Investors aren't out of the woods just yet

Brighter economic news suggests that a cautious return to the markets may be in order. But keep the bubbly on ice, warns Emma Dunkley

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The Independent Online

It was a pleasant surprise when figures came out showing that the UK economy had actually grown in the third quarter, lifting the country out of a woefully long recession. But cries of glee that the economy is "healing" and "back on track" might be premature.

Although the 1 per cent growth in the economy – which is the highest rate since the third quarter of 2007 – is no doubt a boost to sentiment, there are major, imminent hurdles that could easily throw the tentative recovery off track again.

"We think the improved GDP data needs to be handled with care," says Jason Hollands at Bestinvest. "A triple dip back into recession in the final quarter is a possibility.

"At best, we feel growth will be anaemic, and any recovery protracted. It's too soon to crack open the bubbly."

So is growth worth getting excited about, and does it actually affect your money? "All year, we have found the official GDP data to be at odds with what companies trading in the UK have told us," says Richard Buxton, head of UK equities at Schroders. "It wasn't as bad as the 'double dip recession' that numbers suggested; nor has it bounced back recently as strongly as recorded."

Instead, Mr Buxton anticipates a gradual improvement over the next two years – although the pace of this will be tempered by weak global trade among other issues. "Companies which benefit from self-help improvement rather than purely levels of economic activity will still do well," says Mr Buxton.

Debenhams, Ladbrokes, Taylor Wimpey and Legal & General are a few of the names Mr Buxton is backing in this category. The manager of the Schroder UK Alpha Plus fund also invests in banks, including Barclays, Lloyds and Standard Chartered.

"Most investors are too concerned about further write-offs and regulatory uncertainty to invest in bank shares, but we still feel these are more than reflected in valuations," he adds.

For anyone who points to the ongoing turbulence in Europe and other parts of the world, it is worth remembering that just because the economy might be in the doldrums, it doesn't mean the markets are in the same situation. The FTSE 100 is up almost 9 per cent in 2012, rising from lows of around 5,300 to highs of 5,900 this year, while the economy has, for the most part, been in recession.

So is it worth taking the plunge and investing some of your cash sitting on the sidelines before it's too late? "By the time good economic data and news come through, the market has long since reacted and rallied," says Rob Morgan at Hargreaves Lansdown. "I believe those brave enough to enter the market will be rewarded over the long term, especially from large companies with diverse, international earnings ideally with a good dividend."

Indeed, UK companies that aren't entirely reliant on a domestic economic recovery may provide more robust returns. "We favour international companies," says Gemma Godfrey at Brooks Macdonald. "Those that sell their products and services into more protected pockets of demand have strong balance sheets and good management teams to weather any future storms."

You can invest in these types of companies, which pay out solid dividends, by buying equity income funds. "You are also benefiting from compounding dividends over time – really powerful when growth and interest rates are low," adds Mr Morgan. "These sorts of stocks tend to be less volatile, too."

If you are cautious about simply rushing in to invest and don't want to fall victim to wild swings in the market, Mr Morgan says you can opt to "pound-cost average", which means investing a fixed amount on a monthly or regular basis.

As a result, when market prices are high, your monthly payment might buy fewer fund units or shares, but conversely, will buy more when prices are low. Over time, this averaging means the price you pay will likely be lower than the average market price.

So where should you invest? Equity income funds are paying out more than UK corporate bond funds at the moment, and dividends are generally robust, says Mr Hollands. For months, people have piled into bonds looking for safety, but prices have become expensive as a result and cheaper equities are looking attractive.

And investors are starting to recognise this. According to the latest figures from the Investment Management Association, equity funds were more popular than bond funds in September, for the first time in 12 months.

"We like equity income funds – Fidelity MoneyBuilder Dividend and Threadneedle UK Equity Income, for example," says Mr Hollands.

If you have a bigger appetite for taking on risk, buying funds that invest in smaller companies might mean you get a bigger boost when the economic recovery starts to gather momentum, although you will likely to be hit harder if things take a turn for the worst.

Mr Hollands recommends the Old Mutual UK Select Smaller Companies fund and Marlborough Special Situations in this category.

For an equity income fund with a twist, Mr Morgan recommends J O Hambro UK Equity Income. He says the fund has had exceptional long-term performance and that the managers, Clive Beagles and James Lowen, are great stock-pickers.

But don't forget that the UK is not out of the woods yet, and that there are arguably more attractive investments out there. Still, even if it is too early to crack open the bubbly, you could line up a few bottles so they are ready for the party further down the line.

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