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Market still failing to price in impact of Government spending cuts, says Ignis’ David Clark

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The market is still failing to fully price in the forthcoming impact of swinging public sector spending cuts on unemployment and consumer spending, according to David Clark, manager of the Ignis Smaller Companies fund.

 

Clark says that, while the market has priced in some degree of public sector retrenchment, it has failed to acknowledge both the extent of the cuts and their psychological impact on consumers, even those still employed, which will have a deleterious impact on consumer spending and retail sales.

“It is wrong to think the market has priced in the full consequence of the job cuts because they haven’t been entirely felt yet, and they won’t be for months,” he says. “Add in the fear of unemployment – which in some ways is almost as damaging as actual unemployment – and it is hard to feel anything other than very nervous about consumer spending and retail sales. Companies exposed to these pressures are very vulnerable but share prices – from M&S all the way down – are not fully reflecting the severity of the problems.”

An additional pressure, Clark says, is the rising costs retail companies increasingly have to bear. “Retail input costs are rising – look at the price of cotton – and companies are finding that their overseas factories, which once had very low labour costs, are now not that cheap. Indeed, we’re starting to see more companies repatriating their manufacturing bases.”

Although he believes the biggest impact of spending and job cuts in the public sector will be felt by larger companies – “from the Mid 250 upwards” – Clark says small caps will, at some point, be hit. Accordingly, he is limiting his portfolio’s exposure to consumer stocks in niche areas, such as internet fashion retailer ASOS.

“ASOS enjoys strong overseas demand, it’s cheaper than the high street and its customer base is quite young – it’s a stock we really like,” he says. “We are also fond of Ted Baker, which has been performing well and making steady returns. Because it operates worldwide, it has a cushion against the plight currently facing British consumers, and we will continue to hold it.”

Other stocks favoured by Clark, whose portfolio retains a strong growth bias, include aerospace manufacturer Senior Plc, an international group that provides components for Boeing and Airbus. “Senior has featured in our portfolio for a long time and has become a top 10 holding purely through organic growth. It has lots of cash on its balance sheet and is likely to be making acquisitions in the future.”    

Rising M&A activity will be supportive of the market this year, says Clark, who points out that a very large percentage of all M&A in the last 10 years has involved small and mid cap companies. He believes UK small caps remain well placed to continue to outperform their larger counterparts both in the shorter term and on an 18-month-plus view.

“We see no reason why 2011 won’t be a good year for small caps once fundamentals reassert themselves, which we think they will soon,” he says. “Small caps are facing very few regulatory headwinds and valuations are pretty cheap – below their long-term average. Small caps look well placed to outperform large caps – and probably mid caps – not only this year but also in 2012, which looks very promising as things stand.”

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