One thing that has plagued investors throughout history is FUD: fear, uncertainty and doubt. When beset by FUD, I try to behave rationally, taking a long-term view in scary situations. For example, after the Brexit vote of June 2016, my wife and I agreed that the UK faced many years of political and economic uncertainty. Therefore, we immediately and massively reduced our exposure to UK shares, reinvesting this capital into global and US-focused index funds. Over the next three years, this proved very profitable, as the FTSE 100 hugely underperformed other major stock markets.
America the beautiful
However, with US stocks soaring and other financial assets looking fully priced, FUD returned. In 2019, we de-risked our wealth, moving half (50%) of our capital into the safety of cash. Our goal was to buy equities when prices became more attractive. When Covid-19 collapsed markets in March 2020, we acted decisively. By early April, all of our available capital was again invested in global stocks. Our absolute gain since this market meltdown has been the largest in over 30 years. Now, after years of depressed returns, we believe that UK shares look set to shine.
Since mid-2016, our family portfolio has been heavily weighted towards the US, with modest exposure to Britain. Over the past five years, the S&P 500 has doubled, excluding dividends. Over the same half-decade, the FTSE 100 has gained just 11%. Thus, moving our exposure from UK to US after the Brexit vote delivered outstanding returns. Then again, given the extreme price differential between frothy US stocks and cheap UK shares, I feel this will change.
US stocks look frothy
Looking at the performance of US stocks in 2020 — a pandemic year — I’m stunned. The S&P 500 gained almost a sixth (16.3%) and the tech-heavy NASDAQ Composite index soared by three-sevenths, leaping 43.2%. To me, this smacks of excessive exuberance. Would these indices have climbed so high in a normal year of modest economic growth, absent Covid-19? I cannot find any fundamental justification for these market moves (other than ongoing ultra-low interest rates and huge global liquidity). Today, the S&P 500 trades on a trailing price-to-earnings ratio above 40, an earnings yield below 2.5%, and a dividend yield of 1.6%. Even with earnings recovering strongly in 2021, this is too pricey for me. Today, I prefer less frothy UK shares.
UK shares seem cheap
While US stocks soared in 2020, cheap UK shares missed the party. In 2020, the Footsie dived by a seventh (14.3%), dropping almost 1,100 points to close at 6,460. Yet I think the worst could be over for UK equities. With vaccinations being rolled out, Covid-19 should be under control in the second half of 2021. Likewise, with a last-minute Brexit deal agreed, the no-deal worst-case scenario has been averted.
For me, 2021 will be about finding, buying and holding cheap UK shares for their long-term returns. My aim is to buy quality businesses with solid balance sheets, strong earnings and, ideally, market leadership. What’s more, as a value investor, I’m digging in the FTSE 100’s bargain bin for lowly rated shares with high earnings yields and juicy dividends. With top dividends ranging from 5% to double-digit percentages, the Footsie has a lot to offer income-seekers and bargain-hunters today. That’s why the FTSE 100 is my #1 index pick for 2021!