How to profit from Britain’s cheap-money fuelled rebound

The British economy looks stronger by the day.

Growth forecasts are being revised upwards while inflation remains low.

That’s practically the holy grail for UK policymakers. A low-inflation British boom!

You see, UK economic recoveries traditionally hit the wall because inflation takes off. Then interest rates have to rise to choke off inflation.

So George Osborne must be delighted. Can he now sustain this low-inflation recovery?

Sadly, I fear not. The UK still has some serious structural problems. You can still make money from Britain’s pre-election rebound – but you have to be careful…

A typical British recovery – built on house prices

The NIESR, a well-respected think tank, has just raised its GDP growth forecast for the UK this year from 2% to 2.5%. Capital Economics is even more upbeat, predicting 3% growth this year.

That would be impressive. It’s significantly faster than its long-term trend rate of 2.5% a year.

But here’s what I’m worried about: this recovery has too much in common with previous UK recoveries. As the NIESR says: “We expect consumer spending to remain the key driver of the recovery in 2014 and 2015, supported by continued buoyancy in the housing market.”

In other words, rising house prices are boosting confidence. The classic British mindset is kicking in. It goes something like this: “Next door has just sold their house for £300,000. That means our house must also be worth £300,000. We’re rich! Let’s go and buy a new car and then go on holiday.”

And the main reason why house prices have picked up has been loose monetary policy – low interest rates and money-printing.

Now, unlike some MoneyWeek writers, I think that loose monetary policy was the right response to an emergency in 2009. But that’s all it was – a response to an emergency. It hasn’t solved our more deep-rooted problems. In fact, some of those problems have got worse.

There’s still too much debt across the economy. We have a weak financial system, too few world-beating businesses, and a painfully large trade deficit.

And on top of those ‘classic’ British problems, we face turbulence in emerging markets and the threat of deflation in the eurozone. Neither of which will help UK exports.

So when loose monetary policy ends – which it has to, at some point – we’ll realise that we haven’t made as much progress as we had hoped.

Of course, Osborne will do his level best to keep the economy growing nicely until the next election. And Bank of England boss Mark Carney seems keen to help – there’s no sign that he wants to push up interest rates any time soon.

So I suspect the recovery could continue for a while yet. But it won’t be as long-lived as many people currently think. My best guess is that we’ll see a slowdown in late 2015 or 2016. I just can’t see how you can sustain the current recovery when it’s built on flimsy foundations.

Potential triggers for the slowdown include an end to ‘Help to Buy’, a rise in the base rate, turbulence in China, a further deterioration in the trade deficit or the spillover from a renewed eurozone crisis.

How to take advantage of the pre-election surge

Now, I reckon canny investors can still benefit from the recovery. All of the government’s efforts will be focused on keeping it going until May 2015 at least.

So if you want to invest in the UK for a year or two, you could consider housebuilders or some retailers: especially those selling furniture and homeware goods.

You won’t find many pure UK-focused businesses in the FTSE 100 as most FTSE companies are large global businesses with substantial operations abroad.

You’re much better to look in the mid-cap FTSE 250.

But there are also plenty of UK-focused businesses on Aim as well, which you can now pop in your individual savings account. In fact, I highlighted five great Aim-listed companies in this week’s MoneyWeek magazine cover story: Five Aim stocks worth a flutter. (If you’re not already a subscriber, you can read the piece and get your first three issues of the magazine free here).

Remember, if you pick quality stocks, you shouldn’t suffer too badly even if the slowdown comes earlier than I expect.

But here’s the really important point: don’t get carried away and think that most of our problems are solved, and that we’re now at the beginning of a nice five-year boom. We’re not.

There’s going to a lot more volatility in the economy and the stock market. Prepare for a bumpy ride and a slowdown within the next couple of years.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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  • Oscar Foxtrot

    Any suggestions for a small cap IT or UT? I have a number on my watch list but have yet to commit.

  • Chester

    “There’s going to a lot more volatility in the economy and the stock market. Prepare for a bumpy ride and a slowdown within the next couple of years”

    The slowdown will probably happen sooner and much faster than most anticipate, which would be disasterous for investments dependant on “growth”. And AIM stocks have proved more volatile in times of uncertainty than their blue chip cousins on the main market

    It looks like all markets are starting their long unwind from all time highs, so shorting stocks seems a safer strategy than praying for growth that may never come. As we have seen recently, it takes a nanosecond to lose real capital when a selloff happens, but could take months to post meaningful gains

  • laurence

    the general publics sucking on a 40 billion pound ppi “feelgood”dummy at the moment,something that needs considering in this economic recovery debate we are being sold methinks.

  • Donny Boy

    Oscar Foxtrot,the Aberforth Smaller Companies Trust, LSE: ASL,may fit
    the bill.It was tipped in Money Week,17th January edition.At the time of
    writing,the discount to NAV was 9.91% and the on-going fee 0.81%.The
    top five holdings were JD Sports,QinetiQ Group,RPC Group,Northgate and
    St Modwen Properties.
    ” It is the biggest trust in the smaller companies sector and last year

    delivered the best NAV performance of any such trust over 12 months,according ”
    to Leonora Walters in the Investors Chronicle.

    • Oscar Foxtrot

      Thanks Danny Boy – will have another look at Aberforth

  • Timbertop

    Moneyweek talks of a new “body” which will get all banks to agree to a visit to our planet where savers get buttons for interest while the banks pay out billions in reparations for mis-selling. Sadly the reparations do not come to us – where they belong – but to regulatory bodies.
    Can any of us start up a bank? Oh, just try it! forget probity, personal interview,
    sound advice etc and you might just get a sniff. No wonder credit unions thrive and good luck to them.

  • Anonymous

    “I just can’t see how you can sustain the current recovery when it’s built on flimsy foundations.”

    You could be forced to change your view if shale fracking gets under way proper as it did in the US? Or perhaps not if the Great British politician gravy train do with the proceeds as they did with North Sea Brent: farm out the best bits to their British foreign domiciled fat-cat mates, and then squander (Labour-style) what’s left on increased benefits to ‘non-performing’ sectors of the social fabric!

    Oh, if only we could contract the Norwegians (strictly those NOT connected to the Great British politician gravy train) to run our country….