Business

Value in the market?

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THE frequent refrain at the moment is that “the market is so high” and many investors are nervous about committing more money. It's well-known that cash is a poor home for funds, as the interest rates on offer are well below the rate of inflation, meaning that essentially you are losing value over time.

Despite the FTSE 100 hovering just below its all-time high, if it is adjusted for inflation it is around 26 per cent lower than it was at the end of 1999, which is a sobering thought and it is also lower than it was in 2007 on this basis. Thus at first glance the FTSE 100 has suffered 18 years of real losses – hardly a recommendation for what is supposed to be one of the best long term investments.

However, there is one simple and vital element that is missing from looking at the FTSE 100 like this: dividends. Investment professionals have long advocated the merits of looking at total return (capital plus income) and when this is applied, the FTSE 100 is 34 per cent above its level in December 1999.

It is often not appreciated that most of the long term returns on the FTSE 100 come from dividends, not price movement. It is very difficult to always buy at the bottom and sell at the top of the range but even if you do get lucky, in the short term price changes can be the bulk of returns, but over the longer term dividends matter more.

This does not mean that investors should favour stocks that pay a high dividend (often there is a reason for this and dividends can be cut as well as increased), but it is a very significant factor when considering performance over the longer term, as is inflation. The most frequently used stock indices, such as the FTSE 100, do not take either factor into consideration and thus can be misleading.

Equity indices have been somewhat calm of late, with very little volatility, much to many market observers' surprise – volatility is usually associated with uncertainty and given the high level of political uncertainty we are facing, a more bumpy ride might have been expected.

This will probably not continue indefinitely: US bond yields are rising, with Fed rates increasing for the second time in two months in March and a further two rises this year have been flagged. The real question is whether earnings are able to keep up and here we enter the realms of greater uncertainty.

The US has seen favourable sentiment in terms of a positive impact from the election of Donald Trump, but there is a general view that US equity valuations are stretched based on underlying earnings, thus any disappointment will have a negative impact.

As the financial year draws to a close we are facing so many uncertainties, both in political terms across the spectrum and in economic terms. The next few months will be an interesting time for markets and investors and one which merits close scrutiny.

:: Cathy Dixon is a director at the Belfast office of Cunningham Coates Stockbrokers, a trading name of Smith & Williamson Investment Management (SWIM). This article does not constitute a recommendation to buy or sell investments and the value of any shares may fall as well as rise. Investments carry risk and investors may not receive back the amount invested. The views expressed are those of the author and not necessarily of SWIM.

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