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November 2018 Market Report
During the month to October 31st, 2018, major equity markets displayed a very weak trend, falling by 8.52% overall and the VIX index rose sharply to 22.05. The month was the worst equity performance for more than six years. There continued to be an abundance of market moving news over what is traditionally a volatile month, at macro-economic, corporate and political levels.
The European Central Bank appeared to become more certain of removing QE over coming quarters, with more hawkish policy statements, but delaying any interest rate increase until 2019, while economic news seems to have been weaker than forecast in recent months, particularly in Germany. Political events were not in short supply, and in Turkey for example, continued to affect bond and currency markets while Italian bonds oscillated with the growing tension between the two-party Government and the ECB. Angela Merkel stood down as CDU leader late in the month, a position occupied for 18 years. US market watchers continued to grapple with ongoing tariff discussions, Federal Budget, Turkish stand-off, NAFTA follow up and North Korean meeting uncertainty as well as Trump’s growing domestic issues, ominously becoming higher profile, before the important November midterm elections. US economic data and corporate results so far have generally been above expectation and the official interest rate was increased again in September to a range of 2%-2.25%. Provisional third quarter GDP growth figures showed very buoyant consumer trends but weak corporate investment and foreign trade. In the Far East, China flexed its muscles in response to Trump’s trade and other demands while relaxing some bank reserve requirements and “allowing” the currency to drift to a recent low. Recent indicators and statements would suggest a slowdown in 2018 growth to a still very respectable 6%-6.5%. Japanese second quarter GDP growth appeared higher than expected and Shinzo Abe consolidated his political position, both perceived as market friendly, and the ten-year bond continues to trade near the recent yield high. At the October BoJ meeting, the current easier fiscal stance was reconfirmed. The UK reported mixed economic data with satisfactory developments on the government borrowing side, inflation higher than expected, but poor relative GDP figures and deteriorating property sentiment, both residential and commercial. Recent retail data shows mixed trends, some “weather related”. Market attention, both domestic and international is clearly focussed on ongoing BREXIT developments and their strong influence on politics. Although the Budget presented on October 29th, showed a slightly higher GDP forecast and a more expansionary fiscal approach, the Chancellor made frequent references to the unsettling effects of any unsatisfactory Brexit outcome.
Aggregate world hard economic data continues to show steady expansion, although forecasts of future growth have been trimmed in recent months by the leading independent international organization. Fluctuating currencies continued to play an important part in asset allocation decisions, the stronger Yen being the major recent feature recently, largely for haven reasons. Emerging market currencies have had a particularly volatile period, showing some relative recovery over October from very weak levels. Government Bond holders saw mixed moves over the month-some more inspired by equity market turmoil rather than changed fundamentals.
At the end of the ten -month period, “mixed investment” unit trusts all showed negative performance, and only a small number of asset class sub sectors are showing a positive return. Source: Morningstar
Global Equities displayed a strong downwards trend over the month of October the FTSE ALL World Index falling 8.52% in dollar terms and now showing a negative return of 6.55% return since the beginning of the year. The UK broad and narrow market indices fell by 5.09% and 5.42% respectively over the month and have both underperformed world equities in sterling adjusted values from the end of 2017 by about 6%. The NASDAQ index, driven by technology companies, saw some of the steepest declines with many bell weather stocks showing significant falls. In sterling adjusted terms, America and Japan are the only two major markets now showing positive returns year to date The VIX index rose 75.84 % over the month, and at the current level of 22.05 is up about 115% from the year end.
Sector volatility remained high during the month, influenced by both global factors e.g. commodity prices, tariffs, as well as corporate activity and a general risk aversion mood. Industrial stocks fell significantly while utilities and banks registered positive returns. Over the ten-month period, pharmaceuticals are outpacing the worse performing major sector, telecommunications by around 45%.
