MPC's early Christmas present provides boost to Scott's positive outlook

Despite widespread predictions of doom and gloom for investors, one of the UK's most respected fund managers – who 12 months ago accurately predicted that 2007 would see a major market correction – has now defected from the "bear" camp.

Ted Scott, whose F&C UK Growth & Income Fund has been one of the top performing UK equity income funds during 2007, believes that whilst the economy and housing market could continue to deteriorate shares are set for a good year.

"This time last year I was relatively cautious on the outlook for markets. Excessive levels of speculative activity, fuelled by high leverage and cheap credit, were unsustainable. I felt that after a bumper run for equities a significant correction was on its way. Rotten hangovers tend to follow wild parties," explained Scott.

"But 12 months on and following a credit crunch that has blown away investor confidence, I'm no long siding with the bears. In fact I am pretty sanguine about the prospects for the market and today's shot in the arm from the Bank of England adds to that," he said.

Scott concurs with the view that the risks of a recession have increased, though a 'hard landing' for the economy is most likely, but believes that "much of this is already discounted into share prices."

"The stock market is an aggregation of everyone's expectations," he explained, "but the consensus view is often wrong."

"Commodities also represent around a quarter of the UK market, so if the slowdown has global dimension, oil and mining stocks are going to be vulnerable," he added.

"However, unlike the last time the economy slowed down, which was in 2001, the market is not expensive. Back then shares peaked at 22 times earnings but now UK shares are trading at around 12.5 times earnings. UK stocks therefore are fair value."

Scott argues that the level of real interest rates has continued to decline and that equities should be priced off real rates, not nominal gilt yields.

"Currently the 10 year index-linked gilt equivalent yield is only 1.4% so unless the equity risk premium is going to rise further then this should support the stock market."

He believes that some stocks have fallen so much, value is starting to emerge, including in the unloved financials sector.

"Some of the banks and life company shares are basically discounting a full-on recession and even dividend cuts and rights issues. I think some of this will need to happen. However, even allowing for dividend cuts and earnings downgrades of up to 40%, some of these shares are cheap and the yields are attractive for income funds. In my view there is considerable upside potential once the clouds of the credit crisis dissipate."

One of the areas where he remains cautious is the mining sector.

"Miners and emerging markets have been largely driven up by liquidity. M&A activity, such as the bid for Rio, has also provided a fillip to the sector. Speculation may continue to prop up the sector for a while but share prices have clearly decoupled from underlying base metal prices which have been falling for some time. If M&A dries up – as it did in the pub sector – the downside could be considerable."

"In my view, falling base metal prices are also indicative of the likelihood that emerging markets will not decouple from the US and other developed markets as they slow. Emerging markets now trade at a premium to the US and other developed markets and that makes them vulnerable to a considerable correction should they show some collateral damage from the credit crisis and slowdown," "So, while there are definitely some potential pot holes to avoid. As confidence slowly returns, and a turn in the rate cycle may assist that, 2008 will shape up to be a positive year for shares," he concluded.