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Is the UK recovery priced in?

UK economic data is looking increasingly positive of late but does this mean it is harder to spot value in the market?

Data from the Office for National Statistics shows UK GDP grew 0.8 per cent in Q1, up from 0.7 per cent in Q4 last year.

The International Monetary Fund has also increased its UK growth forecast from 2.4 to 2.9 per cent for 2014 and the EY Item Club also expects the UK economy to grow 2.9 per cent. The Office for Budget Responsibility predicts a slightly lower 2.7 per cent.

The positive sentiment has inflated valuations in parts of the UK equity market and forced some asset managers to reallocate capital. 

Psigma Investment Management chief investment officer Thomas Becket feels valuations may have gotten carried away on the back of the recent positive data. He believes economic growth is already being priced in, which assumes positive equity performance will follow as a result.

Becket says: “The big issue investors face is over-complacency. They are extrapolating economic growth into equity returns which does not work as equities are quite inefficient in that way.

“My view is we have already borrowed a lot tomorrow’s economic performance into yesterday’s equity prices.”

Fund managers have seen the prices of companies focusing on the UK market increase rapidly. 

Standard Life Investments fund manager Thomas Moore has been forced to sell out of such companies. He says while these companies still have good fundamentals they are just too expensive to continue to hold. Moore, who manages the £463m UK Equity Income Unconstrained fund, says: “We sold out of Whitbread and The Restaurant Group and decided to move on and let someone else take the risk. That is not the case for all consumer-facing stocks but there has been a stark divergence in value in the past three to six months.”

According to FE Analytics, the FTSE All Share General Retailers index returned 78.19 per cent from 30 April 2012 to 30 April 2014 while the FTSE All Share Household Goods & Home Construction index ret-urned 61.35 per cent over the same period. These indices outperformed the more defensive FTSE All Share Oil & Gas index which returned 10.22 per cent over the year and the FTSE All Share Mining index which made a loss of 12.89 per cent.

Valuation shifts following the sentiment surrounding the UK recovery have prompted Becket to shift emphasis away from early cycle, straightforward UK recovery exposure to larger caps.

Becket says: “At the start of the year we started moving out of the fund which had done the best for us – the £180m River & Mercantile Long Term Recovery fund. It has done fantastically well but I think the valuation in recovery and cyclical stocks has now passed. We felt good rotating into large cap names, such as the Artemis Income fund and the Schroder Income Maximiser fund.”

Fidelity Worldwide Investment multi-manager Nick Peters has taken money out of UK exposure and allocated to other markets, such as moving from underweight to neutral on emerging markets. He is waiting on further signs of strong earnings growth before returning to the UK market.

Peters says: “The funds I am looking at now are those that have a large and mega cap bias. We have been taking money out of smaller companies funds because of valuation concerns. Markets are likely to be volatile but I have no idea in which direction. Hopefully we will see earnings growth increasing, which will justify valuations. We are seeing tentative signs of this. We would be more comfortable about putting money back into the UK once we see earnings growth.”

With a neutral exposure to the UK market, Threadneedle Investments fund manager Stephen Thornber is looking to buy UK names that can give him upside from international consumer markets.

Thornber, who manages the £1.2bn Threadneedle Global Equity Income fund, says: “We are avoiding UK-focused stocks, instead we are looking to play the global recovery through these UK names. For instance it is difficult to get access to high quality consumer companies in Asia and emerging markets, that is why we have Unilever.”

EXPERT VIEW: Mark Dampier 

Mark-Dampier-MM-Peach-700x450.jpg

We entered the year far too optimistically. For the first time in many years, all the commentary at the beginning of the year was universally upbeat about the stockmarket and the economy. I immediately thought that was a problem.

The market has not been bad but it has churned slightly, it depends where you have been. 

Some of the small and mid-cap stocks have given something back recently. 

A lot of people have missed out on the small and mid-cap story as they have been watching the FTSE.

It is much tougher now to gauge valuations. 

The market needs to see more evidence of company profits improving now. I think this year will be more of a churn year.

Mark Dampier is head of research for Hargreaves Lansdown

Reasons to be cheerful – recent UK economic data

GDP – UK GDP grew 0.8 per cent in Q1, up from 0.7 per cent in Q4. This represented the fifth consecutive quarter of UK GDP growth, driven by consumer spending. Economists have hailed the data, with some suggesting the recovery has gone into “overdrive”.

Unemployment – Unemployment fell to 6.9 per cent for the three months to February, compared to 7.1 per cent from the previous three months. Bank of England governor Mark Carney dropped the direct link between unemployment and interest rate rises as part of an overhaul of his forward guidance policy in February.

Inflation – The consumer price index fell to 1.6 per cent in March from 1.7 per cent in February. This is the lowest level since 2009.

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