Gilt prices rose marginally over the month largely on haven buying but are still down 2.67% year to date in capital terms, the 10-year UK yield standing at 1.26% currently. Other ten-year yields closed the month at US 3.1%, Japan 0.13%, and Germany 0.3% respectively. UK corporate bonds rose 1% in price terms ending October on a yield of approximately 2.71%. Amongst the more speculative grades by contrast, yields rose, although US lower grade bonds are still one of the few sub-categories showing year to date price gains. Floating rate bond prices underperformed gilts over the month but are still showing positive year to date total returns. I continue to strongly recommend this asset class. See my recommendations in preference shares, convertibles, corporate bonds, floating rate bonds etc. A list of my top thirty income ideas (all yielding over 5%) from over 10 different asset classes is available.
Amongst the major currencies, a stronger Yen was the monthly feature largely on safe haven buying as global equities tumbled. Currency adjusted, the FTSE World Equity Index is now outperforming the FTSE 100 by around 6% since the end of 2017 and about 20% since the June 2016 BREXIT vote.
A generally weak month for commodities with the notable exception of gold, related precious metals, iron ore and sugar Over the year so far, oil, wheat and uranium (renegotiation of longer-term contracts) have shown the greatest gains.
Over the coming months, geo-political events and Central Bank actions/statements will be accompanied by the continuation of the third quarter corporate reporting season, resulting in an abundance of stock moving events. With medium term expectation of rising bond yields, equity valuations and fund flow (both institutional and Central bank) dynamics will also be increasingly important areas of interest/concern, and it is expected that any “disappointments”, economic or corporate, will be severely punished.
US watchers will continue to speculate on the timing and number of interest rate hikes 2018/2019 and longer-term debt dynamics, as well as fleshing out the winners and losers from any tariff developments -a moving target! Third quarter figures (and accompanying statements) will be subject to even greater analysis after the buoyant first half year, and the growing list of headwinds. Additional discussions pertaining to Saudi Arabia, North Korea, Russia, Iran,Brazil, Venezuela, and Trump’s own position could precipitate volatility in equities, commodities and currencies, especially with the November mid-term elections just days away. In Japan market sentiment may be calmer after recent political and economic events although international events e.g. exchange rates and tariff developments will affect equity direction. The recent China/Japan summit may signal closer co-operation in the area. European investment mood will be tested by economic figures, EU Budget discussions, Italian bond spreads, German, Turkish and Spanish politics, and reaction to the migrant discussions. It must also be remembered that the QE bond buying is being wound down over coming months. Hard economic data and various sentiment/residential property indicators will continue to show that UK economic growth will be slower in 2018 compared to 2017, and any economic upgrade over current quarters appear extremely unlikely. Whichever Brexit outcome is agreed, it is highly likely that near term quarterly figures will be distorted. The current perceptions of either a move to a “softer” European exit, or a “no deal” will undoubtedly lead to pressure from many sides. Political tensions stay at elevated levels both within and across the major parties and considerable uncertainties still face individual companies and sectors. Industry, whether through trade organisations, international pressure e.g Japan, or directly e.g. Bae, BMW, Jaguar Land Rover, Toyota, Honda, Ryanair is becoming increasingly impatient, and vocal, and many London based financial companies are already “voting with their feet”.
On a valuation basis, most, but not all, conventional government fixed interest products continue to appear expensive against current economic forecasts and supply factors, and renewed bond price declines and further relative underperformance versus equities should be expected in the medium term, in my view. See my recent ‘iceberg’ illustration for an estimate of bond sensitivity, particularly acute for longer maturities. Price declines are eroding any small income returns leading to negative total returns in many cases. On the supply point there are increasing estimates of US bond issuance against a background of diminished QE and overseas buying. European bond purchases are also winding down. Apart from debt implications, corporate earnings growth and discounting purposes, remember that higher bond yields also are starting to play into the alternative asset argument. In the US for example the ten-year bond yield at 3.1%, is over 100 basis points higher than that on equities.
