10 November 2015

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The recent growth and inflation figures have prompted further speculation on the timing of a UK interest rate rise. We believe this speculation neglects the real story behind these statistics, which is what they reveal about the relative inflation rates for different parts of the UK economy. This is ultimately far more useful for investment selection than simply using them to predict when rates may rise.

The most recent set of UK economic statistics from the Office for National Statistics (ONS) showed lower GDP growth than the market had expected, at 0.5% for the third quarter, compared to the 0.7% predicted. But beneath these lacklustre headline figures was a far more nuanced and interesting picture.

While the ONS data also showed output in manufacturing and construction fell by 0.3% and 2.2% respectively, the services sector expanded by 0.7 per cent in the three months to September compared to the previous quarter. This strength in services was also reflected in the recent inflation statistics, where services inflation – including accommodation, education and culture – was 2.5%, compared to -2.4% for goods inflation. It is clear that the UK’s recovery is not evenly distributed.

Only the strong survive

As such, within our portfolios, we are focusing on those companies where macro trends are benign as well as those companies that are well positioned in their respective markets. Typically, the strongest companies within a sector get stronger while the weak companies continue to struggle. Identifying those companies in the right sectors with strong market positions that are ultimately in control of their own destinies is more important than the impact of an eventual half-point rise in rates.

Fundamental factors

There are sectors where the trajectory of interest rates is important to the investment case, such as the banking sector. We currently have a number of banks in the portfolio and while we expect the banks to be beneficiaries if and when interest rates rise, in the meantime we are encouraged by the attractive valuations and sharper focus on shareholder returns as demonstrated by their dividend commitments. These factors are likely to prove far more important than rate rises to the future trajectory of their share prices.

In contrast we do not own any real estate and utility companies. For these groups, debt levels are high and cash generation under pressure such that we worry about their resilience if and when interest rates rise. Additionally, they trade on premium valuations with limited growth prospects.

Less ‘when’, more ‘who’

The trajectory of interest rates is important and the most recent growth and inflation statistics highlight some interesting nuances within the UK economy. However, in terms of stock selection, a focus on identifying the winners and avoiding the losers in the current UK recovery, rather than the timing of monetary policy, is likely to be more productive.

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 04 November 2015 and may change as subsequent conditions vary.

Identifying those companies in the right sectors with strong market positions that are ultimately in control of their own destinies is more important than the impact of an eventual half-point rise in rates.