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Wallowing in a hippo year

After a year in which investor sentiment improved and stockmarkets climbed, it is tempting to suggest that the most savage bear market for decades is finally over.

But is it really? Characteristically, fund managers have failed to reach any kind of consensus and have this time even devised a new met-aphor to describe the current investment environment – a hippo market.

Jupiter chief investment officer and undervalued assets fund manager Edward Bonham Carter believes hippos are apt because they “wallow around most of the time with occasional bouts of activity which can be hazardous to observers”.

Although it is not doom and gloom for the UK, Bonham Carter says spells of sluggish growth cannot be ruled out because of the influence of cautious business investment and household spending – problematic in his view because even tentative efforts to rein in increasingly debt-saddled consumers can be inadvertently heavy-handed.

As a result, Bonham Carter concurs with conventional wisdom that the stockmarket will be 10 per cent higher in 12 months, with the caveat that it will be “plus or minus 10 per cent – probably”.

More decisive is Fidelity, which depicts a world in which economic activity accelerates in the US while Japan and Europe undergo a gradual recovery. But it again points to risks such as high consumer debt and high commodity prices, arguing that much of the good news has already been discounted, leaving the stockmarket vulnerable to negative surprises.

Nevertheless, it believes equities will still outperform bonds and advises investors to diversify their portfolios by asset class. Fidelity believes picking stocks based on fundamental analysis should be more rewarding than sector or investment style calls as they are likely to be prone to rotation this year.

Schroders takes a more neutral view, arguing that, as the UK has been among the least affected by the global recession, other markets could present better opportunities.

Asset allocation committee member Mark Pignatelli says: “There are many high-quality, stock-specific opportunities in this market. However, balancing this is the fact that the market as a whole has less to gain from global recovery as the UK economy has been robust. From a top-down perspective, we believe that other markets offer better prospects in the current environment of economic recovery.”

M&G, however, takes a different tack, pointing out that the UK stockmarket is among the most international, meaning investors can access the global upturn by investing in household names. But it expects the FTSE&#39s various markets to perform very differently in 2004.

Head of global analysis John Hatherly says: “We expect a better relative performance from the FTSE 100 index which lagged behind mid-cap and small-cap indices in 2003. Many of its constituents yield more than the current base rate (3.75 per cent), providing a rich field for equity income fund managers.”

Hatherly says recovery investing also looks well placed to continue its run against an improving business background, with the best returns this year likely to be achieved by effective stock selection rather than trying to identify undervalued sectors. But some fund managers are quite bullish about the macro outlook and expect the effects of this to be felt keenly in the UK.

New Star UK growth fund manager Stephen Whittaker says: “2004 has the potential to be a positive year for UK equities. The Government is still committed to ambitious spending plans so fiscal policy remains supportive, corporate profitability is rising and global recovery should help boost external trade and begin to pick up some of the slack from domestic consumers. As a result, the UK economy should become slightly more balanced after a period of serious imbalances.”

Axa Investment Managers, however, believes the extent of this rebalancing will depend on the type of company involved. Head of UK equities Stuart Fowler says: “Operational gearing is going to be key in 2004. For commercial companies seeing an upturn in their business, we are likely to see a dramatic increase in profitability as revenue growth flows straight through to the bottom line. For consumer companies potentially suffering from a slowdown, we may well see profit downgrades.”

Fowler says now that the “extremes” of the bear market have gone, many stocks are appropriately priced and will be driven by newsflow rather than re-ratings or deratings. Legal & General Investment Management agrees, saying it expects equity markets to continue to move forward this year – predicting that the FTSE 100 will end the year at 4,700 – but that other asset classes could suffer.

Financial economist And-rew Clare says: “The US economy has picked up strongly this year and after a couple of years in the doldrums, even Europe and Japan are showing signs of recovery. Equity markets have reflected this with modest gains this year. In the UK, we believe this progress can continue. The outlook for interest rates is one of modest increases and this will make it a difficult year for investment-grade corporate bonds and gilts.”

Threadneedle also argues that fixed-income investors should consider raising their risk profile due to low inflation. Although it concurs with L&GIM&#39s view that interest rates will creep up, it believes bond markets have already priced this in, with Government bonds returning no more than their interest payments.

Marketing director Dick Eats says: “In contrast, in the world of corporate bonds, falling default rates, rising global growth, better company newsflow and the first indications that a number of fallen angels could be upgraded represent a compelling environment for high yield.”

So, there you have it. Among the big groups, there are no staunch bulls or bears this year – the only consensus is that investors need to take more risk. But then the industry does have something of a history in calling these things wrong.


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