This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Fidelity's Michael Clark, of the Fidelity MoneyBuilder Fund, and Sam Morse, of the Fidelity European Fund discuss the outlook for the UK stock market.
The UK market has had another good year and I think we can say that the stock market has fully recovered from the swoon of 2008 and 2009. Despite this, the valuation of the market at 14 times earnings is still reasonable in my opinion. The dividend yield of 3.5% remains attractive versus the yields offered by fixed income and is well above the rate of inflation.
On the face of it, therefore, we can look forward to another year of positive real returns in 2014. There are encouraging signs of economic stabilisation and renewed growth. The housing market continues to recover and industry is doing well in many sectors. But economic growth has not yet returned to normal fully and consumer incomes continue to fall in real terms. Any disappointment on future GDP growth could provoke some turbulence in markets. But as a result of that I think we are unlikely to see a destabilising move upwards in interest rates.
Dividend payout ratios remain below 50% of earnings – a very comfortable level. Companies are generally cash rich and management policy generally targets progressive dividends across all industry sectors.
In summary, I think that both valuations and the prospects for dividend growth will continue to support our equity income strategy in 2014. This is true even in a weak economy and if GDP growth is better than expected, it will support equity prices.
I believe that recent share price movements can only be justified by a return to the sort of growth seen pre-crisis. This may well lead to disappointment, given that some of the longer-term impediments to global growth remain, such as high consumer and government debt levels. Economic improvement is already discounted in share prices and the recent seeking out of higher risk opportunities – seen as the last remnants of value – suggests that the market may be about to lose steam.
Shares have rerated from a low base in the last 18 months but earnings and dividends have grown little during that time. Aggregate valuations do not look extreme relative to history as we came from a low base. However, on a bottom-up basis it is increasingly hard to find attractively valued opportunities where fundamentals are robust.
In this environment, I will continue to focus on attractively valued companies with sound balance sheets, which can deliver consistent dividend growth. Consistent dividend growers are no longer selling at such a premium to the market – calculations suggest a 20% premium against a 60% high. Although they have lagged in the recent surge, consistent dividend growers have not been de-rated in absolute terms.
