Why I've Turned Bullish On Shares

By Maynard Paton | 25 March 2008

| 11 Comments

Back in July I warned you about the market. I wrote: "Tracker dividends have gone flat and gilts now offer a much greater income than the index. Looking at my tables, I think this situation is not dissimilar to 1998-2001 -- a period in which anyone investing would have generally endured poor subsequent returns.

Overall, I get the impression today's All-Share is not cheap -- and I could understand if you wanted to Prepare For A Downturn."

At the time, the FTSE All-Share stood at 3,468. At the end of last week it stood at 2,814 -- a drop of almost 20% in nine months. I hope you were prepared for the downturn.

Revisiting my July article, I'm no longer so pessimistic. In fact, I've turned optimistic.

For a start, I'm encouraged how dividends have regained their momentum. Judging by the 'dividend points' currently available from the All-Share (i.e. the index value multiplied by its yield), the index is paying 17% more than it was in the summer:

I must admit the 17% sounds very impressive, but I recall heavyweight shares such as BP (LSE: BP.) , Royal Dutch Shell (LSE: RDSB) and GlaxoSmithKline (LSE: GSK) raising their annual payouts by hefty amounts earlier this year. I also sense exchange-rate fluctuations -- many blue-chip dividends are declared in US dollars -- may have helped.

I'm also pleased how the market's dividend yield has closed the gap with the income available from government bonds. Back in the summer, gilts offered 2.79 percentage points more income than the All-Share -- the highest premium since 2001. Now the 'yield gap' is about 0.4 percentage points:

I think that's the lowest yield gap since the latter stages of the brutal 2000-2003 bear market. In hindsight that was a great time to buy the index. I calculate subsequent returns have approached 100% with dividends.

Of course, 'this time could be different'. In particular, payouts from blue-chip banks could be at risk from the ongoing credit squeeze. Yields of 10% or so on big-name shares such as Royal Bank of Scotland (LSE: RBS) surely come with some doubt. Furthermore, the credit squeeze has kept the rates available from deposit accounts at 6% or more -- well above the income from government bonds -- so my yield-gap comparison in this instance may involve the wrong 'safe haven'.

Still, I'm generally quite bullish. Dividends seem to be still growing while a near-4% market yield is the highest income for five years. Of course we may not be right at the bottom of this bear phase, but the All-Share certainly doesn't look expensive to me and I get the feeling longer-term market returns from here could be very worthwhile. You may wish to read this old Qualiport article, which used the yield gap to predict a "medium-term annual return of nearly 9%" back in 2003.

Maynard writes Champion Shares, the Fool's share-tipping service. This 30-day free and no-obligation trial to the Champion Shares community gives you complete access to Maynard's favourite shares. Maynard also owns shares in GlaxoSmithKline.