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Bull fight

With the UK in the fourth year of the bear market, most fund managers remain distinctly gloomy, cursing poor investor sentiment and anaemic corporate earnings&#39 growth. But some investment managers believe the recent rally in mid-March and subsequent flurry of company activity mark the beginning of a bull market.

JO Hambro UK growth manager Mark Costar, a highly regarded fund manager with an impressive track record at previous employer Clerical Medical, insists the upturn shows that investor sentiment has started to turn around.

In particular, he believes the cash bids that were lodged for companies almost immediately following the rally indicate that the long-hoped for bull run is already under way.

He says: “We are seeing a resumption of corporate activity in the marketplace. This means that a £500m bid could inject £500m into the market. No one has said where the market may be in one year&#39s time but I think it will be substantially higher. We are in a bull market in all but name.”

That there has been a recent rally is not in question. At the time of going to press, the FTSE 100 had risen by around 16 per cent over three months.

Many fund managers attribute the surge to the certainty that the war in Iraq was going to be won convincingly. Others believe that war had already been priced in, arguing that the bounce was down to a brief boost to investor sentiment. Most agree, however, that the bull market has yet to emerge, citing the short-lived nature of the latest rally as clear evidence.

Liontrust Asset Management marketing director Jonathan Harbottle says: “The most notable aspect of this is that the rallies are getting shorter. When the market bounced in spring 2001, it lasted 43 days. In March this year, it lasted seven days.

“The reason is that there has been much more technical short selling which leads to more volatility. We are not in a bull market.”

In fact, Harbottle believes the market has some way to fall. Over the next 18 months, Liontrust expects the FTSE to slump to the 3,000 mark – roughly the level at which the fund manager believes the market is cheap. At 3,500 – a barrier that Liontrust expects the market to hit in the short term – Harbottle says the FTSE offers reasonable value.

Most investment companies agree with Liontrust&#39s view that UK stocks are currently cheaper than their US counterparts, with the result that fund managers running international portfolios tend to be underweight in America. But it is also a reflection of the widespread view that the UK economy, although stuttering, is reasonably robust relative to those of other major countries.

Invesco Perpetual income fund manager Neil Woodford says he does not hold high hopes for the global economy but expects the UK to fare reasonably well. He says: “We continue to see relatively strong domestic consumer-led momentum. The housing market is relatively robust, employment is still strong and Government spending, particularly on public sector wages, will grow in the coming year.”

He is also encouraged by the Bank of England&#39s recent decision to protect growth – and to guard against external deflationary pressures – by cutting base rates. Nevertheless, he says it would be “over-optimistic” to expect a strong equity market recovery this year as over-capacity, poor pricing power and weak growth will depress corporate profit growth.

Not all fund managers are as bearish as Woodford. Schroder UK alpha plus fund manager Richard Buxton is among those who believe there will be a volatile recovery in the near to medium term.

He says: “The recovery is most likely to be W-shaped, with some form of relief rally due to the removal of uncertainty in the Gulf. There will then possibly be a further retracement later in the year as economic data reveals that nobody spent any money during the whole of this period and things still looking pretty tough for the profit front.”

Nevertheless, Buxton believes there will be a final move up the W later in the year when there will be much greater certainty and confidence about a profits recovery in 2004. This is a view common to many fund managers, who believe it will be the corporate earnings&#39 data coming out later this year that will prove pivotal to any recovery.

Costar, however, believes such views are short-sighted. Although conceding that the economy is weak – he considers it likely that it will deter-iorate further as house prices fall and consumers rein in spending – Costar does not believe this necessarily affects the stockmarket. He says history shows that economic and stockmarket cycles do not necessarily coincide – a view supported by some IFAs.

Michael Philips proprietor Michael Both says: “The stockmarket leads the economic cycle, not the other way round. The stockmarket is usually past its peak when the economy is at its height. The FTSE could head back down again but if it continues as it has been, Costar may be proved right.”

Investor sentiment is crucial to Costar&#39s argument but it has been very poor this year.

Nevertheless, Costar bel-ieves investors are not only starting to recover their appetite for risk but are also gradually lowering their expectations of how quickly they expect to see returns. If this is the case, then the prognosis for the stockmarket is good. But unless there emerges strong evidence to back his argument, Costar will remain a lone voice in a market filled with bears.

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