Despite the slowdown in the housing market, the UK Construction and Housebuilding sector has been on...
Despite the slowdown in the housing market, the UK Construction and Housebuilding sector has been one of the best performers in the FTSE All-Share so far this year.
The sector is ranked third out of the All-Share's sub-indices, with a total return of 28.08% from the start of the year to 10 June.
Martin Cholwill, UK equity income fund manager at Axa Investment Managers, believes the construction industry is favoured by current conditions as it benefits from interest rates.
However, Keith Burdon, UK investment manager at Britannic Asset Management, says there is a higher likelihood interest rates will increase early next year following Chancellor Gordon Brown's announcement the UK will not join the euro in the short term. Because Europe has lower interest rates than the UK, the Bank of England (BoE) will be expected to keep rates low prior to any referendum on the euro. Now that the possibility of a referendum this year has been eliminated, Burdon feels the market is expecting rates to be increased.
Another factor facilitating the increase in interest rates is the Chancellor's announcement the housing market will no longer form part of the official inflation measure. Burdon says: 'This will create less fluctuation in inflation and enable the Government to better measure underlying inflation.'
This will relieve pressure on the BoE to change interest rates without having a big rise or decrease in inflation, he adds.
Cholwill believes the BoE will not raise rates this year because it wants to avoid a recession and curb deflationary pressures.
The managers agree recent declines in housing prices are of no concern to the construction sector. Cholwill says affordability ratios are not high, meaning there is still room for prices to stretch further.
Burdon says although growth in the housing market is slowing, its projected growth remains high, at 5%-10% this year. Moreover, government-mandated construction projects such as a new terminal at Heathrow Airport will continue to lend support to the sector.
According to Burdon, valuations in the sector are somewhat low because of concerns over the cyclical boom-bust nature of the industry. 'In the past, the sector has been susceptible to booms and busts but despite the market doing so well, there are no signs of a bust,' he says. 'This is because interest rates and unemployment are not going to increase drastically.
'Unemployment has increased in the private sector but extra labour has been absorbed by the public sector.'
Construction companies' low valuations have attracted investors who were reluctant to spend during the Iraq war, according to Cholwill,
He says: 'Investors in the market are becoming less risk averse because the uncertainties at the beginning of the year are starting to clear.
'During the Iraq war, some investors were sitting on cash and now the war is over they are starting to invest again, so we are seeing a boost in sectors such as mid and small-caps, as well as housing.'
Both Cholwill and Burdon favour companies like construction firm Wolseley because of what they describe as good management and exposure to both the UK and US markets.
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