All statements made in this article are opinions of the writer(s) and are not to be constituted as advice. Please refer to our full Risk Warning at the end of the article.

Source: Bank of England

Bubblicious

When the history books come to be written, it is probable that the decade of zero interest rate policy (ZIRP) and QE will come to be associated with promoting asset bubbles. To some extent that was the deliberate point of the policies…to keep credit flowing around the financial system.

It is logical for asset prices to rise as the cost of funding falls.  But enthusiasm for high-yield bonds, residential property, loss-making tech shares, infrastructure, private equity and cryptocurrencies has only been so high because interest rates were so unusually low. As interest rates rise, and the cost of credit normalises, some of this is becoming more apparent.

No Bubble Here

One area where the changing cost of money has definitely not been distortive is the UK equity market. The chart below shows the yield of the broad UK equity market (Blue Line) alongside the UK 10 year gilt yield (Orange Line) since 1995.  

From 2010, the UK market dividend yield refused to follow the 10 year gilt yield lower, instead sticking in its usual range of 3% to 4%. Whilst bubbles may have been blowing in other classes, the UK equity market steadfastly refused to join in.

Having missed the party, the UK equity market is now in the happy position of not suffering the hangover. Interest rates have risen and still the UK equity market yield trades within its range.

Chance to Shine

The next few years in markets will likely be dominated by the unwinding of the distortions caused by ZIRP and QE. This is only just beginning. As one of the few undistorted asset classes, this should refocus investor attention on UK equities.

The remarkable consistency with which the UK equity market trades in a yield range of 3% to 4% gives some pointers for the future. Currently the market yields 3.7% so at the cheap end of that range. A good start. But the key to progress will not be to rely on a re-rating but on finding companies most capable of growing their dividends.

If yields remain constant, then simple maths dictates that the only way share prices can go up is if dividends increase. This is the reason for the Slater Income Fund’s mantra of “good and growing income”. The Fund has a yield approaching 5% (which counts as “good”) but identifying companies that are growing their dividends will be key to benefiting from rising share prices. The Slater Income Fund continues to hunt out those companies, from across the whole spectrum of the UK market, most likely to be capable of delivering that dividend growth.