Scott: "We're now officially in a Bear Market"

With UK and European equity markets opening sharply lower this morning led by miners and banks feeling the worst of the pain, the FTSE 100 Index has now declined by more than 20% since its peak last Autumn marking the technical definition of a ‘Bear Market'.

Ted Scott, manager of the F&C UK Growth & Income Fund, comments: "Over recent months the UK equity market has become increasingly polarised between relative strength in commodities on the one hand and weakness in domestic and cyclical sectors, reflecting the worsening macro backdrop."

The under performance of domestic and cyclical stocks, which has been particularly savage in the house building sector, raises the question as to when is the right time to starting aggressively buying.

Scott's own view is that: "We are not there yet. While we are now technically in a bear market for equities, in terms of the economic backdrop we are still not in a recession. At present the UK economy has only just begun to slow after a robust 2007 when GDP growth was above trend. Despite months of gloomy headlines, house prices have so far only fallen a few percent from their peaks and unemployment is low, albeit rising. Therefore, if a recession does become a reality - and the risks lean that way - there could be further to go."

Against this backdrop, Scott argues that the Bank of England's rate cutting policy has been rendered impotent by lenders largely not responding to it and, indeed, he points out that mortgage rates and consumer credit has tightened.

"Meanwhile, inflation is a real concern that I believe is still not adequately factored into the market. For the last decade we have enjoyed a stable economy, abundant credit and low inflation of around 2.5% on average. Bond markets are already pricing in inflation of 3-3.5% and this is limiting the Bank of England's scope for rate cuts," he said.

"Some will argue that the valuation of UK stocks is attractive at 12 x earnings but I am cautious about valuation traps," added Scott. "Unlike the period prior to the bear market of 2000-2003 we have not been in a valuation bubble but we may well have reached a peak in cyclical earnings, i.e. an earnings bubble. Earnings expectations are already being downgraded for domestic cyclical stocks and any fall back in commodity prices could see substantial downgrades."

Given his views Scott has positioned the F&C UK Growth & Income Fund conservatively in recent months and he intends to remain defensive.

"We have not held house builders, cut most of our exposure to miners and have had very little exposure to sectors such as general retail, travel and leisure. We have also reduced our exposure to small caps compared to the fund's historic profile. On the flip side we have favoured stocks with resilient earnings profiles - which will justifiably be able to command premium ratings - and gone overweight defensive sectors such as utilities, telecoms and tobacco," he concluded.