Cautious optimism for UK Equities

With the UK housing market continuing to weaken, unemployment ticking higher and inflation rising above the Bank of England's upper 3.0% limit, Chris Burvill, manager of the Gartmore Cautious Managed Fund, continues to invest defensively, with equities remaining at his fund's lower limit of 40%.

However, following the stock market's sharp declines since the start of the year, Chris says that now may not be the time to be too negative about the near-term prospects for equities.

"Equities are looking well priced. While it is important not to rely too heavily upon earnings-based valuations, today's bond-equity yield gap would suggest that now is not the time to be out of the equity market altogether," comments Chris.

Inflation concerns dominate the markets currently yet, according to Chris, the picture is not straightforward. He highlights the fact that the recent sharp rise in headline inflation has not been reflected in core inflation. The Bank of England is wrestling with this problem, as it knows that recent rises in the CPI have been caused by global (supply-side) spikes in food and energy prices as opposed to demand-side pressures at home.

"There is a high probability that inflation will decline next year, after the economy has slowed and recent price hikes have fallen out of the headline numbers due to high base effects. While we did not foresee the oil price rising to US$140, we believe there is a high probability that recent gains will not be repeated this year or next."

The Cautious Managed Fund has held a large exposure to index-linked gilts over the past year, a factor that has proven advantageous to returns in an environment where investors have been worried about the credit crisis and inflation simultaneously. However, the Fund's exposure to these was reduced in June, as the manager considered real yields had fallen too far to be considered attractive.