Equities appear more reasonably valued after recent price falls, but there are wide variations. Equity investors will be looking to see if superior earnings growth can compensate for higher interest rates in several areas. Helped in no small part by tax cuts, US companies have been showing earnings growth more than 20% so far this year, although the current quarter is widely expected to be the peak comparison period, and ‘misses’ are being severely punished e.g. Caterpillar,3M Facebook, General Electric,Kellogs, and Twitter. Accompanying corporate outlook statements are being carefully scrutinised.
Outside pure valuation measures, sentiment indicators and the VIX index are showing significant day to day variation, after the complacency of last year. The current level of 22.05 reflects the uncertain market mood, as does the relatively high put/call ratio.
In terms of current recommendations,
Depending on benchmark, and risk attitude, first considerations should be appropriate cash/hedging stance and the degree of asset diversification.
An increased weighting in absolute return, alternative income and other vehicles may be warranted as equity returns will become increasingly lower and more volatile and holding greater than usual cash balances may also be appropriate, including some outside sterling. Among major equity markets, the USA is one of the few areas where the ten-year bond yields more than the benchmark equity index. The equity selection should be very focussed. Certain equity valuations are rather high, especially on a PE basis (see quarterly), although not in “bubble” territory. A combination of sharper than expected interest rate increases with corporate earnings shocks would not be conducive to strong equity returns. Ongoing and fluid tariff discussions could additionally unsettle selected countries, sectors and individual stocks Harley Davidson, German car producers, American and Brazilian soy producers etc.
- UK warrants a neutral allocation but is starting to look good value on certain metrics. Ongoing Brexit debate, political stalemate and economic uncertainty could cause more sterling wobbles, which in turn could affect sector/size choices. I would expect to see more profits warnings (Countryside,Foxtons,H&M,BHS,Homebase,WPP,Computacentre- latest casualties) and extra due diligence in stock/fund selection is strongly advised.
- Within UK sectors, some of the higher yielding defensive plays e.g. Pharma, telco’s and utilities have attractions relative to certain cyclicals and many financials are showing confidence by dividend hikes and buy-backs etc. Over recent months, value stocks have been staging a long overdue recovery compared to growth stocks. Oil and gas majors may be worth holding despite the outperformance to date. Remember that the larger cap names such as Royal Dutch and BP will be better placed than some of the purer exploration plays in the event of a softer oil price. Mining stocks remain a strong hold, in my view (see my recent note for favoured large cap pooled play). Corporate activity, already apparent in the engineering (GKN), property (Hammerson), pharmaceutical (Glaxo, Shire?), packaging (Smurfit), retail (Sainsbury/Asda), leisure (Whitbread), media (Sky), mining (Randgold) is likely to increase in my view, although the Government has recently been expressing concern about overseas take-overs in certain strategic areas.
- Continental European equities continue to be preferred to those of USA, for reasons of valuation, and Central bank policy, although political developments in Italy, Spain and Turkey should be monitored closely. European investors may be advised to focus more on domestic, rather than export related themes. Look at underlying exposure of your funds carefully and remember that certain European and Japanese companies provide US exposure, without paying US prices. I have recently written on Japan, and I would continue to overweight this market, despite the large 2017 and 2018 to date outperformance. Smaller cap/ domestic focussed funds may outperform broader index averages e.g. JP Morgan Japanese Smaller Companies and Legg Mason.
- Alternative fixed interest vehicles, which continue to perform relatively well,in total return terms, against conventional government bonds, have attractions e.g. floating rate funds, preference shares, convertibles, for balanced, cautious accounts and energy/ emerging/speculative grade for higher risk. These remain my favoured plays within the fixed interest space. See recent note
- UK bank preference shares still look particularly attractive and could be considered as alternatives to the ordinary shares in some cases. If anything, recent sector “news” has highlighted the attractions of the sector.
- Alternative income, private equity and renewable funds have exhibited their defensive characteristics during the October market wobble and are still strongly recommended as part of a balanced portfolio. Most of these are already providing superior total returns to both gilts and equities so far this year, and indeed some produced positive returns during October. Reference could be made to the renewable funds (see my recent solar and wind power recommendations). Recent results from Green coat and Bluefield Solar reinforce my optimism for the sector. Selected infrastructure funds are also recommended for purchase after the recent Corbyn/Carillion inspired weakness (see note). The take-over of JLIF during the month highlights the value in the sector!
