Is now the time to buy cheap UK shares?

SO far this month, the technology motorcade has kept rolling. Wall Street’s “Magnificent Seven” mega-cap stocks have continued to dominate the US and, by virtue of America’s immense weighting in world indices, global stock markets too.

Artificial Intelligence (AI) fever shows little sign of loosening its grip, despite the emergence of euphoric valuations. NVIDIA – thought to be the leading future beneficiary of AI – now has a market value of $1.1 trillion after almost tripling over the past year¹.

If all this looks overly optimistic to you, you won’t be alone. While valuations aren’t everything, there’s a good reason why investors look at them as part of their decision-making processes. It can help to avoid being swept up in a bubble – perhaps the most common means by which investors lose money.

Too much caution can be almost as expensive. Historically, missing out on the final throes of a bull market in stocks can seriously harm your medium-term returns.

That was certainly the case in the late 1990s. Those that called time on the relentless rise of stock markets when the networking equipment company Cisco Systems first traded at 100 times earnings might have missed out on at least one more boom year².

Even so, eight months into this latest market rally, there is now a yawning gap between the valuations of today’s stock market darlings and undervalued markets like the FTSE 100.

The UK market has certainly remained in the sidelines during the latest bout of chutzpah. The MSCI United Kingdom Index now trades at a discount of about 40% to the MSCI World Index based on the amounts companies are expected to make in the year ahead³.

That seems a very low price to pay, especially given the UK economy’s continuing ability to confound recession fears. Inflation remains the chief fly in the ointment. However, if the Bank of England is to be believed, inflation should revert quite quickly to lower levels over the next few months.

In any case, the US faces its own portfolio of risks, given the Fed’s elongated programme of interest rate rises and recent signs of weakening consumer spending. That appears not be reflected anywhere much in US valuations.

This valuation mismatch favours investors seeking to shift some of their global portfolios further towards the UK. For example, numerous, respected UK equity income funds currently offer yields of around 5% from portfolios that are far from expensively valued.

Equity income funds can offer investors approaching retirement an attractive way of staying engaged in stock markets with less volatility than that associated with riskier out-and-out growth funds.

Going the whole hog might also be a mistake. Many of us tend to have a “home market bias” which, over the past decade at least, would not have served us well. There’s no hard and fast rule about how much sterling investors should hold in the UK. However, the Fidelity Select 50 Balanced Fund currently has about 30%.

Fidelity’s Select 50 list of favourite funds caters for investors seeking an income or growth from UK shares via three actively managed funds and two ETFs.

The FTF Martin Currie UK Equity Income Fund is a £1 billion portfolio actively managed by Ben Russon, Will Bradwell and Joanne Rands out of Leeds. Its objective is to generate an income higher than that of the FTSE All-Share Index plus investment growth over a three to five year period after fees and costs.

Among the fund’s current 52 investments are holdings in some of the UK’s largest dividend payers, including Shell, AstraZeneca and Rio Tinto, although it is invested in some medium sized companies too – Cranswick, Rathbones and  Spectris, for example.

The fund pays a quarterly dividend and currently yields approximately 5.0%, an amount that is not guaranteed⁴.

The Liontrust UK Growth Fund is another actively managed Select 50 choice. It seeks to invest in companies with a durable competitive advantage that allows them to sustain high levels of profitability for longer than the market expects. Current large holdings include Shell, Unilever, Diageo and BAE Systems.

Find out Tom Stevenson’s view on the prospects for the UK stockmarket in his latest Investment Outlook video below.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. The FTF Martin Currie UK Equity Income Fund and Liontrust UK Growth Fund invest in a relatively small number of companies, so may carry more risk than funds that are more diversified. These funds use financial derivative instruments for investment purposes, which may expose the funds to a higher degree of risk and can cause investments to experience larger than average price fluctuations. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.