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Division bell

Bond and equity markets are split over prospects for the global economy and fund managers are warning that investors will take a hit if they are on the wrong side of the divide.

Bond markets have shifted to pessimism as traders ploughed into safe-haven government bonds while equity investors have remained in more cyclical parts of the market despite negative newsflow.

But Royal London Asset Management equity fund manager Derek Mitchell says if the bond markets are right, then equity investors could take a 30 per cent hit.

He says: “One is right and one is wrong. If the recent rush of bond investors are correct and we are heading for a double dip, certain areas of the equity market look 20-30 per cent overvalued and due for a correction.”

Mitchell believes equity markets are right and a double-dip recession is not on the cards. He says: “I am still looking for equity markets to make progress from current levels.”

Nevertheless, Mitchell is hedging his bets on his £394m special situations fund by building up defensive stock exposure to mitigate any fallout if equity markets are proved incorrect.

Liontrust bond fund manager Simon Thorp agrees there is a divide between bond and equity markets, as yields on government bonds have plunged to all-time lows.

As of last week, he says, the yield on 10-year UK government bonds, known as gilts, had fallen to just 2.9 per cent and on five-year gilts it was 1.6 per cent. When bond yields fall, their market prices rise. If sentiment turns negative and yields rise then prices fall.

Thorp feels there is more to the recent flight to gilts than meets the eye, saying investors would have to believe the UK was going to fall into deflation if they were buying the bonds based solely on their economic outlook.

He says asset allocation by market participants, such as pension funds, for asset liability matching may be a factor, as well as banks borrowing cheaply from central banks and then simply investing the proceeds in gilts.

However, the manager will not put any money in gilts on his credit hedge fund or credit absolute-return retail fund and will not consider equities.
He adds: “Credit looks pretty good value relative to government debt.”

Even within equity markets themselves, the most respected investors are in disagreement. In early September, Legg Mason’s US equity veteran Bill Miller declared blue chip stocks are at once-in-a-lifetime bargain prices for investors buying with a long-term time horizon. This came just days after legendary US investor Jeremy Grantham insisted the market is overvalued.

On August 26, SocGen strategist Albert Edwards said the S&P 500 index of US blue-chip companies could crash from 1,043 points to 450.

In the UK, double-dip fears have been stoked by indicators, including a purchasing managers’ index report on September 2 heralding an unexpected fall in expansion in the service, manufacturing and construction sectors.

What should investors do faced with this array of conflicting information?

Last week’s fund sales data from the Investment Management Association showed retail investors have been piling back into bond funds as all the negative sentiment is hitting home.

But Hargreaves Lansdown senior analyst Meera Patel says the answer for investors could lie in equity income funds.

She says: “There are all these companies that have bonds but actually their equity yields are higher than the bonds.”

Patel says that while value stocks, which tend to be more income-focused, have outperformed growth stocks over the long term, in the past three to five years, growth has outperformed, suggesting that income is undervalued.

She recommends Tineke Frikkee’s Newton higher-income fund, which is trading in ultra-high income equities that she feels are at all-time bargain prices and Neil Woodford’s defensive Invesco Perpetual income fund.



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