Last week the yield on UK shares (4.6%) exceeded the yield on ten-year government bonds (4.4%). You might think that isn’t much of a big deal. But to those who watch technical market signals, it is: the last time it happened was in March 2003, the month that marked the end of Britain’s post-tech-crash bear market. Between then and September last year, when the equity market peaked, the FTSE 100 rose an astonishing 105%.
So might the “cross over” be a buying signal this time too? I doubt it. It often works simply because it reminds everyone of relative yields and, on the face of it, makes stocks look good relative to gilts. But to believe that it should lead you back into the market now, you have to believe a currently unbelievable thing: that UK dividends are safe. In our cover story, we look at why we expect the global economy to move into a real and long-lasting recession as a result of the credit crisis. We also look at the impact this will have on corporate profits. It isn’t a good one. When profits fall, so do dividends. And that will be the end of the cross over.
Anyway, I’ve been caught out by this one before. It happened in Japan in April this year, prompting me to write a story for the magazine headlined “Japan looks good: now’s the time to buy” and to point out that historically, on every occasion that the dividend yield on the Topix index had risen above the ten-year Japanese Government Bond yield it had marked “the start of a major rally”. Whoops. The Topix has fallen 13% since. Clearly, the gilt dividend cross isn’t quite the infallible signal it is put about as being.
Still, while I’ve clearly been very wrong on Japan, I’m not quite prepared to give up yet. As Christopher Wood of Asia specialist brokers CLSA pointed out last week, Japan’s stockmarket does have a few things going for it. First it has long been “discounting a weak economy”, which makes the scope for disappointment smaller than it is anywhere else, even as the current “growth scare” intensifies.
And just look at the things Japan has that the rest of us just don’t. It’s got a serious manufacturing and industrial sector filled with cash-rich firms. It’s got savers, a strengthening currency and, most importantly, it’s got a solvent financial sector. See how Mitsubishi UFJ is buying into Morgan Stanley? How Nomura is buying up Lehman’s European and Asian operations? And how Sumitomo is rumoured to be looking at Goldmans? Quite. Japan is far from perfect – growth has stalled and its property market isn’t immune to the fall out from the global property bubble nor its economy to global recession. But if I had to be in any equity market at all at the moment it would still be my first choice, cross over or no cross over.