The Market Signal That Keeps Flashing ‘Buy’

The market’s dividend yield approaches 5% and shares look very cheap.

Amid all the bail-outs, bankruptcies, meltdowns and mayhem, there’s one market signal that keeps flashing ‘buy’.

During the last few months, the dividend yield on the FTSE 100 and All Share indices have reached almost 5%. That’s the highest income since the early Nineties and it now exceeds the yield on offer from 10-year gilts (government bonds).

(Source: Daily Telegraph 4^th February 2009)

The last time shares in general yielded more than gilts occurred right at the bottom of the 2000-03 dotcom crash.

Had you bought the All-Share back then, you’d have more than doubled your money four years later. Beyond that single day during March 2003, I think you have to go back at least forty years to find the last time the market’s dividend yield topped the income from gilts.

So why does this so-called ‘reverse yield gap’ signal a market ‘buy’. It effectively means investors have become so depressed with their shares that they think aggregate company payouts will shrink over the long run. That belief, however, defies decades of market history. During the last fifty years for example, dividend payments from London shares have grown a collective 30 times according to the Barclays Equity-Gilt study.

Certainly there is going to be some short-term dividend pain. Banks for instance have very uncertain payouts at present. The sector represents 15% of the All-Share index and yields 8%. If aggregate bank payouts halve in value, the market’s yield could fall to 4.3%. If bank dividends disappear completely, the market’s yield could fall to 3.7%.

The other worry is that gilts could be the wrong ’safe haven’ comparison.

So what now? The headlines are grim, share prices keep falling and there are plenty of reasons not to buy. But that was the case during March 2003, on Black Monday in 1987 and when the Seventies bear market bottomed during early 1975. All were extremely anxious times, but all proved to be first-class buying opportunities for patient investors. For now at least, there’s a market signal that keeps flashing ‘buy’ and

I for one am still backing the index.  

Peter Waller - Investment Director