- Any new commitments to the commercial property sector should be more focussed on direct equities and investment trusts than unit trusts (see my recent note comparing open ended and closed ended funds), thus exploiting the discount and double discount features respectively as well as having liquidity and trading advantages. However, in general I would not overweight the sector, as along with residential property, I expect further price stagnation especially in London offices and retail developments e.g. (Hammerson, Intu). The outlook for some specialist sub sectors e.g. health, logistics, student, multi-let etc and property outside London/South-East, however, is currently more favourable. Investors should also consider some continental European property See my recent company note.
- I suggest a very selective approach to emerging equities and would continue to avoid bonds. Although the overall valuation for emerging market equities is relatively modest, there are large differences between individual countries. A mixture of high growth/high valuation e.g. India, Vietnam and value e.g. Russia could yield rewards and there are signs of funds moving back to South Africa on political change. Turkish assets seem likely to remain highly volatile in the short term and much of South America is either in a crisis mode g. Venezuela or embarking on new political era e.g. Mexico and Brazil. As highlighted in the quarterly, Chinese index weightings are expected to increase quite significantly over coming years and Saudi Arabia, is just being allowed into certain indices.
Full fourth quarter report will shortly be available to clients/subscribers and suggested portfolio strategy/individual recommendations are available. Ideas for a ten stock FTSE portfolio, model pooled fund portfolios (cautious, balanced adventurous, income), 30 stock income lists, hedging ideas and a list of shorter-term low risk/ high risk ideas can also be purchased, as well as bespoke portfolio construction/restructuring. Feel free to contact regarding any investment project.
Good luck with performance! Ken Baksh 01/10/2018
Ken has over 35 years of investment management experience, working for two major City institutions between 1976 and 2002.
Since then he has been engaged as a self-employed investment consultant. He has worked with investment trusts, unit trusts, pension funds, charities, Life Fund,hedge fund and private clients. Individual asset managed have included direct equities and bonds pooled vehicles currencies, derivatives and commodities.
Projects undertaken in a number of areas including asset allocation, risk control, performance measurement, marketing, individual company research, legacy portfolios and portfolio construction. He has a BSc(Mathematics/Statistics) and is a Fellow Member of the UK Society of Investment Professionals.
Phone 07747 114 691
All stock recommendations and comments are the opinion of writer.
Investors should be cautious about all stock recommendations and should consider the source of any advice on stock selection. Various factors, including personal ownership, may influence or factor into a stock analysis or opinion.
All investors are advised to conduct their own independent research into individual stocks before making a purchase decision. In addition, investors are advised that past stock performance is not indicative of future price action.
You should be aware of the risks involved in stock investing, and you use the material contained herein at your own risk
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Diageo DGE produced a strong performance in the 6 months to the 31st December. All regions contributed to organic net sales growth of 4.2% although organic volume growth was considerably lower at 1.8%.This was all due to constant and rigorous execution of strategy by management – nothing like self praise when things are claimed to be going well, although a fall of 2% in reported growth is hardly consistent and is not thought worthy of particular mention. Basic earnings per share rose by 36.3% and the interim dividend is to be increased by 5% to 24.9p. As for 2018, that is expected to bring in mid single digit top line growth.
SKY plc SKY The half year to the 31st December produced a strong set of results. Indeed the blurb for the half year outcome is almost such a parrot like repetition of that for Diageo that it takes some convincing that they were not both written by the same script writer. In the case of Diageo the excellent performance was down to “consistent execution of strategy” by management. Now where did I read that before. Like for like revenue rose by 5% and earnings per share by 11%. On a statutory basis operating profit was up by 24% and earnings per share by 39%. 365,000 new customers were signed up and pay as you go buys rose by 8%. .All this was achieved despite a challenging consumer environment. The interim dividend is to be increased by 4% to 13.06 p per share, on top of the previously announced special dividend of 10p per share.Plans for 2018 and beyond are said to be ambitious.
