Funds bet on economic growth and equities

By Pratima Desai
LONDON (Reuters) - Optimism about global economic growth and expectations of higher equity prices persuaded British fund managers to raise their stock holdings for the second month running in April, a Reuters survey showed.

Fund managers shrugged off China's decision to raise interest rates, saying it had been expected and that it would make little difference in the long-term as the Chinese government was not aiming to choke, but only slow growth.

The survey of 10 asset managers, with nearly 800 billion pounds under management, carried out April 19-27 showed the average equity holding at 73.2 percent in April compared with 72.9 percent in March and 71.6 percent in February.

February's figure was the lowest since the 71.2 percent recorded in May 2005.

Some of the recent rise in equity exposure is because of investment gains as markets have been trending higher, but some is also due to new stock market investments.

"The corporate growth story is intact ... It's interesting that for this particular quarter earnings haven't been revised down to the extent they usually are," said Frances Hudson, global strategist at Standard Life Investments.

"It's also interesting to note that this will be the 11th consecutive quarter of double digit earnings growth for companies in (U.S. benchmark) the S&P 500."

Bond holdings slipped to 19.1 percent in April from 19.3 percent in March, while cash holdings averaged 4.4 percent compared with 4.5 percent.

VIOLENT REACTION

Given this benign scenario, what are the risks?

Managers expect a turn in sentiment, but are reluctant to try and pinpoint the time. Some think equity prices could be approaching a peak by the end of this year, while others think they could start have started slipping by then.
An early reversal could be triggered if the U.S. housing market slowed by more than economists are expecting or if the consensus on U.S. benchmark interest rates changes.

Expectations are the U.S. Federal Reserve will halt the tightening cycle when the funds rate reaches 5.0 percent in May. But there is speculation, despite comments to the contrary by U.S. officials, that more hikes could be in the pipeline.

"The economic and earnings news flow has been very positive, but the market is nervous about interest rates " said Tony Dolphin, strategy director at Henderson Global Investors.

Worries about tighter U.S. labour markets, the risks of higher wage costs eroding corporate profit margins and rising inflation are surfacing in bond markets.

Bond markets historically react more violently to too-strong growth and inflationary signals then they do to indicators which show that an economy is weaker then was previously thought.

For equity investors, the danger sign is when yields on 10-year U.S. Treasury bonds rise above 5.5 percent. At that point they too start worrying about inflation and pare back stocks holdings to lock in profits.

"If you look back through history, you don't get many 3-year upswings without (equity) markets falling 10 percent," Dolphin said. "It will be a modest reversal, not the start of another bear markets in stocks."

The equity bear market which started early in 2000 continued until the first half of 2003.