Comment: Can junk rally take FTSE to record high?

Traders work on the floor of the New York Stock Exchange. Picture: Reuters
Traders work on the floor of the New York Stock Exchange. Picture: Reuters
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According to a highly-regarded income fund manager, the FTSE-100 will hit a record high this year, topping the 6,900 peak of more than a decade ago.

Gary Potter, co-manager of the Thames River multi-manager funds, says overly-cautious investors are set to miss out on the opportunity of a lifetime.

Funds holding high cash balances “are going to be dragged kicking and screaming into the markets when the support is there,” he said.

But if you’re tempted to pile in, “don’t” is the firm admonition of another.

Bruce Stout, manager of the sector-leading Murray International Trust, says the quantitative easing by western governments is “economic vandalism” that will ultimately prove a disaster when the inevitable inflation ensues.

However, investors, says Potter, have been so brainwashed by negative news that they are set to miss out on the rally and are likely to buy in at the peak. Speaking to TrustNet’s Joshua Ausden, he said “2013 will be a very important transitional year and the year when the real inflation bubble starts to deflate, and that is the bubble of risk aversion”.

Investors, he adds, are set to lose lots of money on holding on to bank deposits. That is certainly true, while the £677 million fund that Potter co-manages – Thames River Distribution – has made 55 per cent over four years, handsomely outperforming a 14.4 per cent rise in the consumer prices index over this period.

Potter even cites super-bear Albert Edwards in support, with his observation that pension funds have far too much in bonds rather than equities. “It could be a virtuous spiral which takes equities to expensive valuations. Within 12 months we will see an all-time high on the FTSE.”

However, it comes with a telling qualification: “As long as the economics are seen to be stable-to-improving, people will see there’s no reason not to be in equities.”

There is certainly no agreement that the economics are “stable to improving” in the UK, while last week saw the return of euro jitters in the wake of a deadlocked Italian election – and an incipient Europe-wide revolt against austerity budgets.

Stout is not at all convinced this is a rally we should be in.

He says the fact that a low-quality stock such as Lloyds was the best performer in the FTSE last year “tells you all you need to know about the surge in equities” – and he is avoiding the stocks that are leading it.

Stout is a fund manager to be listened to. His Murray International Trust has made more money than any other trust in the global growth sector over five and ten years, more than doubling the returns of its benchmark over the shorter period. It has returned 91 per cent over five years. However, over one year the trust has performed only marginally better than its peers. This, says Stout, is due to his sceptical attitude to the rising equity market.

“Anything that’s low in quality tends to go back down the way it came from,” he said. “And this has been a low-quality rally. What was the best-performing stock on the market last year? Lloyds. It is a low-quality investment because you can’t analyse it properly.”

Stout believes that the quantitative easing used by western governments is “economic vandalism” that will ultimately prove to be a disaster when the inevitable inflation ensues.

“It’s the arrogance of the establishment that dismisses history and believes that the Weimar Republic cannot happen in the UK, and the UK can never go down the route of Zimbabwe.” With views as diametrically opposed as these seem to be, private investors can be excused the conclusion that stock markets are fundamentally unpredictable and as likely to disappoint as they are to bring big rewards.

For that reason alone, we should avoid the assumption that these views are mutually exclusive.

My own view is that market rallies are by nature sentiment and “junk driven” and can indeed push market indices to new highs – before the reality of destructive inflation sets in and there is a correction.

It is less the phenomenon of rallies that should concern us but their sustainability and duration.

For the moment Potter’s assessment reflects the mood, with investors seizing on better news as validation that economic recovery may at last be on the way. He sees the UK FTSE-100 bring dragged to a new record by a US economy going “gangbusters” this year.

That assessment drew support last week from a further surge on Wall Street, drawing strength from a surprise rise in US manufacturing activity last month, underpinning optimism over trends in US housing and labour markets. The rally took US stocks close to cyclical highs while helping the FTSE-100 to end the week with a 0.8 per cent gain to 6,378.6.

To hit the previous peak, it would have to climb by another 8 per cent. That’s hard to see in the immediate term, but not inconceivable if the rest of the year brings evidence of an improving economic background.