Caution is key as the number of profit warnings increases

Current environment offers shorting opportunities but little on the long side

It is going to be a tough reporting season for UK businesses, according to Paul Findlay, manager of Threadneedle's Crescendo UK fund.


As such, he remains cautious over the short-term outlook. 'We do not find valuations particularly compelling,' he says. 'Companies have been cutting costs, but there is little pricing power out there.Costs are also rising and there is pressure on the bottom line.'


Findlay was speaking in the wake of recent disappointing statements from Invensys and De La Rue.


'The profit warnings are coming one a day at the moment and we are just picking them off,' he says.


At the moment, Findlay is taking a 'glass half-empty' viewpoint with regards to the recent sufferings on the part of the UK market.


Far from companies taking the opportunity afforded by the recent downturn to become leaner and fitter going into a possible upturn in the economy, firms have tended to 'adopt a strategy of waiting around on the economy improving.'


'But it is going to be a challenging economic environment in the UK this year,' he adds.


All of which means Findlay is 'still making money from the short book, particularly from over-leveraged industries, insurance ' especially life assurance companies ' and consumer cyclicals.'


While not disagreeing about the poor state of the UK market, New Star UK hedge fund manager, Alan Miller, takes a more 'glass half-full' attitude to what this means for his chances of making some money.


Miller believes there are more opportunities to make money in the present environment than at any time previously in the lifetime of his fund, which is now over six years old.


'On the one hand,' he says, 'there are some good quality companies on incredibly low valuations, and on the other there are some perceived safe havens which are often distinctly overvalued.'


Of the latter, Miller mentions Reckitt Benckiser which saw its share price take a hit after the company announced a £670m share placing.


'It was trading at a P/E multiple of around 18,' says Miller. 'Its reported figures were in line with expectations but the valuation was so full it discounted significant upgrades to expectations which did not occur.


'As a consequence the shares fell by 10% on the day of the figures thus showing the dangers of ignoring valuations when investing.'


Miller says his fund is looking to take advantage of the valuation gap between the good and bad companies, spotting where he thought the market had got it wrong. 'Fund managers can often be herd-like, getting into the wrong share at the wrong time at the wrong place,' he says.


The optimistic/pessimistic split between the two managers extends beyond their respective viewpoints on present market conditions and opportunities. On the prospects after what the market now sees as the inevitable war on Iraq, Findlay is downbeat.


'We believe the geopolitical uncertainty is here to stay,' he says. 'Even a resolution of the conflict won't be the end of the problems. It won't mean the end of global terrorism.' The continued stress will not be good for the markets.


In comparison, Miller is more sanguine. 'Above all investors hate uncertainty,' he says. 'But it looks like the uncertainty regarding Iraq will be over in the next two to three months. This should be good for equity markets generally, especially where investor pessimism is pronounced and valuations excessively low.'


The split in opinion between the two managers suggests we are entering unknown territory in terms of the market's reactions to continued global uncertainty.


In an atmosphere where a leaked letter to shareholders of Berkshire Hathaway from Warren Buffet suggests that derivatives are 'financial weapons of mass destruction,' the confusion of opinion is perhaps unsurprising.


However, recent market history suggests those investors who have adopted the less optimistic outlook during the last two years have been proved largely right.


If war does occur in the Middle East, if it is quick and if the region is not further destabilised, then we could see markets head swiftly northwards again. Findlay's comments suggest that at least some parts of the UK hedge fund universe will not be overly keen to join the party.





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