Paypoint PAY claims to have “driven” profitable growth in the UK and in Romania where net revenue rose by 42% most of which was accounted for by the acquisition of Payzone. Where exactly it drove this profitable growth to, is difficult to understand as it included a fall of 4.3% in Group retail Networks, a volume fall of 10.5% in UK bill and generals and a net revenue fall of 6.3% in UK retail services.Nonetheless it did have a good day on the 22nd December, its best trading day of the year where processed transactions rose by 67% on the previous year.
Countryside Props CSP made a strong start to its year with first quarter completions up by 47% helped by a record year end order book and believe it or not, a fall of 11% in its private average selling price. Perhaps somewhere there is a link between those two sets of figures, which no doubt will be studiously avoided by the rest of the British housebuilding industry
Rank Group RNK met challenging trading conditions in the 6 months to 31st December but is still raising its interim dividend by 11% after a fall of 17% in profit before tax and 14% in basic earnings per share. Like for like group revenue for the half year rose by 2%. Nothing like raising a dividend when the going gets tough.
Diageo DGE is raising its interim dividend by 5% after a stronger performance produced a rise of 14.5% in reported net sales and 28% in operating profit for the 6 months to the end of December. On a like for like basis, operating profit grew by 4.4% and basic earnings per share were up by 20% at 60.3p.
SKY plc SKY produced a strong first half performance with operating profit falling only 10% to £679m, after absorbing £314m of additional Premier League costs. Revenue rose by 12% and earnings per share fell by 5%. strongest growth came in Germany & Italy with rises of 10% and 9% at constant currency rates and the UK lagging behind with only 5%
Unilever ULVR saw core turnover fall by 1% in 2016, which ended with tough market conditions.Core earnings per share fell by 7% or 3% at current exchange rates. Sales rose by 4.3% at constant exchange rates. emerging markets performed much better with underlying growth of 6.5%. A slow start is expected to 2017 with tough market conditions expected to continue into the first half. Europe has been particularly challenging with subdued volume growth and price deflation in many countries.
Whitbread plc WTB produced third quarter total sales growth of 8.6% but this masked a patchy like for like position. Restaurants fell by 1.5% on a like for like basis but Costa rose by 4.3% and the total came in at 1.7%
Ladbrokes LAD complains that at Cheltenham bookmaking principles were abandoned because of intense competition and that until then results had been favourable, At least that tells us that one of the main principles of the betting industry is that the bookie always wins and something has gone seriously wrong if they don’t. Similarly Ladbrokes is not looking forward to the end of the football season because it stands to lose 3 million pounds if Leicester wins the Premiership. So come on Leicester, do your best please.
Despite the unwelcome success of the punters, Ladbrokes had an encouraging start to the year with 3rd quarter net revenue up by 10.6% and digital net revenue by over 35%.
SKYplc SKY enjoyed a strong third quarter with strong demand from new customers producing excellent financial results Group revenue rose by 5% and operating profit by 12%. Germany and Austria led the way with a rise of 10% but Italy switched off with a 2% decline in revenue and 49% collapse in profitability.
Sky claims it is building Europe’s leading entertainment business. Looking at the rubbish on offer throughout most of Europe that should not be a particularly challenging task. Presumably “leading” will turn out to mean pandering to the lowest possible audience.
United Carpets UCG Final results will be ahead of expectations and it’s not often you hear that from the carpet industry. The improved trading seen in the first half has continued into the second half with like for like sales up by 6.4%
Go Ahead Group GOG keeps repeating in today’s update that 3rd quarter trading has been satisfactory. In fact it seems to have been a bit better than that with rail revenue up by 5.5%, 9.5% and 3% in its three rail divisions and passenger numbers up by 2.5%, 5% and 3% respectively. Regional and London buses were in line with expectations.
Computacenter CCC Revenue for the quarter to 31st March was flat. Uk revenue was down 4% due to the ending of a large contract.