Should you dump equities?

At present, there is a distinct lack of high-quality income earners to buy at reasonable prices. According to recent research, that should send alarm bells ringing.

High-quality equities are expensive. That's something we've been telling you for a while now (although we haven't been entirely sure what we should all do about it). A note out from one of our favourite analysts, Andrew Lapthorne at Socit Gnrale confirms the extent of the problem.

Thanks to the generally weak fundamentals across the board, the pool of higher quality assets has become more limited in the last few years. And if you try and screen the remaining ones by some kind of valuation filter, not much comes up.

Lapthorne has used a 4% dividend yield, and in doing so finds that "the percentage of companies passing such a screen dwindles to historically low levels." So, "high quality equities are not only harder to find, but they are more expensive." This throws up so many problems it is hard to know where to start. But here are a few.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

When quality stocks are expensive in this way, their absolute returns over the next 12 months tend to be weaker than those of other types of stock. That suggests you shouldn't hold them. But this is only the case if the market holds up. If it 'corrects', the higher quality assets are likely to produce the "best one-year relative performance as weaker and lower quality assets fall further." That suggests you should only hold them if you think the market is going to fall, but you aren't sure enough to get out of the market all together.

Is the market going to fall? Lapthorne has one more bit of performance evidence to chuck into the mix here:"historically, a lack of quality income opportunities has been a bad omen for future equity market returns." He backs this up with a nice chart (that I will ask for permission to reproduce below later) looking at the size of the quality income universe against market returns one year out. It doesn't make you want to hold many equities at all.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.