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Cautionary tale

Invesco Perpetual income and higher-income fund man-ager Neil Woodford has reasserted his view that an economic recovery is still three to four years away.

Woodford has expressed concern over market optimism, claiming the major problems in the economy have not been tackled meaning the downturn still has a long way to go.

He says: “Problems with the banking system, consumer economy in terms of leverage, commercial and residential property and excesses seen around the world have still not been addressed in this correction in markets.

“I believe the ingredients for recovery in this economy are not there and will not be there until we see a rebalancing of the global economy, including the US and the UK.”

Woodford says the rally does have a bit further to run as the markets are in the mood to put a positive stance on almost every macro datapoint, even though companies are suffering on earnings and have had emergency rights issues, largely because it is cyclical companies taking part in a V-shaped recovery.

He adds that the FTSE rise of 1,000 points has meant there is now risk in the market as well as opportunity.

“The market has embraced the V-shaped recovery for the larger part and it is hard to see what will break its confidence but I think it is very clear that is where the consensus is.

“Therefore, it is very important to sound a note of caution. Whereas earlier in the year when the market was at a low there was little downside and lots of opportunities, now a 1,000 higher points and lots of the gains concentrated on cyclical points in the market means there is a lot being priced in.”

Woodford says there is no obvious reason for the improvement in profitability in these companies and all the share price appreciation is adding valuation premium to these stocks.

“I have scanned a number of cyclical stocks and their valuations and it is astonishing where share prices have taken valuations to as there has been no recovery in the economy, no increase in earnings and no tangible sign of any improvement in profitability for many months.

“If I am right and this is not a V-shaped recovery, I think there could be a lot of disappointment and a lot of downside.”

Woodford says he will not buy into the cyclicals rally that has been going on since the beginning of March, preferring to invest in some of the more defensive areas of the market that are well-financed, meaning they are not overly exposed to the “slings and arrows of the economy”.

“Pharmaceuticals, utilities, tobacco, telecoms and businesses like Tesco or Capita are looking incredibly attractive and will be able to grow profits, earnings, cashflow and dividends even in these sorts of environments.

“Sooner or later that is going to be priced into their share prices, meaning you will not see AstraZeneca or Glaxo trailing on seven to eight times earnings with a 6 per cent yield. You may see those earnings double and the yield halve. There is a significant amount of upside on that view.”

Strangely, Woodford feels he is back in the sort of environment he was in 10 years ago when he recognised opportunities in unloved stocks.

“Rolling on 10 years, we are in a similar, but for very different circumstances, polarised market where the businesses I see opportunity in have profoundly undervalued share prices but the greatest upside.”

Hargreaves Lansdown head of research Mark Dampier expects the economy to be more of a grind in the next few years rather than just a recovery from the lows.

“I think the Budget after the next general election will be an evil one and if people think the money being taken out of their pockets now is bad, they should wait and see what happens then.

“Something always breaks market confidence and the summer is a notorious time for markets to be volatile, so I would stick to defensives and steer clear of any type of cylical rally.”

Woodford’s comments are in stark contrast to Fidelity’s Anthony Bolton who said in April that he believes a bull market has already kicked off in equities and that financial shares are set to drive recent gains higher.

Skerritt Consultants head of investments Andrew Merricks says he is in the Woodford camp at this point.

He says: “I do not know how the rally has got to this point, given what has been backing it up. We are quite happy to stick with bonds at this juncture as they can offer up to a 20 per cent return and a yield.”


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