The Financial Stability Review has indicated that the UK shares are valnurable to a crash. Should investors be concerbed? Investment director provides his comments on the ECB UK equities warning.
25 November, AtoZForex – The Financial Stability Review published by the ECB has indicated that the UK shares are more vulnerable to a crash compared to other major global markets. According to the report, Britain was the most overvalued market in October, followed by the US, Europe, emerging markets and China.
ECB UK equities warning
Russ Mould AJ Bell investment director stated that the UK is expensive if looking at a market capitalization to GDP metric. As it is nearly 120 percent market cap to GDP. Russ Mould continues by saying that this can be explained because corporate profits at a percentage of GDP have never been higher. Hence, if investors think that corporate profits will remain where they are or increase further then they will not be concerned. But in case there is a slowdown or recession in the UK, it is “clearly potentially very problematic”. Due to a support of earnings to that high valuation.
Furthermore, Mr. Mould mentioned that the UK stock is cheap on a dividend yield basis or relative to bonds. Dividend yield in the UK is around 4 percent, while the gilt yield is 1.4 percent. So there is a 250 bps premium, which is historically very high. The argument will remain strong, “unless bond yields zoom upwards or there are big reductions in dividends”. Consequently, “dividend yields will provide support even if a cover is thin and unless the economy gets into recession UK equities will prove relatively resilient”. Nevertheless, investors remain avoiding UK equities. With the country seeing outflows of £620m in September.
US equities and emerging markets
In the report, the UK was followed by the US. The ECB indicated that the US was the most expensive on all the three price to earnings metrics it applied. Russ Mould commented that the US is costly on market cap to GDP. Whereas, the S&P 500 yield is almost equal to the 10-year Treasury. Hence, “that element of support is not as strong as it was either before the index offered a yield premium, which is historically extremely unusual”.
On the contrary, emerging markets are quite cheap. Despite they have outperformed this year, emerging markets were underperforming past five years. Mr. Mould says that emerging markets’ price to book value is relatively low. But, currencies of emerging markets remain stressed.
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