3 ways to profit from a rebounding British economy

The world's eighth-largest economy is turning the corner, and deep values abound.

By StreetAuthority Jul 26, 2013 7:04PM
By David Sterman

Even as Europe struggles to avoid further meltdowns, the economic pulse across the English Channel is starting to quicken.

A steady drumbeat of positive economic reports has led to expectations that much better days lie ahead in 2014 and 2015 for the U.K. economy. Meanwhile, British stock prices, which have failed to keep pace with their U.S. counterparts, are starting to emerge as timely bargains.
Green shoots

Back in 2010 and 2011, U.S. economists started to notice signs of life among both manufacturers and consumers, citing a rising tide of "green shoots" that popped up from the soil. That early evidence of a moderate recovery in the U.S. eventually led to robust share price gains across all U.S. asset classes.

Credit: Big Ben and traffic in London, England (© Sylvain Sonnet/Getty Images)Fast-forward to 2013, and the same playbook appears to be emerging in the U.K.  For example:
  • After shrinking 0.2% in the fourth quarter of 2012, the U.K. economy grew 0.3% sequentially in the first quarter of 2013, and grew a further 0.6% in the second quarter.
  • Sales at department stores rose 3% in June (from a year earlier), which was the strongest monthly growth rate in more than a year.
  • The Purchasing Managers Index (PMI) spiked to 52.5 in June, the best showing in more than two years.
  • The number of unemployed fell 51,000 in June, and the national unemployment rate now stands at 7.8%, well below levels seen in most European economies.
  • After digesting recent economic reports, Ernst & Young now believes the U.K. will grow 2.2% next year, which would be the strongest growth rate since 2007. "With consumer confidence returning and the government's initiatives to stimulate the housing market bearing fruit, consumers are switching their attention back from saving to spending," E&Y economists noted in a recent report.
Perhaps the greatest endorsement of the economy comes from surging foreign direct investment. According to the U.N Conference on Trade & Development, foreign direct investment in the U.K. bottomed out at $50 billion annually in 2010 and 2011, but rebounded $62 billion in 2012, and is on track to exceed $70 billion this year. (The U.S. is the leading investor, by far, as U.S. corporations seek foreign platforms for growth.)

"The U.K. has been punching above its weight in attracting overseas investment over the past year, suggesting that reforms to improve the competitiveness of the tax system and our ability to capitalize on strengths such as the science base and flexible labor markets place the U.K. high up the rankings for investors around the world," noted Lee Hopley, an economist with a leading manufacturing consortium in an interview with the Guardian.

Meanwhile, since global markets hit bottom in March 2009, the S&P 500 has handily outperformed the FTSE-100.

There are several exchange-traded funds (ETFs) with exposure to the U.K., including:

1. The iShares MSCI United Kingdom Index (EWU)
This is a very popular choice, trading more than 2 million shares a day, along with a reasonable 0.53% expense ratio. This ETF owns a broad variety of U.K.-based multinationals (such as HSBC Holdings (HBC), Vodafone (VOD), BP (BP) and GlaxoSmithKline (GSK)), and should be seen more as a proxy for the global economy rather than the U.K. economy.
2. First Trust United Kingdom AlphaDEX (FKU)
This ETF focuses on mid-cap companies that have a direct focus on the U.K. economy, with key sector weightings in consumer cyclicals (27% of the portfolio), industrials (19%) and financial services (17%). The 0.80% expense ratio is a bit stiff, reflecting this fund's relatively small $15 million asset base.
3. iShares MSCI United Kingdom Small-Cap (EWUS)
Small-cap stocks tend to outperform in the early stages of an economic recovery, making this ETF a timely investment. The 0.59% expense ratio is middle of the pack, and the focus on smaller stocks adds higher volatility. The sector weighting is quite similar to the First Trust fund, though the average $2 billion market value of each holding is just one-third the size of the typical company held in the First Trust fund.

Risks to consider: The U.K.'s fiscal picture remains quite challenged, and efforts to reduce the budget deficit could impede an economic rebound.

Action to take:
As the U.S. stock market has generated robust gains over the past four years, it's time to seek out markets than haven't kept up. With the U.K. economy showing signs of life, shares may be poised to close the gap with their U.S. rivals.
David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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