Whisper it, but as the UK exits winter, there seems to be a spring in its step.

European gas prices have fallen dramatically, and energy bills may start falling as soon as Q3. CPI inflation has dipped from its 11.1% high of October to just 10.1% in January — and in the absence of another economic shock, the Bank of England predicts the measure will come close to the official 2% target by this time next year.

Accordingly, the Bank thinks the recession will now likely last only one year, and the National Institute of Social and Economic Research thinks the country may avoid a recession altogether — although warns it will not feel like it for millions of households.

And outside of the wider macroeconomic factors — Ukraine, China, et al — there are two key factors that will determine the trajectory of the best UK stocks next month.

First is the trajectory of monetary policy. The bank rate now stands at 4%, and analysts predict this will not rise above 5% any time soon. However, Monetary Policy Committee members are clearly divided over how much further action will be needed — with Catherine Mann and Silvana Tenreyo seemingly at polar opposites of the debate.

It’s also worth noting that to some extent Governor Andrew Bailey remains constrained by his counterpart’s hawkish noises across the pond. To get some idea of Bailey’s mindset, he gave a speech a week ago concerning the cost-of-living crisis at a conference hosted by PR firm Brunswick.

The Financial Times reported that the governor had ‘signalled no pressing need for more UK interest rate rises,’ the BBC testified that he indicated ‘UK interest rates may rise further,’ and the Independent concluded that ‘the Bank couldn’t be more unclear about interest rates.’ As rates rise, growth stalls, so this uncertainly is clearly unhelpful.

Second is the trajectory of fiscal policy. While the budget is unlikely to contain too many surprises, it seems clear that corporation tax will be rising to 25% from the current 19% for most firms, while several investment incentives, including the super-deduction, will be scrapped.

This may not be the best idea as OECD data already shows that investment in the UK already remains below its mid-2016 level, while the IMF has warned that the UK will fare worse economically than any other developed country in 2023.

However, the UK seems to have just about escaped a technical recession in H2 2022, and the OBR has estimated that Hunt now has circa £30 billion of headroom within the current self-imposed fiscal rules to play with. This could be used to help settle some of the more serious strikes, or else be used to make internal UK investment more attractive.

AstraZeneca’s decision to build its new factory across the Irish Sea, ARM’s to list exclusively in the US, and CRH’s plan to move to the states will give the Chancellor ample reason to defend any new investing incentives for larger companies — which could see some of the best UK shares stand to benefit.

Best UK shares

1. Rolls-Royce (LON: RR)

Rolls-Royce shares are up 56% year-to-date to 154p, a result of uplifting full-year results and investor optimism that new CEO Tufan Erginbilgic will see the FTSE 100 aerospace company returned to its former glory.

Recent FY22 results saw Rolls deliver an underlying operating profit of £652 million, £238 million higher than the prior year, driven primarily by the civil aerospace and power systems divisions. This result compares favourably to the £478 million expected by a Reuters poll of analysts.

Free cash flow rose to £505 million, £2 billion higher than in 2021 — predominantly driven by a huge recovery in engine flying hours, which rose by 35% year-on-year as the vast majority of pandemic lockdowns subsided.

Meanwhile, net debt fell from £5.2 billion to £3.3 billion, and the company now expects underlying operating profit of £0.8-£1.0bn and free cash flow of £0.6-£0.8bn in 2023. A strategic review is underway, with medium-term financial targets to be set in the second half of 2023.

It’s likely that a key target will be a return of dividends, while reclaiming its lost investment grade credit rating has already been earmarked by the CEO as a ‘first priority.’ The company is waiting for government incentives to start production of its small modular nuclear reactors.

2. Scottish Mortgage Investment Trust (LON: SMT)

As a long-term investing opportunity for those looking at a timeframe of more than five years, Scottish Mortgage could now be an attractive opportunity.

Parent Baillie Gifford suffered its worst ever fall in assets under management in 2022, with AUM falling from £336 billion to just £223 billion by the end of last year. However, it’s worth noting that only £20 billion of this fall can be attributed to client outflows, with the majority driven by valuation decreases in its portfolio companies.

With circa 75% of Scottish Mortgage’s shares held by UK investors, and the Trust’s objective to
best the All-World over a period of five years, it’s clear that holders are prepared to wait for a return to grace.

Co-manager Tom Slater recently admitted that the SMT experienced a ‘humbling year’ in 2022, with shares falling by 46% in the year. He noted that it was ‘slow to recognise the significance of the shattering in SINO-US relations’ and further acknowledged the mistake in thinking that pandemic-induced changes in consumer habits would last.

However, it’s worth noting that the company still has 14.9% of its investments in Asia — in companies including Meituan, Tencent, and Bytedance — and despite regulatory spats, exports between the two countries hit a record $690.6 billion in 2022. Moreover, SMT is trading at a huge 15.9% discount to its constituent assets.

With 30.7% of its holdings held in 52 private companies, giving retail investors a rare chance to participate in non-listed opportunities, SMT could be one of the best UK shares to buy next month.

3. Avacta (LON: AVCT)

Avacta shares have experienced significant volatility over the past few years. Indeed, volatility has been the theme of 2023, with the FTSE AIM biotech rising to a high of 185p on 9 February, before falling back to 125p today. For clarity, Avacta is a high-risk investment, but risk can form part of a well-balanced portfolio.

The company’s flagship treatment is its pre|CISION platform based AVA6000. The pro-doxorubicin chemotherapy drug saw Phase I trials begin in 2021, and two months ago the company advised that ‘AVA6000 continues to show a very favourable safety profile in the fourth dose cohort of the ALS-6000-101 dose escalation phase 1 clinical trial.’

Moreover, the AVCT conducted analysis on tumour biopsies procured from six patients that suggested ‘doxorubicin is being released within the tumour tissue confirming the tumour targeting potential of the pre|CISION technology.’ It also saw a ‘marked reduction’ in the ‘typical toxicities associated with the standard doxorubicin chemotherapy administration.’ These include the well-known side-effects of chemotherapy, such as sickness and hair loss.

Amazingly, CEO Alastair Smith envisions that AVA6000 could one day mean ‘chemotherapy without side effects.’

Of course, there’s still months, if not years to wait until Phase II trials are completed. And there are no guarantees that these initial results will be repeated at scale.

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