September’s market rally - as well as company results and GDP figures - suggests the British economy has strengthened and the media’s “recession obsession” masks an optimistic story.
Despite September’s stockmarket surge, equities look modestly-priced relative to other asset classes. This is the case whether it is at the aggregate level, with stockmarkets yielding more than government bonds and offering better value than corporate bonds and residential property, or at the individual company level, where hundreds of stocks are valued on single digit earnings multiples, with dividend yields of over 5%, free cash flow yields of over 10%, and frequently ungeared balance sheets. Yet most investors remain uninterested, as shown by the low equity allocations of many pension funds.
While it is hard to identify who the new buyers of equities will be, as actuaries and slaves to liability matching encourage further purchases of bonds at sub-3% yields, it is possible that it will be companies themselves. If Microsoft can issue bonds with a coupon of less than 1%, share buy-backs look rather attractive.
An era of buy-backs and stronger merger and acquisition activity therefore looks increasingly likely, particularly as evidence grows of economic recovery. And given the prejudice against the British economy and market, it is no surprise that there are more and more opportunities in domestically-orientated stocks, in areas such as retail, leisure and construction. After all, UK PLC seems in pretty rude health. But then good news often gets left on the cutting room floor.