Will the gathering UK recovery translate into returns?

This article is part of
UK Equity Investing - May 2014

What a difference a year makes. From being one of the problem children of the developed world with a debt dependancy and an austerity plan to wean the country off spending that was being criticised as adding to the problem, the UK is now the flavour du jour among economists.

Latest official statistics put GDP growth in the first quarter of 2014 at 0.8 per cent, equating to a six-year high annual growth rate of 3.1 per cent. The International Monetary Fund (IMF) and the OECD have suggested the UK will be the fastest growing G10 nation this year.

This has prompted debate about when the Bank of England is likely to raise UK interest rates, although the general consensus is it will be comfortable to wait until next year.

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Stewart Robertson, senior economist at Aviva Investors, sums up the mood of optimism by highlighting that 12 months ago the country was “worried about a triple-dip recessio” and embroiled in a “fierce debate about fiscal austerity driving the UK economy back into stagnation”.

Now, he says, the economic revival is “well established”, although he also summarises a lingering complaint and concern among his peers that want to see “greater contributions from investment and exports and a little less from housing and the consumer”.

Beyond borders

So what impact will the recent economic growth have on the performance of equities in the UK?

Some would say not much. As Nick Peters, portfolio manager at Fidelity Solutions, highlights, a number of studies conclude there is no direct link between GDP growth and the performance of the market - a supposition proved by equity market performance in recent years.

He explains: “2012 illustrates that point, when the UK equity market delivered double-digit returns alongside a GDP growth close to flat.”

Having said that, Mr Peters adds: “Emerging signs of economic growth should boost corporate profitability and cash flow generation, and the impact of these will work their way through to stock valuations thereafter.”

Mr Peters also emphasises that the UK - and UK companies - are not solely defined by their home country economy, and that improving prospects further afield should be adding to any optimism being felt by investors.

“Investing in the UK market means exposure to a wide variety of countries. Around half of the business done by companies in the FTSE 100 is done overseas, so optimistic prospects for the US, Asia and emerging markets should translate to good opportunities for UK businesses and their stocks.”

By all accounts an economic recovery in the US is already underway, while investors will be hoping that a period of underperformance in emerging markets could be about to turn round.

One such indicator is the level of mergers and acquisitions activity. A recent report from Standard Life Investments claims not only that M&A is picking up in the US and beyond, but that activity will continue into next year.

The investment manager argues that increased availability of business funding, an improving economic backdrop and continued pressure on companies to reduce costs has encouraged M&A activity to start up again. It identifies that the upturn began in the US, with Europe, Asia and emerging markets now following suit.