a while for the UK stockmarket to rise materially from current levels, equity investors are getting paid handsomely to wait.

Spotting gold medal-winning stocks ,however, is not easy. Holdings in higher-yielding utility and telecoms companies often form the backbone of dividend-seeking equity portfolios.

However, these sectors have outperformed dramatically in recent months as investors sought out safe havens. As a result, valuations relative to other sectors in some cases look excessive, particularly if you believe the eurozone won’t fall apart.

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