Bulls stay cautious as market rises but the doubts remain

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The Independent Online

After six months of stunning equity returns, many investment professionals are hailing the end of the bear market. Others, however, still say it is far too early to be optimistic and are convinced that far tougher times lie ahead.

The FTSE 100 index of the UK's largest companies has risen by some 25 per cent since it plunged to a low of 3,287 in mid March. If you had had the foresight to invest around this time, you would now be sitting on a healthy profit. The average UK equity unit trust has turned £1,000 into £1,234 since 9 March, and the best performing, Insight UK Dynamic, has turned £1,000 into a startling £1,623 after all charges, according to Standard & Poor's. The big question is whether this type of growth can be continued, or even sustained.

Bulls expect that the UK market will continue its upward climb, while the more bearish expect that the world's economies and markets still have too many fundamental problems in order to make further progress.

The seesaw between the two opposing groups is lurching from side to side as the professional investment world tries to assess whether the March low really did mark the end of the three-year bear market - or whether the surging rally of the past six months is a false dawn, borne on a tide of hope, only to return again to flirt with a FTSE index reading of 3000. As each month passes, confidence grows, and more doubters become convinced that the market has moved on to a new bull phase. This stage could last some time, because confidence had been so badly shattered: when the stock market hit its low point in January 1975 it took years to recover any genuine sense of optimism. And some highly respected names are still refusing to be budged from their bearish stance.

Neil Woodford, manager of the Invesco Perpetual Income fund and one of the most highly respected and successful managers in the UK, believes the bear market is far from over.

He rightly called the collapse of the technology bubble in 2000. Despite much criticism at the time, Mr Woodford avoided highly expensive technology, media and telecoms (TMT) stocks while most of his peers were continuing to pay above the odds and eventually suffered the share-price collapse. Once again, he is taking a view that differs from many other fund managers.

Mr Woodford believes low interest rates have led to too much debt at both a personal and government level. "This unprecedented borrowing has in turn borrowed too much consumption from the future, leaving little scope for demand to increase significantly. There is no pent-up demand, thus there is little scope for recovery," he said.

Furthermore, Mr Woodford believes the excesses in the global economy must start to unwind, which could once again raise the threat of deflation. Under such a climate, many companies will find it difficult to thrive.

In addition, many companies are now expensive, he added. "Market consensus has now embraced cyclical recovery and this is reflected in the relatively high valuations of cyclical sectors such as media and house builders. Expectations, and therefore valuations, of these stocks have been raised to levels which are unrealistic," Mr Woodford said.

Jeremy Lang, successful manager of the Liontrust First Income fund, is also bearish and expects the market to get far worse before it improves. Mr Lang believes the FTSE 100 index will fall to about 2,800 over the next year.

"Companies are reporting decent results now because they have managed to implement some cost-cutting, which has led to higher margins. Soon there will be no more scope to cut costs, and strong company reporting will not be able to hold up," Mr Lang said.

But Mr Lang and Mr Woodford are in a minority: there appear to be more bulls than bears among fund managers.

Trevor Green, manager of the Allianz Dresdner UK Growth fund, points to improving economic data from the US feeding through to the rest of the word and ultimately benefiting corporate profits. "The market will trend upwards, but we will not see anything like the explosive growth seen in the past," he said. Mr Green expects the FTSE 100 to climb to 4,800 by this time next year.

Robert Talbut, chief investment officer at Isis Asset Management, expects the FTSE 100 will reach 4,500 over the next few months and is likely to hit 4,780 in a year's time. He believes equities are cheap. "After the battering that UK stocks have taken, share prices are, in many cases, half of what they were three or four years ago, while the outlook for the businesses themselves is brighter than it has been in years," he said.

Jon Thornton, head of UK equities at Gartmore, is also cautiously optimistic, forecasting a FTSE 100 of 4,800 for this time next year. "I am not suggesting the world is a fantastic place for investment, nor that we will go back to the boom cycles of the past," he said. "However, I never believed the stories of desperation, despair and deflation."

He argued that with an election in the US next year, the US Government will continue doing everything in its power to facilitate a robust macro environment.

"Masses of liquidity is being pumped into the system through monetary and fiscal stimulus. Growth is being encouraged rather than discouraged," Mr Thornton said.

The bullish managers concede, however, that further terrorist attacks are a major risk to future growth because they will inevitably undermine investor confidence.

And Stephen Whittaker, manager of the New Star UK Growth fund, cites a major risk as growth being far stronger than expected, which will prompt the Bank of England to increase interest rates.

EXPERT VIEW: WHERE WILL THE FTSE 100 BE THIS TIME NEXT YEAR?

Neil Woodford, manager of Invesco Perpetual UK Income: FTSE forecast: 4300

By this time next year the market will be roughly the same as now or perhaps 5 per cent higher, but I expect it will dip below 4000 within the next six months. The market is too high in anticipation of economic recovery and, when strong economic data does not eventuate, share prices will once again fall as confidence is undermined. I expect I can still make money from UK shares, as defensive companies like tobacco and utilities are out of favour and very cheap. This is a very good buying opportunity for me.

Jeremy Lang, manager of Liontrust First Income: FTSE forecast: 2800

Stock market direction hinges on the reporting season of the first quarter of 2004. The current reports are not too bad - mainly due to cost-cutting. The next reporting season in March and April will be the acid test, as little more cost-cutting can be achieved. When the market sees there is no revenue growth, confidence could ebb away. Exactly when over the next year the declines will come is less certain and within a year's time the market may well have rebounded and be on its way back up. I expect the market will be lower this time next year.

Edward Bonham-Carter,

manager of Jupiter Undervalued Assets: FTSE forecast: 4900

I'm optimistic in the short to medium term, but we won't see another bull market of the magnitude of the 1990s. The US economy will recover as the benefits of low interest rates compound. The risk is that the economic recovery will be anaemic and that corporate earnings, in a low inflation environment, will not be as strong as we would like. Additionally, there is a lot of debt in the world that could constrain consumption at government and consumer level. Over the medium term, I expect the market will move largely sideways, which is what we call "range trading".

Stephen Whittaker, manager of New Star UK Growth: FTSE forecast: 5000

Economic growth is going to be better than people expect and hence earnings will come in better than anticipated. There is simply too much unwarranted pessimism around. Interest rates will stay low for longer than expected and that will lead to further growth. The main risk is that growth proves to be too strong, and that interest rates go up sooner than I now anticipate. Although I expect growth going forward, we will not see anything like the returns of the late 1990s; absolute returns of about 8 per cent a year are possible.

Robert Talbut, chief investment officer, Isis Asset Management: FTSE forecast 4780

Valuations are cheap, but another reason to be positive is increased merger and acquisition activity. We have already seen about £3.5bn of proposed de-listing this year, as business managers believe their prospects are now so attractive that many want to take their companies private. This makes it an ideal time for cash predators to pounce. Almost every sector has at least one juicy takeover target. While such activity has a habit of triggering a spate of such deals, this means we could see some focused and explosive price movement across the market.

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