Where to find winners when markets are slumping and recession looms

The economic outlook may be bleak, but there are still plenty of opportunities for investors, says James Daley
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The Independent Online

The UK economy is teetering dangerously on the brink of recession. Last week, new figures showed that GDP growth came to a complete standstill in the second quarter, and most economists are now predicting a fall in the third quarter of the year. If it materialises, it will be the first period of negative growth in Britain for almost two decades.

Unsurprisingly, such gloomy economic conditions have taken their toll on the housing and stock markets too – with the FTSE 100 now down around 18 per cent since its recent peak last July, and house prices down around 10 per cent over a similar period. Many stocks – such as the banks and housebuilders – have seen much greater falls, as have properties in certain regions of the country, such as Northern Ireland.

But a consumer and housing market slowdown are not bad news for all companies. Defence companies, for example, tend to continue to see a steady stream of revenue, even when economic conditions are depressed. Furthermore, in today's global economy, there are plenty of British companies who are not dependent on a vibrant UK to remain profitable, as the majority of their revenues come from overseas.

Tim Steer, the manager of New Star Asset Management's UK Alpha fund, says these are the companies that he has been focusing on in recent months. "The FTSE All-Share is full of companies that grow regardless of how the UK economy is doing," he says. He points to oil services firms, such as Wood Group and Wellstream, which provide support and equipment for the booming oil industry, as well as engineering companies such as Weir Group and Cookson, which are profiting from major infrastructure projects abroad.

He adds that most of these companies are also benefiting from the recent higher dollar, which is increasing the value of their earnings. In the defence sector, he points to BAE Systems, VT Group and Chemring, noting that the war in Iraq and the "war on terror" continue to be lucrative for these businesses.

On a more domestic level, Steer says he also likes the bus and train companies, such as National Express, Stagecoach and First Group, which are benefiting from a shift away from car usage. "Video games are another good one," he says. "People are tending to stay at home more, and video games are actually realty good value. For the cost of a night out, you can get a game that you can play again and again. And more people are playing games, too – older people and women, for example." In this sector, he picks out Game Group.

When it comes to the banks, the house builders and most retailers, however, Steer shares with most other fund managers a fairly bearish short-term outlook. "You don't want to try to catch the falling knives at the moment," says Robin Geffen, the managing director and chief investment officer of Neptune Investment Management. "They've got further to fall."

Geffen has been interested in the pharmaceutical sector in recent months, and believes that companies such as GlaxoSmith-Kline and AstraZeneca could emerge as some of the best performers on the UK market this year. "The large pharmaceutical companies haven't gone down anything near as much as the rest of the market this year," he says. "These companies have got very strong yields – and drugs are not something that people cut back on" in a recession.

Geffen is also keen on the inter-dealer brokers such as ICAP and Tullett Prebon, which have seen a surge in trading in the volatile conditions of the past year, and have been one of the few direct beneficiaries of the choppy markets.

Buying a small handful of equities directly is a risky game for the unsophisticated investor. There are a number of professional funds that aim to make the most of a forthcoming recovery in markets. Alan Adam, a consultant at the financial advisers Alan Steel Asset Management, says that, in the UK, he believes equity-income funds, which tend to be value-focused, present some of the best opportunities for playing the recovery. He points to funds such as the Psigma Income fund, run by Bill Mott, which has started to take some exposure to the banking sector, and the Jupiter Income fund, managed by Tony Nutt, who has one of the best track records in the UK fund management industry.

Investors looking for a recovery play may also want to take a look across the Atlantic, Adam says. "The States is further down the road to recovery than the UK. The UK is also probably going to reduce interest rates over the next few months, which will further weaken the pound, so you might get a double-whammy from investing in the US."

UK-based funds that invest in the US have been hampered by a weakening dollar over the past few years. But the greenback has actually strengthened against the pound recently, moving from more than $2 to $1.83 against £1 over the past week. If the trend continues, it will help returns in UK-based American funds. Adam recommends Martin Currie's North American fund and Resolution's American Growth fund. For investors prepared to take on more risk, he recommends Neptune US Opportunities. He warns, however, that investors should take at least a four- to six-year view, acknowledging there may be more difficult times ahead before things improve.

Unless you're an experienced investor, it is best to seek professional financial advice before you invest.

To find an independent financial adviser in your area visit www.unbiased.co.uk.

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