UK long/short managers drew on the market's resources stocks as oil broke more new ground in October The UK equity market finished a volatile and fractious October around 1% higher, despite a mixed market and the emergence of more evidence that economic activity is starting to slow. In the UK, both industrial production and consumer price inflation fell for the third straight month, while private sector employment figures were also weak.Overall values of UK equities have been somewhat compressed. Paul Findley, manager of Threadneedle's closed Crescendo UK Fund, explains that the difference between the highest- and lowest-priced sectors is smaller than normal, creating a favourable environment for both long and short bets. Findley says it is not just the sectors that are seeing level prices but also stocks. He uses the analogy of walking into a wine store where every bottle is priced £5.99 - in such a situation, eventually Bordeaux will sell out and the sweet German wines will be left on the shelf."This is a great position for us: as growth is slowing, we are looking for weaker cyclicals masquerading as growth stocks and this is a great short for us. When the bad news comes and the shares prices drop, we will get nice returns," he says. Not all managers agree that this price squeeze is positive. Ross Hollyman, manager of the GAM UK Hedge Fund, says: "If stock A and stock B are on the same rating and one is cheap and one is expensive, there is risk involved in determining which is which. Value for value's sake doesn't work anymore - we are looking for strong balance sheets."There were a few key sector themes during October. Oil prices again broke new records before succumbing to profit-taking. There is very little spare capacity in oil production and many UK equity hedge managers are convinced these prices will eventually be driven higher.Hollyman, Findley and Ashton Bradbury, manager of Old Mutual's closed UK Specialist Equity Fund, all have long positions in resources. Findley is 13.4% long on resources and Bradbury is long by 1.1%. Findley and Hollyman are both favouring BP, and Shell and Bradbury recently added holdings in Oriel Resources and Gulf Keystone - an AIM-listed drilling company. Hollyman is not investing in specialist resources stocks because he thinks investors could lose a lot of money on these positions as, he says, everyone thinks they are an expert in this area now.A surprise rights issue from Prudential and some fallout from the US insurance investigation by New York Attorney-General Eliot Spitzer hit Britain's insurance sector, although it rallied sharply to finish only modestly down. Bradbury and Findley are shorting insurance companies. Findley expects more cash calls from insurance companies and is short on Prudential, Aviva and Royal & Sun Alliance. Bradbury is shorting Amlin and Lloyds Brokers. Cyclicals and market-sensitive sectors returned to favour in October as evidenced by the strong performance of steel and mining, while areas such as personal care, autos and housebuilding were weak. Steel and mining stocks are still favourable long positions; Findley especially likes Corus, BPB and CRH. Hollyman is long on mining but has less conviction about this sector than resources. Findley is shorting consumer cyclicals - including household products - by -1.1%.Findley says: "Consumer cyclicals are strong shorts, as the household cash flow in the UK is getting smaller as council tax, energy bills and gas prices grow at a rate faster than average pay rises in the UK." Findley thinks big companies like Unilever, Nestlé and Colgate will suffer but that the costs of lost profits will also be borne down the chain by business-service providers for these companies - that is where he is finding his short positions. Bradbury disagrees. He is long on cyclical consumer goods by 1.3% and cyclical services by 4.1%. He thinks support service has hit a growth trend and has his top two long holdings in service providers WS Atkins (2.9%) and Serco (2.3%).Findley, Bradbury and Hollyman are all shorting housebuilders. Hollyman said building stocks were "looking very cheap but, compared to the book value, these stocks have a way to fall. These stocks did well on the back of the housing boom but are coming to more realistic values now. We are also looking for short positions in the suppliers to building companies, as the shock should be felt down the supply chain."The reining in of the UK's housing market is not only affecting the builders but also mortgage banks. Hollyman, Bradbury and Findley are all shorting mortgage banks as they see self-certified mortgages as contributing factors to the decline in this sector. Bradbury and Findley are both shorting Countrywide, which Findley describes as one of his most successful stock positions.key pointsBrent Crude's new price highs saw UK hedge managers take long positions in oil, with some favouring Corus, BPB and CRH.Managers are shorting housebuilders, as well as their suppliers, after profiting from these companies' performance during the housing boom....
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