UK equities: Where to invest now economy is improving

GDP grew by an annualised 0.3 per cent in the first quarter of this year, and by 0.7 per cent - up from an initial estimate of 0.6 per cent - in the second. The Organisation for Economic Co-operation and Development subsequently revised the UK’s 2013 growth forecast up from 0.8 per cent to 1.5 per cent earlier this month.

In addition, data released by manufacturers association EEF indicate manufacturing has hit a three-year high, while the latest survey from the Purchasing Managers’ Index estimated that the UK services industry grew by the fastest rate in six years in August.

Positive external factors such as the afterglow from last year’s Olympics, the birth of the royal baby and an unusually hot summer have helped increased consumer confidence, as has the gradual recovery of other European countries that are key buyers of British exports.

At the end of last month BNP Paribas’ UK economist David Tinsley argued that the nation was back on track, although he added could not be completely confident of the sustainability of the recovery.

“Overall there has been an overwhelming avalanche of positive economic indicators out of the UK of late,” the economist said.

He said there is little doubt the economy is currently growing at or above ‘trend’ rates of growth - the OECD, for example, predicts that the UK will grow faster than the US, France and Germany in the second half of 2013 - adding that there is a “reasonable question as to whether this state of affairs can last, but for now it is real”.

Jon Ingram co-manages the £149.3m JPMorgan UK Dynamic Fund, which the firm says is suitable for investors looking for “aggressive exposure to the UK stockmarket.” Mr Ingram is similarly very bullish on the UK’s prospects.

“All the signs coming out of the UK are positive. Trade and services news has surprised on the upside, the OECD doubled its growth forecast- everything is OK in the UK,” Mr Ingram says.

Where are managers investing?

Housing has been one of the crucial factors in the UK’s economic recovery, partly thanks to a host of government schemes aimed at first-time buyers, such as the Help to Buy scheme. Mr Ingram says he has been upbeat about the construction, but that valuations now look more challenging.

“We have been very positive on construction sector for a long time but some of the valuations have got a bit lofty and we have been recycling that into volume plays,” the manager says, explaining that he has transferred some of the money from housebuilders into Countrywide, the UK’s largest estate agency, and the fund’s seventh largest holding at the end of July.

Mr Ingram explains that while house building will slow, banks are becoming more willing to lend for mortgages and estate agents will continue to be able to charge fees regardless.

The manager adds that this improvement in the housing sector has “fed through to consumer confidence,” with cyclical stocks experiencing an upswing in performance.

In particular, the UK Dynamic Fund is looking to increase its position in the retailer Next, which Mr Ingram thinks is a beneficiary of “phenomenal management” which should be able to capitalise on the British public’s return to the high street.

James Henderson, manager of the £397.3m Henderson UK Equity Income fund, is also looking to capitalise on the consumer spending renaissance, but he is seeking to do so through increased spending on leisure.

He invests in Marstons, which runs a chain of pubs, and Greene King, which makes the Speckled Hen ale, two companies he says have been beneficiaries of increased consumer spending and the warmer weather.

“People were feeling more money in their pocket, and the sun was out,” the manager says.

Another area which he says has been extremely beneficial to the fund is aerospace, with Boeing and Airbus both replacing their fleet now that new technology and new investment are coming through.

Is all what it appears?

Despite all the optimism, Sue Noffke, who runs the £175.7 Schroder Income Growth fund, argues that investors should not get too carried away by this recent deluge of good news.

“We have to put the recent data in context. It feels robust because we are used to negative headlines, but in the long term we are still trying to get up to pace of pre-recovery levels,” she says. “The UK is still 3 per cent behind its pre-recession GDP peak.”

Despite the more bearish stances, like the other managers Ms Noffke sees consumer confidence as a key driver of the improving data points.

“Valuations are relatively attractive in cyclical sectors compared to safe areas, which have been priced highly in times of uncertainty,” the manager says, adding that “domestic banks play nicely in to this trend.

She adds that a good example of this is Barclays, which saw “a lot of negative sentiment that translated into the share price but is “normalising through a pick up in business confidence.”

Ms Noffke agrees with Mr Henderson that housebuilders are “having a fantastic time”, but as valuations are now high she says the fund will not be increasing its exposure.

Instead, she is geared towards a strengthening retail market following “a difficult 18 months” for the sector through an investment in bicycle shop Halfords, which she says has benefitted from the British public’s renewed enthusiasm towards cycling.

She also invests in Home Retail Group, a manufacturer which includes Homebase and Argos, to capitalise on the ‘click and collect’ internet boom.

Elsewhere, the media sector is “strongly represented” in the portfolio, as the manager anticipates a pickup in advertising as companies feel bold enough to spend some of the cash on their balance sheets.

It seems that UK equity managers are predicting a return to health for the embittered retail sector now that consumers are feeling able to spend again, although all of the managers stressed stock selection was key, as retailers have had to evolve with the advent of the internet and out of town shopping centres.

They believe that valuations, while perhaps not as appealing as they were, still have a lot to offer in terms of price-to-earnings ratio, and the time has come to focus on high quality cyclicals, as investors no longer need to take refuge in over priced “safe haven” stocks now that the economy is brightening.