Those seeking to live off their income are susceptible to a couple of siren calls at the moment.
Siren one
British stocks in particular sound attractive. Nearly one in four FTSE 100 companies is currently yielding 6 per cent or more.
On average, the UK market is yielding around 4.7 per cent. It has not been higher since the financial crisis.
By comparison, the S&P 500 in the US is yielding around 1.86 per cent.
British shares are unloved. According to a Bank of America Merrill Lynch survey of global fund managers, allocations to UK equities are at a 20-year low.
They are trading at a double-digit discount to global shares, so valuations, relatively speaking, are appealing (only Japan offers better value on a price to earnings basis).
Investment lore and common sense say buy low, sell high.
Is this not a buying opportunity? Hear that siren call.
Siren two
Even within the UK market there is a wide dispersion of discounts, with the cheapest on around 8x earnings, and the most expensive nearer twice that.
Surely this means there are bargains aplenty in a market that already presents a bargain?
The risks
Stop right now and cover your ears. Odysseus had his sailors stuff their ears with beeswax and himself tied to the mast so they would not be tempted by their sirens, but that is a little extreme.
When yields are high, there is invariably a reason.
Brexit uncertainty is a major factor in the current attractive yields being offered by UK companies. Companies here are holding off from investment until there is greater clarity about Britain’s relationship with its biggest trading partner, the European Union.
They are redistributing more of their profits to shareholders. That may feel good now, but lack of investment in R&D and productivity enhancement stores up problems for later.
Although prices may look relatively cheap, a relative bargain is not necessarily a bargain.
In reality, UK markets are trading close to historic averages.
Yes, there are quite a few cheap stocks, but the highest-yielding tend to be the ones most at risk. These companies reward investors to attract them, but they can reach a point where that is no longer possible.
When this happens the share price can take a tumble.
In May, Vodafone slashed its dividend by 40 per cent, ending a two-decade run of rising dividends. Its share price fell 12 per cent from the beginning of the month and 37 per cent year on year.
The performance of bonds has encouraged investors to shift to what are known as “bond proxies” – dependable equities with a track record of producing solid yields.
We worry that many of these shares have become overvalued, making them vulnerable to a sharper fall in any market correction too.
