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Distressed UK Markets: A Buying Opportunity?

Distressed Markets
Written by Andy

The market is falling partly because there is intense competition for our cash. The 5 year gilt is priced at 85 p which means you get a 100 p in five years and on top of that you get a pay out every year, yield of 5% tax free too. With some investment grade corporate bonds you get 7%. As such fixed interest looks very attractive right now (especially if higher interest rates are temporary, and start falling again next year and after).

This has made the equities less attractive. The big money has gone for fixed rate and there is less demand for equities.

For retail investors (who cannot participate in the fixed income easily,) this is not a bad thing. we can buy good companies much cheaper than before.

So as I said equities should be cheaper. Things that were priced on PERs in the twenties (or even above) in the last 15 years of zero interest rates should now be much lower. That’s why we challenge high PERs every times we find them, in these SCVRs – are those premium ratings still justified now?

Before 2008, I remember you could buy quite good companies on PERs of about 12. We should be resetting our expectations for shares back to that sort of level, only venturing above it when a company is demonstrating exceptional growth.

Some commentators are saying that higher interest rates won’t stick, because governments cannot afford to service their huge debts in a permanently higher interest rate environment. So maybe we could see a return to quantitative easing and zero interest rates at some point in the future?  That would be incredibly positive for equities of course, and horrible for fixed interest (if the maturities are medium or long term).

This definitely holds true for the UK markets in these times of international neglect. But it’s important to recognise the changing nature of the constituents that make up the market, especially in the US. Once overwhelmed by oil and industrial giants, the S&P500 is now a tech index, dominated by companies with astonishing cashflow generation and the very highest quality of earnings (margins, returns etc). It is entirely sensible that valuations should have fallen since 2021, but equally reasonable that, even with interest rates back at 2007 levels, valuations should settle at a materially higher level than in the days before FAANG etc.

In other words, the valuation gap between UK and US isn’t just about neglect. It’s a market of stacks not a stock market, and the ones in the US are simply superior businesses on a vastly greater scale in a much more dynamic economy. That isn’t to ignore the value opportunities here or to denigrate all UK companies.

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Andy

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