As I wrote earlier this week, I’m worried that financial markets are a bubble of everything. Indeed, in 35 years of investing, I’ve rarely been so anxious about asset valuations. The last two occasions I felt this fearful were in 2000 (before the dotcom crash) and 2007 (heading into the global financial crisis of 2007/09). For me, this bubble blown of excessive prices includes US stocks, government and corporate bonds globally, UK and US housing, cryptocurrencies, etc. But there’s one group of assets that I still regard as cheap: the 101 stocks (one is dual-listed) that make up the FTSE 100 index.
Of course, as I get older (I’m 53, Gen X and proud!), my family stands to lose a lot more from market meltdowns. Hence, I’ve tried to become a hyper-rational investor, particularly over the past decade. My core goal is to buy stocks and shares when prices are reasonable and only sell them when they become over-inflated. As ex-GMO fund manager Jeremy Grantham warned last November, “The one reality you can never change is that a higher-priced asset will always produce a lower return than a lower-priced asset.” And, within this financial bubble — in my view, the largest in modern history — my favourite low-priced asset is FTSE 100 shares. Here are three reasons why I’ll keep buying cheap UK shares over other securities.
1. The FTSE 100 is well below its record high
Hardly a day goes by nowadays without the US S&P 500 index breaking records. Currently, its all-time intra-day high stands at 4,545.85 points — reached just yesterday afternoon, as it happens. On ‘Meltdown Monday’ (23 March 2020), the index crashed to its 2020 intra-day low of 2,191.86 points. Hence, it’s soared by 107% — more than doubling — in under 18 months. This is the largest and fastest increase in global wealth anywhere, anytime. In contrast, the FTSE 100 hovers around 7,179.56 points as I write. That’s almost 725 points (9.2%) below its intra-day high of 7,903.50 hit on 22 May 2018. Thus, I see plenty of headroom for the Footsie to eclipse its former glories.
2. UK shares pay decent cash dividends
Right now, the S&P 500 offers a dividend yield of just 1.3% a year. Twelve months ago, this yield was 1.75%, but it has declined as US stock prices soared. Then again, US corporations tend to pay miserly dividends, preferring instead to reinvest earnings into future growth or stock buybacks. This may partly explain why US stocks are so highly rated on the global stage. On the other hand, the FTSE 100 offers a forecast dividend yield of 3.8% a year for 2021. For me, dividends are the closest thing to free cash I’ve ever banked. I reinvest my dividends into new shares at present, but I will spend them when I retire. Just like John D Rockefeller, I love my dividends.
3. The Footsie is cheaper than the S&P 500
Of course, I could be utterly wrong about the relative merits of US stocks versus cheap UK shares. Indeed, the former have thrashed the latter over almost every timescale. That said, the S&P 500 currently trades on a forecast price-to-earnings ratio of 22.3 and an earnings yield of 4.5%. For the unloved and overlooked FTSE 100, these figures are 14.9 and 6.7%. This shows that the Footsie is considerably cheaper than the main US market index. Therefore, all else being equal, I will buy the cheaper asset for higher hoped-for returns. And only time will tell if I am right…