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Equity market rally set to widen, says Newton’s Nick Clay

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Nick Clay, manager of the Newton Managed Fund, says he is increasingly confident that the equity market rally that has raged since March is likely to widen.  

Clay says that when markets first received government support it was the high beta and real asset areas of the market that initially responded as investors flocked to benefit from the inevitable inventory rebuild required after the squeeze seen in the second half of last year.

Because of that squeeze, he says, the next two quarters will produce some very attractive year on year comparisons in terms of growth. However, with P/E ratios already touching 16 or 17x in early cyclical sectors such as industrials, electronics and some consumer areas, and valuations in Asia at almost twice this level, investors will increasingly focus on those areas that have, so far, been left behind.
 
“If the rally is to remain so tightly concentrated we will need to see hard evidence that underlying demand is indeed improving and that the market is moving from the ‘second derivative’ [the deceleration in the rate of economic decline] to the ‘first derivative’, namely evidence of positive growth,” says Clay. “With no signs yet of unemployment receding, wage inflation returning or capex growing this is not an option hence, we can expect to see the rally widen as investors seek out those stocks that are still cheap in sectors such as telecoms or healthcare. This idea is central to Newton’s ‘large cap laggards’ theme and continues to gain momentum thanks to the M&A activity we are seeing in even the most defensive sectors.”
 
The recent anniversary of the Lehman’s Brothers collapse has coincided with a fresh source of impetus for markets, according to Clay.

“Many in the City are now referring to the ‘Bobby Ewing’ moment experienced by the investment banks,” he says. “This is because after de-railing the global economy and causing a worldwide outcry over their lavish bonuses, they are now acting as if the last year or more was just a dream. Now it’s business as usual once more, with investment bankers poised to collect even larger bonuses than they did in 2007.
 
“With interest rates far lower than when the credit bubble first inflated, M&A activity, rights issues and placements are now a daily occurrence once more. The pace is especially blistering in Asia where IPOs are flying out for everything from sausage skins to bio-engineering technology.”
 
According to Clay, this has resulted from some masterful sleight of hand by the banks.

“Although banks may have hit an ice berg, “they succeeded in making their respective governments rush onto their sinking ship. This has perfectly aligned the ambitions of the banks with those of their new government supporters and explains why all policy action taken since then has been to the benefit of the financial sector. It also explains why the media’s pursuit of banking ‘fat cats’ has simply died on the vine,” he says.
 
Another factor acting to drive a widening of the current rally is the ever increasing constituency of income investors. Western interest rates have never been so low and with over 40 per cent of all US Treasury marketable securities maturing in under a year, Clay says we can be certain that they will stay this way for some time to come.

“This means that income hungry investors can either opt for bonds at a time when yields are declining and western governments are actively devaluing paper assets or they can choose to invest in high yielding equities which as well as offering far higher levels of income, are real assets which offer a genuine hedge against inflation. 
 
“From our perspective this isn’t much of a choice, hence the Newton Managed Fund has less than ten per cent in bonds and under one per cent in cash. The balance is in equities with a broadly equal split between financial, oil, healthcare, industrial and telecom sector stocks,” adds Clay.

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