There are plenty of reasons for investors to be fearful about buying cheap UK shares just now. After all, the outlook for the global economy remains very uncertain. And the domestic economy could face a particularly challenging period due to Brexit.
However, low valuations in many sectors mean this could be the right time to buy a diverse portfolio of shares. Such a portfolio could outperform other popular assets, such as cash and bonds, and generate impressive long-term returns.
UK shares really are cheap!
It’s been a volatile year for world stock markets. We had the spring crash, followed by a fairly rapid rebound. However, the UK recovery has been feeble compared with other major stock markets.
The FTSE All-Share index is currently 21% below its level at the start of the year. Over in the US, the S&P 500 is up 9% and the Nasdaq 33%. Japan’s Nikkei index and China’s Shanghai index are also both in positive territory — up 3% and 9% respectively. And while the eurozone is negative, it’s nevertheless outperformed the UK by a wide margin. The Euro Stoxx 50 is down 14%.
According to the Financial Times, “UK shares are at their lowest valuation relative to the MSCI World Average since the early 1970s, as measured by a combination of price/earnings, price/dividend and price-to-book ratios.”
As the UK stock market is so cheap, buying a diverse range of FTSE shares today could lead to impressive returns in the long run.
Wide margins of safety
Some cheap UK shares are deservedly priced at low levels by the market. For example, some may be in such a precarious financial position there’s a very real danger they’ll go bust.
However, there are others with robust balance sheets, cash flows, and business strategies that could produce improving financial performances in the years ahead. They appear to be suffering from weak investor sentiment towards their industry and/or the UK stock market in general.
Their low valuations suggest investors have priced-in many of the risks facing the domestic and global economies. Therefore, they seem to offer wide margins of safety, and significant upside potential in the long run.
Cheap UK shares versus cash and bonds
Another reason I’d buy cheap UK shares is a lack of value in other liquid mainstream assets like cash and bonds. In March, the Bank of England slashed the base rate to a record low 0.1%.
Low interest rates mean cash and bonds are unlikely to deliver positive real returns after inflation. Furthermore, interest rates look set to remain low for the foreseeable future. As such, the outlook for these assets is poor in the medium term, and possibly beyond.
By contrast, many cheap UK shares not only have the potential to produce impressive long-term capital growth, but also inflation-beating annual dividends. Therefore, now could be the right time to buy a diverse range of such shares, and hold them for the long run.