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Going, going, gone

Over the last few weeks, being a professional investor has been by turns dispiriting and exhilarating. It has even, on occasion, been profitable. But it has rarely been dull.

With each new rumour and fresh piece of economic data, the market’s mood has alternated, swinging from euphoria to despair and back again, sometimes within hours.

On more than one occasion the FTSE has closed down by hundreds of points, only to make up lost ground within minutes of the next day’s opening bell.

This volatility has not been driven by anything so dull as changes in corporate earnings, cashflows or profits, but by the tug-of-war between two opposing emotions: greed and fear. During bull runs, greed dominates; in bear markets, fear has the whip hand. But the type of volatility we have seen of late only occurs when those two emotions are powerful and evenly matched. And right now, investors can find plenty of reasons to be greedy and as many to be fearful.

At times like these how can we investors avoid getting caught up in short-term emotions? What metrics should we employ to help us view the market in a cool, detached manner?

Should we study the VIX, the so-called ‘fear index’, which has recently hit unprecedented levels? Or should we scrutinise changes in the Libor, which has charted the collapse of trust in the banking sector? Should we instead look at credit default swaps?

While all are valuable tools, I would suggest that looking at dividend yields could prove simpler and more instructive.

You might wonder what comfort a bi-annual dividend cheque is when the UK’s biggest banks are asking their shareholders – and, potentially, taxpayers – for billions of pounds. Dividends matter because, irrespective of where we are in the market cycle, it is almost impossible to overstate their importance to long-term equity returns.

Lacking a snappy 21st-century acronym, dividend yields may seem a bit old-fashioned. But they are currently telling us something interesting. As I write, the UK market is cheap – too cheap. As a whole, UK equities are yielding, on a historic basis, more than bonds.

Ten-year gilts currently yield 4.39 per cent against a historic yield on the FTSE All Share of 4.68 per cent.

This is a rare occurrence and has in the past pointed to excellent returns to come. The 12-month forward price/earnings ratio on the market is eight times, giving us a forward earnings yield of more than 12 per centOf course, it can be hard to remain calm when most of the UK’s major high-street lenders are imploding – buying equities when the market is in freefall takes courage, a cool head and good timing.

However, if we look at the dividend yield relative to gilt yields, it is apparent that this is a good time to be upping your exposure to high-yielding stocks.

Recent sterling weakness may actually be good for corporate profits. More than 20 per cent of dividend payments are disclosed in US dollars to the UK-based investor – the fall in the pound this year has already added four per cent to the market’s overall income.

Our recent analysis of the UK market’s dividend prospects revealed that even a worst-case scenario would see 5 per cent dividend growth by UK firms this year and next.

For managers willing to allow dividends to lead them to otherwise unfashionable or unloved businesses, opportunities to generate income are, at present, outstanding. If you are willing to accept the market is more attractive than you might have thought, where should you invest? In a tracker fund? No. More than ever, a selective approach is now called for.

Investors must discriminate between stocks that have been deservedly derated and those that have been unfairly caught up in the panic selling.

Remain calm. Remain selective. But grab those high dividends while stocks last.

Ross Watson is manager of the Martin Currie Securities Trust of Scotland

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