Newton’s Stewart: investors should remain cautious

Newton Investment Management’s Iain Stewart has warned investors not to be too encouraged by the recent recovery in markets and GDP figures, warning structural headwinds could derail growth in the second quarter.

Stewart, manager of the £5.4bn Newton Real Return fund, warned the on-going eurozone uncertainty and significant financial market volatility needed to be watched with caution, as it could de-rail markets.

He also warned further liquidity injections and bailouts, which are once again being mooted, were not necessarily the answer to global markets’ structural problems.

“Despite the recent, more bullish market sentiment, we maintain that investors may be jumping the gun in shrugging off the structural headwinds and anticipating a return to trend economic growth rates,” said Stewart.

“Despite some sell-off in mainstream government bond markets (which has caused yields to rise marginally from their lows), real (inflation-adjusted) bond yields remain broadly negative. This implies that participants in these markets do not yet see a normalisation of economic activity on the horizon,” he added.

According to Stewart, investors in US equities should be wary of corporate profits and margins reaching record levels.

“There is significant debate about why corporations continue to do so well in the context of a sub-par recovery,” said Stewart.

He warned that in an economy where growth is a priority, corporation spending will inevitably eat into earnings levels.

“In the long run, evidence points to profits reverting to an average relationship with GDP. With earnings growth for S&P 500 companies now slowing fast, it may be that we have already seen peak profits.”

Stewart also warned that further liquidity injections and bailouts may not provide the necessary help to markets, and he urged investors to be cautious.

“The sheer scale of the challenges and the unprecedented nature of state involvement continue to threaten a highly volatile and unpredictable setting, in which investors are exposed to both the deflationary risks of continued deleveraging and the inflationary effects of excess liquidity almost simultaneously,” he said.

“Although weaker markets would make us more bullish from a tactical point of view, the outlook continues to suggest investors should remain highly selective in terms of security and asset class selection. In particular, it is appropriate still to avoid those investment areas most acutely vulnerable to the effects of deleveraging in the developed economies,” he said.

Stewart said investors should continue to focus on traditional defensive sectors, either within the debt markets or in the equity of non-financial companies.

“Among our favoured sectors are healthcare, telecoms and non-cyclical consumer stocks. Newton’s themes continue to underscore the rationale for exposure to a number of other areas, such as higher yielding international equities, the technology sector, and gold-focused mining stocks,” he added.

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