Blue Chips for Yield, Gold for Sound Sleep

11/15/2010 11:56 am EST

Focus: GLOBAL

Chris Gilchrist

Editor, The IRS Report

With Europe and the UK retrenching while the Federal Reserve prints money, mega-cap value stocks and bullion have an undeniable appeal, writes Chris Gilchrist in The IRS Report.

UK investment managers are all optimistic to a greater or lesser extent. This is not because they like the UK economy, which they expect to be grim for at least a couple of years; it is because the UK has a flexible exchange rate and a raft of strong companies that are well placed to benefit from the continuing fast growth in emerging markets. And the UK has the ability to manage its exchange rate to preserve their competitiveness, unlike the weaker nations harnessed to the superefficient Germans in the euro.

These managers all reckon that using measures like yield, cash flow, and the cyclically adjusted price/earnings ratio, UK and European shares are a good value, though only marginally so and not in "screaming buy" territory.

But that ignores the economic backdrop. Most economists predict interest rates remaining at current levels for at least two years. This is certain to increase the demand for investments producing income, and with blue-chip shares yielding more than government bonds, there is clearly scope for a steady rise in share prices and a decline in yields.

Since many of these companies expect to increase dividends at a rate of 5% or more over the next few years, their merits in comparison with bonds are obvious. It is only the persistent risk aversion resulting from the credit crunch that has held back their share prices. Blue-chip value looks more and more like a winning strategy.

[Here in the UK,] the long-awaited Comprehensive Spending Review kept the coalition government's doomsday story running, with spine-shivering tens of billions slashed here and there and even supposedly sacrosanct sectors like education turning out to face back-door cuts.

Despite this, analysts continue to struggle to [determine] what, if any, economic effect the actual cuts will have. The cuts in public sector employment should be the easiest to work on, but since they account for only a small percentage of the net employment effects expected in the next two to three years, all one can really conclude is that they will keep the unemployment rate a bit higher than it would otherwise have been.

With [government contractors] mainly shrugging off the effects of the cuts, the optimists expecting the private sector to pick up the slack may be right.

Politically, though, the coalition government has to keep the "crusade against waste and benefit cheats" going to keep Labor pinned in its corner. So, Messrs Cleggeron (Conservative Prime Minister David Cameron and his Liberal Democrat deputy Nick Clegg—Editor) will have to use the megaphone to frighten the public while quietly telling business to ignore the scares and invest. This is quite a trick to pull off, especially with [Business Secretary] Vince Cable playing Boris Karloff.

With another round of quantitative easing, the tide of cheap money engulfing emerging markets seems certain to create bubbles there. But whether it will generate much investment in the US and Europe is more doubtful. More and more investors fear inflation and are buying shares and gold. I'm with them.

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