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Claverhouse: UK shares at their ‘cheapest’ since WW1

Claverhouse: UK shares at their ‘cheapest’ since WW1

(Update) UK shares are trading at their cheapest valuation since the First World War when compared to government bonds and with the risk of a no-deal Brexit receding now is the time to buy, according to managers of JPMorgan Claverhouse (JCH).

William Meadon, lead manager of the £400 million UK equity income investment trust, said the current yield gap of around 3% – or 300 basis points – between 10-year gilts and the FTSE All-Share index was the widest since the Second World War and had not been greater than this since the 1914-18 ‘Great War’.

As yields – the percentage of income generated by an asset – move in the opposite direction of their price, the current 4.3% yield on the All-Share reflects the 10% fall in the index in the last quarter of 2018.

Although yields on benchmark 10-year gilts have risen a long way off their post-Brexit vote lows of 0.5% in 2016, at 1.2% they are well below the 4-5% levels they hit before the 2008 financial crisis.

And though it was undeniable that gilt prices had been pumped to historically expensive levels by the extraordinary 'quantitative easing' policies of the Bank of England after the credit crunch, Meadon said the comparison was still valid. UK shares were cheap.

‘This is the only time that equities have been cheaper relative to gilts since the First World War. Are things really as bad as they were back then?’ asked Meadon (pictured).

No-deal retreat

On a 12-month forecast, the All Share’s yield rises to 5.2%, making the UK the third highest yielding stock market in the world after Australia on 5.3% and Russia on 6.9%.

With prime minister Theresa May today offering MPs a chance to vote against a no-deal Brexit this month and with Jeremy Corbyn’s Labour party moving towards a second referendum, Meadon said it was unlikely that investors’ worst fears over Brexit would be realised.

‘It looks as if a no-deal Brexit is becoming less and less likely yet there is a lot of bad news priced into the UK stock market,’ said Meadon.

The pound surged 0.7% to $1.3182 against the dollar today, close to its end of January peak and up from $1.2607 at the start of the year. Meadon said sterling’s rally was a ‘barometer’ of where the big money was going and a sign that some of the negativity around the UK was being displaced.

While the spike in the pound pushed the All-Share seven points lower to 3,932 today, it has rallied 7% so far this year.

Meadon and co-manager Callum Abbott have ridden the rebound by restoring gearing – or the level of borrowing investment trusts can use to boost their firepower – to 7%, buying a variety of overseas-earning blue chip stocks in the FTSE 100.

Investing in the FTSE is not the same as investing in the UK, said Meadon: just 28% of revenues received by UK-listed companies was generated in the domestic market with 23% from emerging markets, 22% from North America and 14% from Europe. 

Leaning into the wind

Outside battered high street retailers, Meadon said UK companies were generally reporting good results. The outlook for dividends was good from a range of sectors, including banks, oil majors, miners and builders.

However, index-heavyweight Vodafone (VOD) looked likely to cut its payout given concerns about its balance sheet had seen its shares fall a third in the past year with the stock offering an unsustainable 9.5% dividend yield. 'It is really bombed out,' said Meadon, who holds 1% less than the 4% index-weighting believing it could benefit if European rules on telecom takeovers are relaxed.  

The tobacco sector was another exception to positive dividend prospects. The US regulatory threat to menthol cigarettes had savaged the shares in British American Tobacco (BATS) and Imperial Brands (IMD) but with dividend yields of around 7.5%, Meadon and Abbot had started to look at them again. 'They're almost pricing in a dividend cut at that level,' he cautioned. 

Meadon said stock market investing always involved confronting uncertainty. But he suggested investors made money ‘by leaning into the wind’ rather than waiting for the weather to clear.

The managers highlighted sports leisure-wear retailer JD Sports (JD) in which 1.3% of Claverhouse is invested; premium tonics maker Fevertree (FEVR) which accounts for 1%; and housebuilder Barratt Developments (BDEV), where 1.4% is allocated; as examples of companies achieving growth either at home or abroad despite the Brexit uncertainty.

Meadon also had statistics to convince investors to stay fully invested once they had taken the marekt plunge. Investors who had kept their money in the All-Share index through thick and thin this century would have made an average annual return of 5.1%, he said.

By contrast, pulling out of the market and missing just 10 of the best stock market days (eight of which occurred in the dark days of 2008-09) reduced that average gain to just 1.7%. Meanwhile investors who had missed the 50 best days had suffered a 5.1% average annual loss since 1999.

‘That’s the really dangerous consequence of trying to time the market,’ Meadon observed.

Dividend champion

Meadon took charge of Claverhouse in March 2012 with Abbot joining him last year. Under his management, the portfolio has become more focused, with 60-80 UK stocks compared the previous 120. Its ranking in the Association of Investment Companies (AIC) UK Equity Income sector has improved with a five-year total shareholder return of 38.2% placing it third out of 22 trusts.

The company pays quarterly dividends and yields 3.8%. While that is just below the 4% sector average, payouts are growing faster with 6.6% annual growth over five years compared to a sector average of 4.1%, according to AIC data.

The 56-year-old trust has a long history of growing payouts having notched up 46 years of consecutive annual dividend rises. Its ability to maintain this record is strong with revenue reserves equal to 1.1 years of dividends, the biggest in its peer group.

But unlike the UK stock market, Claverhouse shares are not cheap. Having traded as low as 13% below net asset value after the EU referendum, the trust has re-rated with its discount narrowing and, at the end of last year, moving to a small premium. At 708p the shares stand at a modest 1.7% over NAV compared to sector average discount of 3.7%. That's far from expensive though and reflects the improved performance. 



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