The FTSE 100 index declined by more than 20 per cent since its peak last Autumn after equity markets opened sharply down this morning, marking the technical definition of a ‘bear market’.
Scott says: “Over recent months the UK equity market has become increasingly polarised between relative strength in commodities on the one hand and weakness in domestic and cyclical sectors, reflecting the worsening macro backdrop.”
Despite recent gloomy headlines, Scott believes the UK is still not in a recession and suggests there could be further to go: “We are not there yet. While we are now technically in a bear market for equities, in terms of the economic backdrop we are still not in a recession. At present the UK economy has only just begun to slow after a robust 2007 when GDP growth was above trend” he says.
According to the fund manager, the Bank of England’s rate cutting policy has been rendered impotent by a lack of response from lenders. He is also concerned by inflation and believes it is still not adequately factored into the market. “Bond markets are already pricing in inflation of 3-3.5 per cent and this is limiting the Bank of England’s scope for rate cuts” he says.
Scott remains cautious about valuation traps and suggests we may have reached a peak in cyclical earnings or an ‘earnings bubble’. “Earnings expectations are already being downgraded for domestic cyclical stocks and any fall back in commodity prices could see substantial downgrades” he says.
Scott has positioned the F&C UK growth & income fund conservatively in recent months and intends to remain defensive. The fund manager has not held house builders and has cut the majority of its exposure to miners with little exposure to sectors such as general retail, travel and leisure. The fund has also cut exposure to small caps.
Commenting on strategy, Scott says: “We have favoured stocks with resilient earnings profiles – which will justifiably be able to command premium ratings – and gone overweight defensive sectors such as utilities, telecoms and tobacco”.