Equity outlook as FTSE reaches 5,000

The FTSE has hit 5,000 for the first time in nearly a year, but what does this mean for equity markets? AFI panellists are cautious, but say there is a wide range of opportunities available.

On September 9 the FTSE hit 5,000 for the first time in 11 months, buoyed by a combination of positive figures on British exports and manufacturing, and investment banks welcoming “the return of the deal” as Kraft bid £10 billion for Cadbury and Deutsche Telekom and France Telecom agreed to merge Orange and T-mobile.

A week later, the Dow Jones closed at its highest level of 2009 on hopes that America’s recession has ended. But is this the beginning of a recovery or merely a market rally? The AFI panellists are sceptical.

Brian Dennehy, the managing director of Dennehy Weller, describes the FTSE’s return to 5,000 as “meaningless.”

“No one knows [if] this is a new bull market or a bear market rally. The range of possible outcomes remains extremely wide. It could be either,” he says.

Mick Gilligan, the head of research at Killik, agrees that the 5,000 barrier has little real value beyond being “psychologically important for retail investors.”

And Justine Fearns, an investment research manager at AWD Chase de Vere, remains cautious. “Just because the FTSE reached 5,000 last week, and seems to have a lot of momentum behind it this summer, we should not get carried away,” she says. “We have all run with it to date but history tells us to be careful.”

However, Jonathan Wallis, the head of retail fund research at Allenbridge Group, is more optimistic.

“We have been fairly cautious of the rally to date, thinking it was just a rally in a bear market,” he says. But his view is changing. “Now we are gaining more confidence.”

But Wallis does not anticipate huge market gains throughout the rest of 2009. “The market is likely to remain within a sideways trading range, of about 4,500 – 5,000, over the next few months,” he says. “We do not see a huge downside but we do not see it going any higher in the short-term.”

So how do the AFI panellists view the market outlook for retail investors?

Wallis says he is seeing a move back into equities. “Where investors had been bearish, there is now a lot of money waiting to come in [to the market],” he says.

“Whilst bonds have done very well, it is not a bad time, especially for people looking for long term growth, to think about getting back into equities,” he says.

Gilligan agrees that capital flows will be the main driver of equity markets over the coming months.

“I expect markets to get higher as money returns,” he says. However, he fears that the market could be over-priced.

“Looking at the economic fundamentals, it is evident that there is a lot of ‘hope value’ priced into the market.”

Other AFI panellists share his caution. “British investors should probably still be wary of the market,” says Fearns. “Despite noises that we are probably over the worst, higher unemployment is expected, alongside a slow and rather painful recovery.”

Dennehy says that the current market present significant challenges for retail investors. “Advisers and investors need to remain on their toes like they never have before, not for decades,” he says.

“The key for investors is helping their clients understand this. If they are concerned about this level of uncertainty, [they should] have a portfolio of lower risk funds made up of a mix of absolute return, corporate bond, and global bond funds,” he says.

Fearns agrees that “investors should use a diversified approach, looking towards long-standing fund management teams and funds with a good track record.”

She says British funds will tend to concentrate on “good quality franchises with big brand names and on those
companies operating in markets that have a high barrier to entry.”

“There is also very likely to be a focus on companies with different revenue streams from across the globe, who may be able to benefit from earlier recoveries outside Britain,” she says.

Gilligan says that while “funds that have taken big bets on cyclicals have done very well,” he favours high quality, broadly-based funds “that are not too overweight in any one area.”

He disagrees with Dennehy’s suggestion that the market is more challenging than ever. “What is different with this recovery is product choice,” he says. “The growing number of absolute return funds means investors can choose a fund where the manager is able to protect his returns by holding short positions.”

Fearns adds that investors looking for new opportunities could also begin to consider small-caps. “They are still under a lot of pressure as debt issues are sorted out and credit lines re-established, but we are moving to a stage in the cycle where they could begin to look interesting,” she says.

The overall message from the AFI panellists is that while the FTSE’s 5,000 landmark means little, investors should neither be deterred or become over-confident. Panellists agree that there is a wide range of opportunities for investors looking to return to the equity markets, but these should be approached with caution.