Markets looking for a post-brexit bounce

Brexit chaos, mayhem in parliament and yet more cliff-edge votes to come: yet the pound rose last week and the FTSE 100 gained 123 points to 7,228.28. This extends its rise since the start of the most turbulent three months in UK politics for decades to almost 10 per cent.

What’s going on?

Either the markets have switched off the news or they may have their eyes on a post-brexit bounce. Seldom has the stock market presented such a disconnect in the face of widespread fears of acute political turbulence ahead – a general election, a second referendum vote, an Eu-mandated delay of a year or more (take your pick).

Two factors help explain why markets seem so sanguine. One is the Spring Statement presentation last week and those OBR forecasts that the UK economy will not only escape recession but enjoy a modest upturn in growth. This, coupled with continuing improvements in the public finances, suggests that the UK may be better positioned than forecasters had previously allowed for.

The second is that, for all the recent upturn in the equity market, the UK could well be poised for an upturn once the immediate Brexit drama has been overcome. Some semblance of relative calm should follow in time as businesses large and small scramble for stability.

And the UK stock market, shunned for the past three years by domestic and overseas investors alike, is looking oversold. Today the FTSE 100 yields more than four per cent and is pricing in dividend cuts two-thirds deeper than those seen in the financial crisis. All told, some $40 billion has been pulled out of the UK market since the Brexit vote.

According to Sue Noffke, manager of the Schroder Income Growth trust, the UK is on a 30 per cent valuation discount globally – a 30-year low. “We are lower than in the midst of the global financial crisis, we are lower than in the tech boom and bust – you have to go back to the early 1990s recession, which was bloody, but we did recover from that.”

Noffke has looked at what it would take for the FTSE dividend yield to return to its 30-year average of 3.5 per cent – which, she pointed out, would still be an attractive figure relative to inflation. Taking the UK equity dividend yield of 4.8 per cent at the start of the year, “it would take either a cut of 25 per cent of dividend income to get you back to the 30-year average of 3.5 per cent, or a rise in the UK equity market of over 35 per cent. It may be a combination of the two.

“Just to put it in perspective, the cuts that we saw in dividend income for UK equities in the financial crisis were a cumulative 15 per cent. And so we are discounting a situation much worse than that.”

In this context it was heartening to read last week that there are 20 “dividend hero” investment trusts which have raised their dividends for 20 years or more, and four have increased their dividends for more than 50 years in a row.

City of London, Bankers and Alliance lead the way, having increased their dividends for 52 consecutive years. Following closely behind is Caledonia, which has raised dividends for 51 years in a row.

Now high dividend yields also carry a danger. In aggregate, they are a signal of risk – and the higher the perception of risk, the greater the compensation investors require.

Individual stocks with a high yield can also prove a trap. As Investors Chronicle economist Chris Dillow points out, in 2007-08, housebuilders and mortgage lenders such as Northern Rock and Bradford & Bingley were on great yields. But they subsequently collapsed, with investors in some cases being wiped out completely.

A wide range of factors needs to be assessed. These typically include interest rates, inflation, monetary policy, global trade pointers such as the Baltic Dry Index and the likelihood of cyclical recession.

Dillow’s assessment is that such factors point to value stocks doing well over the next 12 months. “The economic dam- age of Brexit might by now be fully priced in, unless we get a messy No-deal exit. Low interest rates, shipping costs and oil prices are also helpful.”

But this does not protect us from companyspecific dividend shocks (such as the M&S dividend cut), adverse investor sentiment (which has hit tobacco giant BAT) and changes in political risk – the impact a Labour election victory would have on utilities through tighter regulation or outright nationalisation.