Six reasons to buy UK shares

Much has been written about the recent attack on global equities, and plenty more column inches arguing the future direction of share prices is inevitable. Only this morning we discussed the likelihood of technical factors plunging the FTSE 100 a further 500 points lower. However, one City analyst has come up with six reasons why investors in UK shares should remain optimistic.

"There are plenty of reasons to lie awake at night worrying about elevated valuations in global equities, the indebtedness of the public sector and whole economic and monetary regimes creaking at the seams," says Panmure Gordon's chief economist Simon French. "But sleep easy tonight as there are also reasons - ones easily overlooked in the current market turmoil - to skip into work each morning off the back of a solid eight hours sleep."

A perfect storm of three distinct yet interconnected factors are responsible for the recent crash - the end of the commodity supercycle, potential for higher US interest rates, and slowing economic growth in China. But while all were well-known to investors, Chinese currency devaluation provided further support to the broker's view that economic activity data out of China underestimates the degree of the current economic slowdown.

"This unknown quantum from a country that has delivered 28% of world economic growth since 2010 - and the degree to which a weaker Yuan impacts economies dependent on currency depreciation for export-led growth - are the predominant risk factors in today’s market," writes French. "Despite the talk of “death crosses” and unprecedented bull cycles it is the global and domestic macroeconomic environment rather than past trading patterns that are our preferred indicators for the sustainability of equity valuations."

It's why, despite slumping 14% from this year's peak, French repeats Panmure's 'overweight' stance on UK shares and has come up with half a dozen structural factors that "underscore current UK equity valuations, limit downside risk and buttress the medium term attraction of equities". Here's a summary:

Structural reforms boosting inflows into equities

Auto-enrolment in the UK is a clear non-cyclical case for sustained inflows into UK equities, reckons French. He estimates that an additional six million people will be accruing private provision by the end of the decade.

The hunt for yield

The ratio of equity returns to the returns from gilts has returned to below its 20-year average following the sell-off. Now, a forward yield on offer from UK equities of 3.8% "provides a stable floor for current valuations in our view".

Lower input costs

Falling commodity prices mean disposable incomes have risen for large parts of the world. It's why US and UK consumer sentiment is at multi-year highs and supports consumption growth and credit appetite in the British economy.

China policy interventions

"China has a $3.65 trillion of forex and gold reserves to go with 460 basis points of nominal interest rates and reserve ratios for the financial sector that have already reversed the slowing growth in credit," points out French. A drop in margin account lending triggered the correction in Chinese equity valuations, and domestic exposure to Chinese equities remains low by international standards. That should limit the wealth effect of the sell-off.

Structural changes to credit

"Nationalisation" of credit markets and balance sheet repair has reduced the risk of a credit crunch, French argues. "With credit growth and both secured and unsecured lending having picked up since the start of the year this is not a backdrop facing the UK economy at present."

UK growth fundamentals

French is also upbeat on UK economic growth - upcoming corporation tax cuts and inward migration are big pluses. We're back to real wage growth after six years, too, and productivity is threatening to pick up. Ultra-accommodative interest rates also remain highly likely. "Collectively this is not the backdrop to a sharp slowdown in economic activity - indeed it as close to a Goldilocks scenario as current policymakers could wish for.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.