Equities vs. gilts – Challenge the conventional wisdom

4th January 2012

One aspect of 2011 that has attracted significant attention has been UK equities yielding more than gilts for the first time in 50 years. Some set ideas have sprung up around this issue but, we at The Value Perspective, believe perceived wisdom should always be challenged to ensure it is robust.

The main reason investors are excited about this dividend-gilt crossover is it appears to highlight how cheap UK equities have become. However, we would note that almost any asset is going to look cheap in comparison with gilts, given their historic low yields – and high prices.

Yes, investors see them as a ‘safe haven' in the current environment but – or, more accurately, as a result – they are very expensive in the context of history. Relative valuation is sometimes a dangerous game in that it does not tell you how attractive something is in absolute terms. To a starving man a Mars Bar may look like a great meal but that does not make it a great meal.

UK equities and, in particular, the UK Equity Income sector are certainly looking more attractive than gilts but income investors should always think in terms of the absolute dividend they are obtaining on the market. As we noted in Lessons of history, the Graham & Dodd P/E ratio suggests that, taken as a whole and in the context of history, the market is neither fantastically compelling – as it was in, say, March 2009 – nor particularly expensive, as in June 2007, but merely about average.

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