Investors must exploit the UK stockmarket’s volatility

Given the apparently unrelenting barrage of gloomy newsfrom the UK economy many people may be taken aback to learn that the stock market – supposedly a barometer of the health of the corporate sector and the economy – has risen by over 9 per cent this year on a total return basis.

However, we are not particularly surprised by this development given the structural nature of the UK stockmarket. Many companies have excellent balance sheets and are cash-generative, have been reporting encouraging earnings growth and have significant exposure to those parts of the globe that are still growing at a relatively robust pace.

But although shares may have made welcome gains this year, the advance has been far from straightforward with equities experiencing considerable volatility. Stocks have been buffeted by concerns over the eurozone and the global outlook with many advanced economies weighed down by debt and the need for austerity measures. As I have mentioned before, investors should be aware that volatility is likely to remain a key theme in financial markets for number of years as the forces of deleveraging unleash economic tremors across the globe.

However, this continuing turbulence will create opportunities as well as challenges, especially for an active manager. When aiming to assess what a company is worth on a three-year view, you can exploit the short-term gyrations of the market to buy companies with long-term value. As mentioned in my previous column, investors need to be aware of the increasing politicisation of the UK banking sector and the growing need to heed the threat posed by political risk in the wake of the scandals involving Libor and Barclays. This trend has been further highlighted recently by the accusation that Standard Chartered has been facilitating transactions with connections to the Iranian regime. We believe that there is little doubt that the robust approach adopted by the New York regulator reflects his political ambitions and that the subsequent share price sell-off in this UK-based bank (with excellent exposure to strongly-growing emerging markets) was an overreaction. We were thus able to exploit the short-term volatility in Standard Chartered’s share price to add to our position in a business that we like very much on a long-term view. The bank’s share price has already rallied significantly since it reached a settlement with the New York regulators.

We have also been using short-term market volatility to build a stake in Tesco, where we again see long-term value. Havingavoided the company for the past sixyears, we took advantage of share price falls earlier this year (the stock fell from £4.50 towards £3.00 after Tesco reduced its UK operating margin for the first time in over 10 years) to buy a stake in a stock that delivers a 5 per cent dividend yield and trades on single-digit PE multiple. Moreover, the business has robust cash-generating abilities, strong positions in overseas markets and has a UK bank operation that is benefitingfrom the withdrawal of capacity from the sector as foreign banks wind down their operations in the UK.

So although the markets remain volatile investors can exploit this to buy companies with long term value at a good price.

Simon Brazier is Head of UK Equities at Threadneedle