End of cult of equities signalled as yield gap reverses

A dramatic break in the historic relationship between bonds and equities yesterday signalled that markets believe the UK economy is doomed to suffer a period of deflation.

For the first time since the "cult of equities" began in the Fifties, the dividend payout from shares is now higher than the yield on government bonds.

At last night's prices, the dividend yield from stocks in the FTSE All-Share this year is forecast to be 4.34 per cent, while the yield on the benchmark 10-year gilt fell to 4.22 per cent after yesterday's interest rate cut, according to Bloomberg.

This cross-over will be seen as a seminal moment for markets with wide implications for the UK economy.

Bulls will see the reversal as a giant "buy" signal on the UK stock market, making equities unprecedently cheap. But bears will argue that it marks the end of the "cult of equities" that began more than 40 years ago when giant pension funds switched from the relative safety of bonds in the expectation of better longer-term returns from investing in UK plc.

Steve Russell, strategist at HSBC, said it showed that investors have lost faith in the ability of companies to constantly grow their dividends.

"The market is saying that there will either be no further growth in dividends or that there will be a sharp fall in dividends in the short term. The former would only be achieved in a deflationary or zero-inflation environment. The latter implies that we are heading into a more serious recession than the slowdown we have just come out of, and that would suggest short-term deflation."

The FTSE 100 fell 81.7 to 3,597 and the FTSE All-Share was down 34.6 to 1,736.5 yesterday on fears that the Bank of England's interest rate cut would fail to stem the slide in the UK economy. The reverse yield gap has been narrowing over the course of the bear market in equities, representing the greater demand for fixed-interest securities. Solvency worries have forced pension funds and insurers out of shares and into gilts, while other investors nervous about war and economic prospects have also made the switch.

The former chief executive of Hermes Asset Management, Alastair Ross-Goobey, whose father is credited with launching the cult of equities with his advice to the Imperial Tobacco pension fund in 1947, said the cross-over represents a "once in a lifetime" buying opportunity.

"I don't believe there will be deflation across the western world when governments are spending more than they are taking in and with monetary policy so loose. That is the big difference between now and the Thirties."

He said that the last time gilts were yielding more than equities, in 1957, the UK stock market soared more than 40 per cent in value in each of the two following years.