As the FTSE 100 index last week broke through 5,300 for the first time since the Lehman Brothers collapse in September 2008, we invited six of the UK’s top fund managers to our offices to discuss the market outlook.

Most were downbeat about the public finances, with Richard Buxton of Schroders saying he would rather invest in Tesco bonds than UK gilts (government bonds).

Official figures later showed that the public finances had deteriorated at a much sharper pace than expected in October, taking public borrowing as a share of the economy to its highest on record. The Office for National Statistics said public sector net borrowing was £11.5 billion last month, against £100m a year earlier — and well above most forecasts of about £6 billion.

However, our panellists were upbeat about the stock market rally, saying it could continue well into next year as interest rates remain low and the Footsie’s international focus keeps it divorced from the ailing UK economy.

David Jane at M&G thought shares could gain 20% by the end of 2010, while Tim Steer of Artemis pencilled 15%. But Steve Russell of Ruffer sounded a note of caution, warning of the risk of resurgent inflation and forecasting a flat market next year.

Here, we outline their views on the market and what investors should be buying:

Kathryn Cooper, Money editor: The one big question facing investors now is, am I too late to invest in these markets?

Tim Steer, Artemis: I remain fairly bullish. The pace of the rally is likely to slow down, but the world economy remains sound. There are huge swathes of the global economy that are growing extremely strongly.

Interest rates are very low and the medium-term outlook for inflation is stable. At the same time, [share] valuations are quite attractive so, in general, I think the stock market can move significantly higher.

Ben Yearsley, Hargreaves Lansdown: The market does not look extremely cheap — like it did in March, when both equities and bonds appeared undervalued — but neither does it look wildly expensive — as it would if we were at the top of a bull market. It just looks like good, long-term value.

Richard Buxton, Schroders: I’m concerned about the UK economy over the next two years. I don’t think we’re going to have a V-shaped recovery. We’re the best-placed country to have an L-or W-shaped recovery. Vat will go up — not just in January, but again thereafter. We’ll have an austerity budget and public sector job cuts. Thankfully, the stock market doesn’t imitate the economy. Shares will get more volatile because nothing goes in a straight line forever, but the market is likely to continue to surprise people by how buoyant it is.

Cooper: Isn’t the rally dependent on stimulus packages such as the Bank of England’s £200 billion quantitative easing?

David Jane, M&G: The initial phase of the rally was clearly caused by free money. However, time has moved on. The financial system in the West is okay and there’s plenty of the world economy that’s growing extremely strongly.

Steve Russell, Ruffer: I’m not convinced. The rally can continue only as long as the government keeps pumping money into the system, although we can’t see that there’s the option of cutting the stimulus for the moment. If it was withdrawn, the rally would collapse: there’s no evidence of any actual recovery in the private sector.

Philip Ehrmann, Jupiter: I expect the Chinese to start withdrawing some of their fiscal stimulus. In fact, there’s plenty of evidence that they’re beginning to do so. But that’s mainly because consumer confidence is building, retail sales are ticking along at 16% year-on-year and property activity is strong. However, I see plenty of other pitfalls elsewhere in the world, which is maybe one of the reasons I feel so comfortable looking East rather than West.

EMERGING MARKETS

Cooper: Is there not an argument that emerging markets are looking overvalued?

Ehrmann: I don’t think so. We’re almost a year on from the period of maximum stress and people forget that markets became extremely undervalued and are now back at fair value. Many analysts expected a very hard landing for the global economy — and China certainly flirted with it at the end of last year, but it’s set to produce very good economic growth of about 8.5% for 2009. On the back of that, analysts are now raising their forecasts for company earnings.

Mark Barnett, Invesco Perpetual: There’s a consensus about emerging markets, with everyone concluding that China is the last man standing. That’s fine, and I’m prepared to buy into that consensus. What I’m not prepared to buy into is the price — the ever-increasing price of buying the likes of BHP Billiton [the miner, which benefits from Chinese growth]. I’m looking at British American Tobacco or Astra Zeneca [the drugs group], which has a decent China business, Balfour Beatty [the builder] or Unilever [the consumer products business]. These are increasingly exposed to emerging markets, principally China, but India as well. For me, it’s a much cheaper and less volatile way of playing the theme.

