By Claire Racine

Due to risk and cyclically sensitive assets such as equities, credit and commodities enjoying a strong recovery during the second quarter of the year, there are hopes that economic recovery is imminent and that the global recession is close to an end.

Despite the S&P500 index moving up by 42% on March 6 and many emerging markets showing even greater gains, Paul Niven, head of Asset Allocation for F&C Investments, is more cautious and feels that investors may be too sanguine on the outlook for the economy and the risks that remain prevalent.

“Despite the significant rally seen across markets, we still stand some way from pre-Lehman levels across asset prices and economic indicators, which is being seen by some as a bullish precursor to a ‘normalisation' of market conditions,” he said.

The collapse of Lehman Brothers led to a seizure in credit markets, a systemic meltdown, he said.

The collapse in output, leading to double-digit annualised declines in GDP even in developed economies, created a massive overshoot to the downside in many market and economic indicators.

Market and economic indicators have moved higher, and, while the period of expansion may still be months away, it was almost inevitable that a “V-shaped” recovery would occur.

Unfortunately, Niven believes the “V-shaped recovery” will give way to an even more turgid economic backdrop.

“That said, we will see a return to positive rates of growth in many economies in the next quarter and there is every likelihood that many emerging areas will remain relatively robust, giving greater credence to the ‘decoupling' theme,” Niven added.

“Nonetheless, the hangover from the credit crisis will be long lasting and not easily forgotten.”

US equities currently trade on 15.5x trend earnings, just below long-run average levels, and credit markets have moved from pricing in defaults consistent with depression to a situation more consistent with severe recession.

On the other hand, insider buying is now low and technical indicators suggest that markets are reaching overbought territory.

In contrast to equities, credits and commodities, government bonds have had a torrid time.

Despite poor long-run valuations and the inflation and rating risks surrounding government bonds, Niven feels that economic disappointment, ongoing risks of deflation and a likely desire of authorities to cap the rise in yields will help yields down in coming months.

“Within markets, we continue to favour emerging markets and are negative on Europe and the US,” Niven said. “We are reversing our long position on UK equities, partly in response to the rapid rise in sterling.”

Although the dollar is supposed to weaken, there is scope for outperformance of overseas assets in sterling terms and the UK equity market now has no clear relative attractions on an unhedged basis.

Niven believes that we are close to the end of the bear market rally.

From here, the risks on equities and credits are much more finely balanced and markets have shown they are capable of rising on ‘no news' or even on what appears to be ‘bad news'.

“With the move upwards in risk assets occurring in such a short space of time and on modest overall volumes there is an argument that most have missed the opportunity and are now being sucked in, which may force prices higher,” Niven said.

“To move much higher in the short term, beyond an overshoot, and into a new bull market will require fundamental improvement beyond what we believe is reasonable to expect.”