Stewart, who also runs the £2.9bn Newton Balanced and £500m Newton Global Balanced funds, says the consensus expectations for the US and global economies are too bullish, with weak earnings growth a warning of troubles to come.
Investors should stay away from the momentum-driven areas of the market in technology and in fashionable IPOs which are likely to end in tears, he warns. “As in the late 1990s, the investment opportunities of today are likely to lie away from the current areas of market obsession,” Stewart said.
“We continue to believe that emphasising ‘haven’ qualities – stability, balance sheet strength, low leverage, high barriers to entry, global diversification, low beta to economic activity – is appropriate.”
“We must, of course, resist overpaying for quality, but where these ideas pass our fundamental and valuation screens, we believe they continue to offer the best risk/reward potential against a challenging backdrop,” Stewart added.
The US market is flat year-to-date following strong gains in the preceding three years which led the world indices.
Performance of indices over 3yrs
Source: FE Analytics
Stewart says that earnings growth is weak and a new set of policy makers at the Fed are threatening to increase the pace of tapering.
Any concerns over a potential withdrawal of liquidity could present problems for what has become an expensive momentum-driven equity market, in some ways reminiscent of the late-1990s boom, the manager says – full of ‘story stocks’, technological miracles, IPOs and stratospheric valuations.
With reported earnings on the MSCI US Index declining over the last 12 months and the downward trend in corporate cash flows this doesn’t bode well for US capital spending levels, he warns that any downturn in the US could cause serious problems in the rest of the world.
“A pick-up is required soon if the enthusiasm built into valuations is to be validated,” Stewart said.
“US policy continues to set the tone for financial markets globally,” he added. “Consensus expectations for the economy are overwhelmingly bullish; expectations for equities are, if anything, even more bullish as, despite the tapering of the current QE programme, the monetary authorities continue to provide a ‘put’ in the form of more stimulus, should the economy falter.”
“In defence of US central bankers, there does seem to be a definable change in the new Yellen-run Fed with regard to the destabilising effects that their policies might be having on the financial system.”
“That said, the economic orthodoxy that drives Fed thinking spends little or no time worrying about the unintended consequences of unconventional policy – despite the fact that financial stability is included in US policymakers’ mandate,” he added.
Investors are getting ahead of themselves in expecting a “normalisation” of policy however, with interest rates likely to remain low for some time to come.
Fed officials believe the key problem is a lack of jobs and that this ‘slack’ in the labour market can be tackled with monetary policy for as long as is necessary – and they see the lack of CPI and wage inflation as confirming this view, he claims.
“It is clear the Fed expects official interest rates to stay low in the foreseeable future as it sees its job as incomplete,” Stewart said.
“Euphoria in equity markets seems, by contrast, to be discounting a return to robust economic growth [consensus forecasts for the US now expect an acceleration from 1.8 per cent annualised GDP growth in the first quarter to 3 per cent in the fourth quarter of 2014] and some ‘normalisation’ of interest rates. Tapering of asset purchases is tending to reinforce this view, despite the Fed’s protestations that tapering is not tightening!”
Although bulls see the tapering of bond-buying by the Fed as a clear negative for US Treasury bonds, it can also be seen as a withdrawal of stimulus from an economy which has become reliant on a constant flow of cheap money.
“We remain broadly positive on US long bonds in the expectation that rates will not rise in a parallel fashion along a yield curve which is already very steep,” says Stewart.
“Moreover, in multi-asset funds, we see long Treasuries as a useful (and cost-effective) hedge against risk asset positions, rising geopolitical risks and the deflationary risks which we continue to see.”
Stewart runs the Newton Real Return fund with James Harries. The fund has performed roughly in line with the average IMA Targeted Absolute Return fund but with more volatility.
Performance of fund versus sector and equities over 5yrs
Source: FE Analytics
On a five year view it has outperformed the sector, however.
The Newton Balanced and Newton Global Balanced funds have underperformed the IMA Mixed Investment 40%-85% Shares sector over three years, according to data from FE Analytics.
Performance of funds versus sector over 3yrs
Source: FE Analytics
Both funds have a lower weighting to equities than the sector average, and this defensiveness will have hurt the funds in recent years.
The top 10s are full of large cap defensives such as GlaxoSmithKline, Vodafone and Royal Dutch Shell as well as Microsoft, BAT and Roche.