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The spend is nigh

Fund managers expect M&A activity to boost UK equities in 2006, says Matt Davis

Most investment professionals expect equities to outperform bonds, property and cash in 2006 but where is the money going to be made?

The UK outlook does not appear optimistic at first glance. The Chancellor’s warning of a slowdown in growth in last month’s pre-Budget report and the threat of lower consumer spending mean that many fund managers are gloomy about the economy.

New Star select opportunities fund manager Patrick Evershed says: “I am bearish on the UK economy as a number of factors are squeezing consumers. They are facing record debt, slowing house prices and may face tax increases in 2006.”

Evershed says rises in fuel prices, transport costs and council taxes are likely to affect consumers.

With sterling lower against the dollar, he expects imports to become more expensive while the rise of the Chinese renminbi will compound the retail slowdown by making shopping more expensive.

Despite limited growth prospects, most fund managers are bullish on the outlook for equities as they believe that strong corporate cashflows and merger and acquisition activity will be a boon. Consumers may be struggling to make their credit card payments but UK stocks are expected to rocket as cheap overseas bond markets fund the debt for potential acquisitions.

Threadneedle head of UK equities Paul Findley made 1bn as a result of M&A activity at the end of 2005, including 02’s proposed takeover by Telefonica, and expects to capitalise this year from his investments in companies with scarce assets. He says such companies will be able to extract premiums from bidders.

As the biggest shareholder in the London Stock Exchange, for example, Findley says he is unlikely to let the stock go cheaply.

Invesco Perpetual chief investment officer Bob Yerbury says: “In recent years, the greater emphasis by many companies on shareholder returns and cash distributions to shareholders and the increase in M&A activity, have played a key part in allowing the stockmarket to perform well in an environment of weaker economic growth.”

A survey by the Association of Investment Trust Companies has found that fund managers are more bullish than IFAs about the FTSE’s prospects in 2006.

In a survey of 42 fund managers and 249 IFAs, the AITC found that 27 per cent of fund managers expect the FTSE to close 2006 at over 6,000 compared with only 15 per cent of IFAs. Ten per cent of IFAs and 3 per cent of fund managers believe the index will close the year below 4,500.

The survey found that IFAs expect emerging markets to be the leading geographical area next year while most fund managers think Japan is likely to outperform.

Emerging markets, particularly the Bric countries of Brazil, Russia, India and China, have seen a glut of fund launches as investors continue to believe in the resources story while becoming more accepting of risk.

Jupiter head of independent funds John Chatfeild-Roberts predicts that Japan is on track for its fourth consecutive year of growth. He says: “In Japan, there have been a number of stimuli for equity investors in 2005. Property prices are recovering, deflation is set to end soon and, most important, domestic demand is beginning to pick up. Asset allocators have been flooding into the country on the back of this positive news and the country still has a long way to run in our view.”

Following the European Central Bank’s decision to raise interest rates at the end of last year and the tax increase in Germany following the election of Angela Merkel as Chancellor, buyers of European equities will look to benefit from focused stock selection this year as economic recovery is now less likely.

In the US, Framlington balanced managed fund manager Richard Peirson says consumers are continuing to spend despite cooling housing markets, high oil prices and rising interest rates. He says the cumulative impact of these could lead to GDP growth slowing next year.

But New Star head of fund of funds Mark Harris says the fact that investors remain underweight in the US could give room for surprise.

Harris says: “The second year of a presidential cycle is often challenging and it is likely that low volatility begins to increase. This suggests that market returns may be modest but this needs to be taken in the context of 2005 having been a relatively disappointing year for US equities. Investor scepticism may leave room for upside.”

Will retail investors be lured back into the market in 2006? Findley is optimistic, saying UK equities are very much at the beginnings of a cycle of retail interest. He hopes that retail investment will accelerate back up to normal levels although, historically, retail investors tend to cotton on at the wrong time.

Equal Partners managing director Vivienne Starkey says: “We have seen investor confidence starting to improve over the last half of 2005. The Sipp money is also going to have to go somewhere if people want to get tax relief and I think we are likely to continue seeing people taking more risks in 2006.”

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