British shares have only been cheaper in the world wars

The only times British shares have been cheaper than they are now was during the two world wars, as global investors have withdrawn from the UK in droves, according to new analysis. The unpopularity of British shares has driven prices down and dividend yields up. The FTSE All Share index has gone nowhere this year and now yields close to 4pc.

The gap between the dividend yield from the FTSE All Share and the yield available from 10-year government bonds ( gilts) – known as the “yield gap” – is a popular valuation metric. A small gap or negative figure (when gilts yield more than shares) may indicate that the stock market is overvalued, as investors are not being adequately compensated with dividends for the additional risk they are taking by investing in shares.

If shares yield appreciably more than bonds, it is an indication that shares may be undervalued. This carries particular weight during times of high inflation, or when there is the threat of rising inflation, when investors are less willing to accept low bond yields.

The yield gap between British shares and gilts has been increasing since 2013 and is currently at 2.2 percentage points, after a peak of 2.4 points in 2017. The only other years on record in which it has been higher than this were during the First World War, two of the interwar years and during the Second World War, according to data compiled by Citigroup, the bank.

Gilt yields were heavily depressed following the 2008-09 financial crisis, as many investors – including large pension funds – rushed into them, as they were perceived to be lower risk. This pushed prices up and yields down. Since the autumn of 2016 gilt yields have crept up, but the unprecedented unpopularity of British shares has pushed the yield gap up to historic highs regardless.

Ritu Vohora, of fund manager M&G, said: “The UK has underperformed world markets over the past 18 months, as Brexit, domestic politics, high debt levels and slowing economic growth are dissuading investors.

“While the short-term outlook looks challenging, with elevated risks, UK shares are now ‘on sale’. There

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are positives: unemployment is at historic lows, government borrowing is falling and there is some wage growth improvement.”

According to Citigroup, the current 4pc yield implies that annualised returns from British shares over the next 10 years will be more than 10pc.

Ms Vohora said: “There are selective ‘contrarian’ buying opportunities for investors who are prepared to spot undervalued companies, particularly those firms that pay generous dividends backed by free cash flow.”

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There are scenarios in which the gap could close, making British shares less attractive on a valuation basis than they currently appear. Ms Vohora said: “If the Bank of England raises interest rates eventually, bond yields are likely to rise and the gap to narrow. This would lessen the valuation attraction of stocks. There is also a risk that dividend forecasts prove too optimistic.”