The "tech wreck" might just be good news for UK plc, writes Ian Cowie.
Higher rates of inflation and interest are bad for assets that yield low or no income but could be good for shares that deliver decent dividend yields. Never mind technical talk about a rotation from growth to value, this fundamental change in the macro-economic environment could mean British shares offer bargain opportunities for investors who understand that the first step toward making a profit is often to buy low.
The explanation is simple enough. It was relatively painless to hold ‘jam tomorrow’ stocks - such as technology shares, that usually pay low or no dividends - when inflation and interest rates were at or near historic lows. Now that central banks including the United States Federal Reserve and the Bank of England are reporting higher inflation and signalling higher interest rates, rising numbers of investors may begin to value a bird in the hand - or dividend income today - rather than the promise of two in the bush or growth tomorrow.
This trend should be beneficial for British investment companies with a long track record of delivering tried-and-tested income, whatever the economic weather. For example, City of London (stock market ticker: CTY) has increased its dividends every year for 55 consecutive years.
That is a remarkable achievement for an investment company with just shy of £2 billion of assets and means long-term shareholders have received a ‘pay rise’ every year for more than half a century. CTY currently yields just over 4.7%, having increased its dividends by an annual average of 3.7% over the last five years. If that rate of increase is sustained - which is not guaranteed - then shareholders’ income would double in the next 20 years, or the length of time many people can expect to spend in retirement.
JP Morgan Claverhouse (JCH) is another investment company in the UK Equity Income sector with a long record of raising shareholders’ income; its dividends have gone up every year for 49 years. JCH has total assets of £547 million, currently yields just over 4% and has raised payouts by an annual average of 5.8% over the last five years.
Along with 15 other ‘dividend heroes’ - or investment companies that have increased dividends for two decades or more - both these investment companies have utilised this form of pooled fund’s unique ability to smooth out some of the shocks of the stock market by building up reserves in good years to sustain or increase dividends in bad years. That is a valuable feature for people - including me - who are preparing to fund retirement with investment income.
However, rising dividends tended to be undervalued during the ‘go-go’ years of growth at almost any price, when the technology giant Apple (AAPL) was briefly valued at $3 trillion (£2.21 trillion). That was almost as much as all the shares on the London Stock Exchange and exemplified an extreme overvaluation of American growth over British value.
Another fundamental way of attempting to assess whether assets are cheap or expensive is to express their price as a multiple of corporate earnings - the price/earnings ratio or P/E. This can be refined to reflect historic ratios in the cyclically-adjusted P/E or CAPE.
According to calculations by Schroder Investment Management, American shares were trading on an average CAPE of 38 and yielding 1.3% while Europe ex-UK had a typical CAPE of 24 and yielded 2.1% by the end of last year. By contrast, the UK market was trading on an average CAPE of 15 and yielding 3.6%.
Sad to say, British businesses were being valued on a par with those in emerging markets where the average CAPE was also 15 and the typical yield was 2.4%. But few things fade as fast as fashion and this is also true on the stock market where a trend is only a trend until it stops.
Last month saw many technology share prices fall sharply when Mr Market began to rediscover the value of dividend income. Over the past year, shares in the AIC UK Equity Income sector achieved an average total return of 18% while UK All Companies delivered a total return of 8%, according to Morningstar.
By contrast, the Global sector delivered an 8% loss, while Technology & Media fell 4%. The past is not necessarily a guide to the future and both UK sectors mentioned above have performed worse than the Global and Technology & Media sectors over the past three years.
To return to where we began, this means investors who believe the first step toward making a profit is often to buy low may still find medium to long-term bargain opportunities in British investment companies. After more than a decade of low inflation and interest rates, last month’s ‘tech-wreck’ may indicate valuations in that sector have passed their high water mark and the investment tide has turned.