BLUE-CHIPS

Cooper: You seem to favour larger companies. Does this mean that you’d be worried about medium-sized firms?

Russell: I am very much in favour of the bigger companies. They’re strong financially, they’ve got access to funding through the corporate-bond markets and they’re global. The rise in the value of UK and US blue-chips over the next six months could astound people.

The Tescos, Vodafones and BPs of the world will go to premium ratings. When interest rates are so low, where else do you get a safe dividend?

Jane: I disagree. Pretty much everyone round the table agrees that the Western economies are going to be okay and emerging economies are going to be great.

If that’s the environment, then clearly companies that are able to grow their revenues will outperform, whether or not they are small or large.

THE NEXT BUBBLE

Cooper: What are the dangers ahead?

Steer: When you have low interest rates, generally, people try to find a return from somewhere else. I think there could be a massive asset bubble building up as a result of low interest rates in the developed world that will pop just as the credit market popped or the tech market popped.

Jane: It’s surely a long way off. It doesn’t feel like a bubble to me.

Ehrmann: China’s 30% below its peak, even now, so it’s certainly not overcooked.

Barnett: I think equities are the right asset to be in but I’m not prepared to play a dangerous game with investors’ money. I’m buying the section of the market that’s sitting on historically cheap valuations and with strong dividend yields. You could never imagine Vodafone trading on eight-or nine-times earnings with a dividend yield of 5%, when 10 years ago it was trading at 100 times earnings with no dividend yield.

Russell: We could see global inflation of 5% or 10%. That’s why we’re not gung-ho for equities.

HOUSING MARKET C

ooper: Could a long period of low interest rates also inflate another housing bubble?

Russell: I’m definitely a bear on the housing market but there’s a possibility that it could go up 10% to 20% in the next 18 months. It’s totally unsustainable.

Yearsley: There’s bound to be a double dip. There will be more unemployment, banks are not lending and loads of people are coming off their low tracker rates. I don’t see residential property rising from this level.

WHAT TO BUY

Cooper: What other themes or sectors are you focusing on?

Yearsley: Technology looks interesting: it’s the one sector that has no pension problems and cash on the balance sheet. And how can you become more efficient? You employ technology to best use.

Jane: Consumer goods firms — like Colgate, Unilever and PZ Cussons — are looking good. They are potential bid targets and are exposed to emerging market growth.

Ehrmann: Hollysys Automation Technologies, listed in America, and China High Precision Automation, listed in Hong Kong, are two industrial automation companies benefiting from the drive for productivity. Pharmaceuticals seem to be pretty cheap again, too. The only thing people seem to agree on is medical reform, whether that be in the US or in China. Some of the leading pharmaceuticals companies in China are Chinese-based subsidiaries of major global firms — the likes of Novartis or Glaxo Smith Kline.

Steer: Companies that might benefit from outsourcing is a good theme. Britain has two or three pretty big outsourcing companies — VT Group and Babcock — and I’m sure there’ll be others.

Barnett: One area that has been left behind this year is defence-related companies, such as BAE Systems. I think the market is being over-pessimistic.

Russell: The safest real asset in uncertain times is index-linked bonds.

Do they get it right?

AT OUR roundtable in February 2008, Richard Buxton of Schroders was far too bullish about stocks, saying “2007 was the year you made no money from equities, not 2008”. In fact, the FTSE All Share fell 33%.

Tim Steer, then with New Star, called the credit crunch correctly. “It’s far too early to talk about the bottom or the trough until banks’ results are out of the way, ” he said.

Schroders was still bullish at our roundtable this February — and this time it paid off. Andy Brough, Buxton’s colleague, forecast positive returns for 2009 and suggested buying banks including Lloyds, whose shares have subsequently soared 97%.

Dock worker Michael Rogers, 47, and his sales manager wife Karen, 39, pictured with their six-year-old twin daughters Sophie and Holly above, have just taken profits from their investment portfolio — to buy a motor home. The couple, from Felixstowe, Suffolk, had invested the proceeds from a buy-to-let property that they sold at the height of the housing market into the stock market through Bestinvest, their broker, and have just taken profits of around £10,000. “We had been looking to buy either a villa abroad or a motor home for a few years now, and we’d done so well recently on the stock market that we decided to cash in,” he said.

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