IT seems that every week the UK economy clocks up more evidence of its disappointing recovery from the recession. The spectre of a hung parliament and a mountainous fiscal deficit is only adding to the image of the UK as the sick man of Europe.
And the UK does indeed look sick. It can’t even capitalise on a weak pound; the UK’s trade deficit has actually deteriorated since the start of the year. “The UK economy remains in a terrible mess,” says Jeremy Batstone-Carr, head of research at Charles Stanley, the stockbroker. “Debts need to be repaid in both the household and public sectors and this could weigh on growth.”
But, the UK is the seventh largest economy in the world, and it surely has a better chance of pulling itself out of recession than most. And unlike Greece and the other Club Med countries, it at least has control over its own fiscal policy. So if you think it can succeed in pulling itself out of this black hole, then how should you invest?
In this environment, covered warrants are useful products to trade since your potential downside is limited to your initial stake – you are therefore hedged against any future disasters.
Another feature of covered warrants is that they can be held over a number of months. This is expedient, since it could take time for an investment in the UK’s economic recovery to become profitable.
Although sterling has fallen 7 and 11 per cent against the euro and the US dollar respectively, it has failed to fuel a boom in exports. But this might not be the case for ever. “It could take a couple of years for the export sector to grow to a reasonable size so that it has a meaningful impact on growth,” says Vicky Redwood, UK economist at Capital Economics, a consultancy.
So far the leading economic indicators have been relatively strong for the UK’s manufacturing sector. The future perfromance of manufacturing companies will also be boosted if access to credit becomes easier in the near future. Manufacturing companies that should benefit from a weak currency and strengthening financial conditions going forward include Rolls- Royce and BAE Systems, the British defence and aerospace company.
Remember too that some of the UK’s biggest companies have operations across the world. So, even though the outlook for growth in the UK is weak, companies such as Barclays, BP and Vodafone have exposure to faster growing foreign markets, especially in the emerging world, which should guarantee revenue streams even when the UK is struggling. Royal Bank of Scotland has recently launched new call and put covered warrants for Barclays, HSBC, Xstrata and Vodafone, all of which derive a large portion of their earnings from outside of the UK.
The outlook is also less grim for those investors with long time frames who can wait for the UK to turn around. Paying off the UK’s deficit will be a painful experience but the sooner we get started, the sooner it will bear fruit. Once the UK gets on this path of fiscal consolidation, it should cheer the markets. This has been the case for other nations afflicted by debt problems. After the Greek government announced its plans to tackle the deficit, yields on credit default swaps on Greek government debt narrowed relative to yields on German bunds. Once the UK’s fiscal position starts to improve, cyclical UK companies should fare better, such as consumer companies, telecoms and financial firms. Due to the prevalence of these sectors in the FTSE 100 buying a covered warrant in the UK’s stock index, with a long date to expiry, could be a winner for those who are patient.
Right now there is not a lot of good news for the UK markets. But looking ahead there are reasons to be cheerful. Covered warrants might be just the thing for forward-looking investors.
RBS is hosting a free seminar tonight at 5.30pm on covered warrant strategies with independent expert Andrew McHattie. It will be held at RBS’s offices, which are located at 135 Bishopsgate, London. For more information go to www.rbs.co.uk/marketsseminars or to register email: firstname.lastname@example.org