Autumn blues?

The FTSE 350 low-yield index is at an 18-year high relative to its high-yield counterpart in price terms

SINCE the beginning of September the market has turned downwards again and it is now almost at the same level it was in September 2017.

In contrast the S&P 500 is trading approximately 16 per cent higher than its level a year ago. It is now six months to go until the UK leaves the EU, although in reality it is highly likely that we will have a lengthy transitory period after March 29. This has prompted a great deal of media coverage and the political wrangling seems to be never-ending. While it is true that historically economics has a greater impact on the stock market than political events, Brexit is bound to impact the market with the uncertainty generated by the lack of clarity surrounding a deal. Companies have generally slowed investment and this will undoubtedly have an impact on growth in earnings.

The market never sees all stocks moving in the same direction and at the same pace. We have seen underperformance from domestic stocks, US $ earners benefitting from the weak pound and indeed growth stocks outperforming. The FTSE 350 low-yield index is at an 18-year high relative to its high-yield counterpart in price terms. Naturally this raises the question of whether growth stocks are now overvalued. The two most important factors are valuation and sentiment – growth stocks (which include AIM stocks) perform better when investors expect better economic times and this includes rising inflation expectations as this is associated with growth stocks outperforming. At the moment growth stocks are not yet overvalued: the dividend yield on the low-yield FTSE 350 index is still marginally above its long term average and the same is true of the traditional growth sectors such as technology and media.

However, there are indications that sentiment is now quite high – we have seen an unusually good performance from AIM stocks relative to the FTSE 100, a sure sign of investor confidence, although some stocks may have been boosted by inheritance tax planning. It is almost impossible to predict what might trigger a reversal of sentiment, although top contenders might be any slowdown in economic growth or a disorderly Brexit. Another risk is higher real bond yields: historically growth stocks have been very sensitive to these as higher real yields mean that expected future cash flows are discounted more heavily. By definition growth stocks offer more of these than value stocks, so they suffer more as yields rise.

There are obviously no guarantees of the future performance of growth stocks, despite the fact that they are not overvalued, there are obvious dangers. The same is of course true for most aspects of the market and it is, as ever, impossible to predict its future path. There is a big risk being out of the market too: if investors had listened to all the predictions of a correction or crash over recent times they would have missed out on a strong rise in both capital and income terms. Certainly caution is advisable, but precipitous action seems unwise.

:: 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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