Some are insisting that the news proves the UK economy has finally turned a corner.
In an article last week some of the more bullish industry commentators highlighted small caps and commercial property as being well-placed to deliver strong returns in an improving economic backdrop.
The optimistic tones were brushed off by many of our readers, who remain unconvinced – and in some cases downright insulted – by those who declare the financial crisis is over. This view is shared by a number of high-profile experts, who view the GDP numbers as anything but a milestone, and are expecting a sharp correction in light of complacency and expensive valuations.
Here we hear from four experts with a more bearish outlook who believe it is time to de-risk, diversify or even hide in cash, in spite of the growth in the economy.
Charles Hepworth, investment director at GAM
Hepworth (pictured), also a fund of funds manager, has been reducing exposure to the UK in recent weeks and months.
He believes the recovery has been unbalanced, and therefore at risk from an interest rate rise, expected later this year.
“GDP numbers are always lagged and so the market has already anticipated the recovery that is coming through now and to some extent last year. It has risen to its current level on the back of that, so it is already priced in,” he said.
Performance of indices over 6yrs
Source: FE Analytics
“We see this as a reason to become less bullish and have actually taken a bit of money away from the UK. The recovery as such is really very unbalanced still and so we can’t say we are in full-recovery mode – I don’t think we are.”
Hepworth says the housing market recovery has been the key driver of overall boost to GDP numbers.
“The overall recovery we have allegedly been getting has been in the housing market, which has boosted GDP numbers in the short term,” he said. “However, business investment really isn’t there, which is usually the main driver of a recovery.”
“I don’t think [the market] is going to continue going higher from here. It looks like we are in the mid-stage of the cycle, which is not the best stage of the business cycle.”
Robin McDonald – co-head of Schroders’ multi-manager range
Despite the strength of the recent GDP numbers, McDonald (pictured) is cautious for the prospects of both bonds and equities.
He points out that both equities and bonds have been in a bull market since 2009, meaning that positive fundamentals are outweighed by expensive valuations.“The Q2 reading of 3.1 per cent growth in GDP is the highest since mid-2007. The economy is also close to recovering the absolute level of GDP it held pre-crisis. This is obviously welcome five years after the recession but the US recaptured its pre-crisis peak level a while back,” McDonald said.
“In our view now is a time to invest conservatively. In terms of the investment implications, we think the best returns this cycle for both UK bonds and equities are behind us.”
McDonald, alongside FE Alpha Manager Marcus Brookes, has been upping cash in expectation of a market correction.
The managers have upped the cash weighting to 33 per cent in their flagship Schroder MM Diversity fund over the past 18 months, and increased the weighting from 24 to 42 per cent in the Schroder MM Tactical fund.
The managers have also been piling into alternative assets such as absolute return funds, which have little to no correlation to the equity and bond markets.
McDonald says cyclical businesses that are traditionally more sensitive to economic growth are at particular risk of a downturn.
McDonald and Brookes benefited from high cyclical exposure throughout 2012 and 2013, with funds such as Fidelity Special Sits delivering strong returns over the period. However, he says these portfolios are now screaming sells.
“They have underperformed the market this year in spite of the strong headline performance of the economy. This follows a strong few years for cyclicals when measures of economic growth were – ironically – weaker,” he explained.
If the economy continues to grow there should also be a modest pick-up in inflation, says McDonald, which will be a headwind to bond investors.
“With higher nominal growth we would anticipate higher bond yields and higher short term interest rates,” he added. “This will be a headwind for investors in traditional fixed income funds and could result in negative absolute returns.”
“Higher bond yields would also be a headwind to equities in our view.”
Ben Willis – head of research at Whitechurch
Willis (pictured) says the news is less positive for equity markets than the numbers suggest and that investors should place greater emphasis on earnings.
“Generally GDP isn’t correlated to stock markets and if you look at earnings growth it has been pretty poor in the UK with a lot of downgrades,” he said.
“At the moment it is looking a bit patchy as to whether earnings will grow. UK markets are not cheap and are looking a bit toppy.”
Iain Stewart – manager of the Newton Real Return fund
Stewart (pictured) has been at the helm of the £9.1bn fund for a decade but anticipates an even tougher decade ahead.
The fund has stayed ahead of the FTSE All Share for much of the past 10 years, although has recently slowed relative to the index’s gains. This is in part because of a higher cash weighting, which now stands at almost 20 per cent.
Performance of fund and indices over 10yrs
Source: FE Analytics
Due to high valuations and record corporate margins, as well as various structural headwinds to economic growth, equities are unlikely to perform as well as they have done over the past three to five years, Stewart says.
“Financial assets are looked upon in a very different way to everything else,” he explained. “If a price of potatoes goes up, you’re more likely to look elsewhere to find something cheaper, but in investment quite often it’s the opposite. If the price goes up, more people want to buy.”
“I’m not convinced the growth coming through is sustainable, although demand has been brought forward, real disposable incomes are not increasing.”
“When you hear people talking again about the lack of need for absolute return, it’s often been the case that this is the time you should be doing the opposite. Investors tend to work in herds.”
