The FTSE 100 is having a tough time, and investors’ confidence in the government’s fiscal policy is still far from solid. Will UK shares head down on a fresh crash in October? I see reasons for optimism.
Dividends remain strong
If it looks like we’re heading for dividend cuts across the board, then I think investors could easily get cold feet. But so far, we’re not really seeing that happening.
A couple of top dividends have been cut back. Rio Tinto, for example, shaved its interim dividend. But that’s more of a reflection on worldwide demand for commodities than an indicator of UK stock market ills. And forecasts still put the yield at 10%.
We have long-term income stocks like National Grid on a predicted dividend yield of 5%. And bank and insurance yields still look good. While that continues, and average FTSE 100 yields remain above 4%, I’m still reasonably confident.
But what’s the outlook like for these dividends? I’m waiting for AJ Bells‘s third-quarter Dividend Dashboard to give me the latest roundup. I’m hoping we won’t see much degradation from the Q2 situation, which had total forecast FTSE 100 dividends coming close to 2018’s record of £85.2bn.
Valuations are low
While dividend yields look resilient, at least for now, the valuations of some top UK shares appear remarkably low.
Inflation has resulted in big interest rates rises, and that’s making mortgages more expensive. In turn, that’s led to a big fall in housebuilder share prices. Persimmon, for example, is on a forecast price-to-earnings (P/E) ratio of only 5.2 now. Taylor Wimpey has fallen to a P/E of 5.
Bank shares are on very low valuations too. We’re looking at a forecast P/E of 6.1 for Lloyds Banking Group. And Barclays is down to 5.5.
Those are the kind of valuations I’d expect to see if a plague of super-Covid started killing everyone, just as we were in the middle of World War III and the Sun was about to explode.
And it brings me to my third reason.
Maximum pessimism
Sir John Templeton, one of the most successful investors ever, once said: “The time of maximum pessimism is the best time to buy“.
That’s a time when everyone fears the worst, when investors are shunning shares and rushing to buy gold. When we face a bleak economic outlook, and a cold winter struggling to pay our energy bills.
What usually happens is that investors overreact. Just as share prices get pumped up too far when optimism is at its peak, so they also fall too far when we’re all gloomy. It’s all about how much bad news we expect, and how much share prices fall to compensate.
Right now, I think all of our dire outlook is already built into low UK share prices, and then some. Even after the turmoil of the past week, the FTSE 100 has already recovered above 7,000 points.
To me, that seems like resilience, and I think it suggests investors see shares as too cheap to allow them to get much cheaper. I was going to finish by asking how things could possibly get any worse. But no, I won’t risk that.