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Sterling and UK gilts most vulnerable in New Year, says Newton’s Ben Russon

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Ben Russon, manager of the Newton UK Opportunities Fund, says 2009 has been anything but an average year for the UK market.

Interest rates have plumbed new depths, while the economy has experienced its longest period of contraction since the Second World War and equity markets have bounced over 50 per cent from their March 2009 lows.

Meanwhile, record rights issues and savage dividend cuts were also witnessed across the board. These extremes resulted from a multitude of factors, many of which will continue to exert an influence in 2010.

However, Russon says next year will also bring with it a host of new market forces to consider. 
 
“Ongoing corporate belt-tightening will feed through to further increases in unemployment and muted wage growth, which, in turn, will continue to dampen UK consumer confidence in 2009,” he says. “The household savings ratio will also continue to rise as consumers emulate UK companies by concentrating on their domestic balance sheets. Importantly, we believe we have finally reached the point where the housing market is no longer operating as a cash machine for UK consumers.”
 
Despite the latest surprise tranche of quantitative easing in the UK, 2010 will also see the UK monetary authorities grappling with exit strategies as they attempt to close the monetary stimulus taps without sinking the UK economy once more.

“This is likely to entail the gradual removal of the UK’s ultra low interest rates, as the Monetary Policy Committee shifts away from its emergency stance,” says Russon. “At the same time we expect to see new market forces taking hold following the expected change in UK government. Regardless of the election result, the incoming party will have few options. Unless a credible plan is laid out to get the public finances under control, sterling and UK gilts will suffer. Consequently, we expect to see taxation increases way beyond the reversal of the VAT cut, along with big cuts to public spending – the painful yet unavoidable consequences of the economic downturn.”  
 
From an investment perspective, this backdrop would create considerable drag for the domestic and consumer focused parts of the market, such as banks, retailers, house builders and leisure companies.

“Although the emergency stimulus measures have managed to stabilise the UK economy, it’s still far too early to suggest that this marks the beginning of a new era of economic expansion, where the world bounces back to how things were before the credit crisis hit. Unfortunately, simply piling on public debt to plug the hole created by the withdrawal of private borrowing doesn’t provide a sustainable basis for economic progression,” he says.

Even so, Russon is quick to point out the opportunities that are likely to await more disciplined stock pickers.

“We’ve already seen evidence of mergers and acquisition activity returning to the UK, and there seems no reason why this cannot continue into 2010. There is also still value to be found in non-cyclical sectors which don’t rely upon a sustained recovery to justify their share prices. There are many such UK stocks still on very reasonable valuations that will continue to deliver profit progression. The economy may not be out of the woods yet, but there are quality companies available that are not reliant on it being so.”

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