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Woodford takes the plunge

Leading fund manager Neil Woodford has forecast that UK house prices will fall by 8 to 10 per cent this year. In an investment analysis from Invesco Perpetual, he predicts that consumers will start reining in their borrowing and spending. He says a correction in house prices will begin to bring the house price/earnings ratio back to a more healthy level.

Some industry commentators suggest the UK is less vulnerable to a housing market downturn than the US but Woodford, who controls over £15bn in assets, believes the UK is just as likely to see prices plunge.

He says: “I would point to excessive construction in certain sectors of the market. For example, newbuild flats aimed at the buy-to-let market are now almost unsellable. So, although my forecast is for house prices across the UK to fall by 8 to 10 per cent in 2008, in certain areas, the decline may be much worse.”

Woodford believes a correction in house prices would be positive in the long term because they are unrealistically high.

He says: “House prices are too high, especially when measured in relation to incomes, and an adjustment in house prices may now be starting. House prices are now 5.7 times average earnings – higher than the previous peak reached in June 1989.”

Hargreaves Lansdown head of research Mark Dampier says the housing market is “well and truly overpriced” after a 200 per cent increase in prices over the past 10 years. He believes prices need to fall by 25 to 30 per cent over the next three years to get the market back to a healthy level.

Dampier says: “Residential property is a grand illusion. Prices do fall. In the longer term, a drop in house prices is good. Some resemblance of value needs to come back to the market.”

Plan Invest joint managing director Mike Owen says: “There is a lot of froth in the market at the moment. Some sort of correction is inevitable as it is not healthy to have prices rising so much.”

In June 1989, the house price/earnings ratio peaked at 4.97 before declining steadily until December 1995 as house prices fell and earnings rose. Woodford says the ratio is about to decline again but he expects turmoil in the banking sector to be the catalyst triggering the correction this time round.

Cazenove head of multi-manager Marcus Brookes says demand is likely to dry up at the top and bottom ends of the market. He says first-time buyers will struggle to afford to buy property as many lenders withdraw high loan-to-value products but the situation is also grim at the top end of the market as City bonuses are falling.

In the US, the bursting of the house price bubble is causing a fall in consumer confidence. Woodford believes this will instil a desire in people to save. He says an element of distress has entered the market, making the changes quicker and more painful. He says UK consumers were happy to fund their lifestyles with borrowed money as long as house prices were rising but that model is “running out of steam” and consumer retrenchment is very likely.

What effect would a 10 per cent fall in house prices have on the stockmarket?

Dampier says the FTSE should weather a storm fairly well but the retail sector is likely to suffer because many consumers will be borrowing and spending less.

He says: “If house prices fall, people are less likely to move and the market will stagnate. Consumer-related retail businesses will suffer, which is probably why Woodford has not got anything in consumer retail markets at the moment.”

Owen says: “A rein back on spending would feed back to the retail sector which is the sector that would suffer the most.”

Woodford says there are many companies which are not exposed to the problems of slowing consumer spending and a weaker housing market which offer good value.

He says tobacco stocks, utilities and big pharmaceuticals can grow their earnings, cashflow and dividend payments over time while being relatively immune to a consumer downturn.

Brookes believes large caps will be more popular. He says: “Larger companies tend to have more solid balance sheets. Anything with lots of debt will come under pressure.”

In terms of investor confidence, Owen says many people will be more cautious with their money and choose to invest less.

Brookes says the average person has a lot of debt and would be well advised to pay this off and then start saving. He says it is a time for consumers to “rebuild their balance sheets” but adds that many people will still be investing through their pension fund.

T Bailey fund manager Jason Britton says: “The stockmarket has a number of issues to address this year and house prices would be just one of them but pockets of value are starting to show. Retail does not look optimistic but whether that is down to house prices is debatable.”

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