Share prices have swiftly rebounded over the past fortnight which whilst welcome is also somewhat perplexing, unnerving even. Markets were previously pricing in a cocktail of unreserved negativism: a prognosis of extended deflationary global recession, the possibility (dare I say it) of large scale bank collapses and a Chinese hard landing. Panic was in the air frankly with heavy downward momentum and what looked like automated forced selling. But prices have duly turned higher amidst unprecedented volatility making short term directional predictions virtually impossible. Buyers and holders of the market have been rewarded for adding on weakness and staying calm. Infact we have witnessed a textbook case regarding the importance of not acting in drastic fearful haste, for example by succumbing to the negative sentiment. That said, one must remain on alert when markets are in moods like these.
Much confidence may have been lost with central bank policy but markets appear self-evidently to be calming, accepting (most probably) of the now near zero chance of interest rates rising any time soon. Commodity prices (oil and metals) are now recovering and we have witnessed material moves higher in these sectors. Rio Tinto and Shell are now 30% up from their recent lows. Bank shares are recovering and thus far there has been no confirmation of any significant bank ‘event’. Lloyds Banking Group’s recent results were for example very reassuring. Assuming the global economy can continue to move in the right direction (and this remains my view), the equity market was likely oversold two weeks ago and investors (at least for now) seem to be moving back into this camp.
Without doubt, the new dinner party talking point for everyone, certainly for those in the investment business is the Brexit possibility. For the capital markets this referendum is hugely important, way more so than any general election. While it is easy to be selfishly focused on the pros and cons for the UK on both sides of the debate, the fact is, if the UK does leave the EU, the contagion damage to residual Europe as a whole could be colossal. This is the “they need us more than we need them” angle I keep reading about. Europe remains a highly indebted place with sluggish levels of growth; a UK exit from the EU would logically make things worse.
We have already seen a significant fall in the value of the pound (and this is already making life difficult for some businesses) and we are playing out the hypothetical impact of less migration and higher interest rates in the event of the UK leaving the union. The housebuilding sector has for instance been trading lower. But it is this risk of Eurozone capitulation (political and economic) coupled with the increased likelihood of other countries wanting
out that investors will be most wary of. This factor will undoubtedly be playing on our minds until the end of June.
Is the market ready for this ‘step into the unknown’ (to coin Mr Cameron’s phrase) and how might it react in it becomes a reality. In this regard, the recent market rally seems somewhat odd but the FTSE 100 is of course an international blend of large capitalisation companies not just those exposed solely to the UK and Europe. Perhaps the impact will be an absorbable one though (despite some scaremongering) and after all, at the end of the day, we may not even leave.
Market specific comment
Whitbread (3850p), the Costa to Premier Inns FTSE 100 play has hit my investment radar. This company has grown earnings (profits) by 48% over the past three years and has seen its shares fall 30% from 5450p last year. The PE ratio or valuation of the stock has thus fallen significantly and I suspect excessively. The market has been happy to price it well over 20 times earnings and now the shares reside on circa 15 times. An update is due imminently which should reassure that the business in on track. Costa continues to have growth potential (possibly overseas) and is a self-financing cash cow of a business. It seems highly plausible that an exit strategy for the company would involve a full demerger of Premier Inns; many believe the sum of the parts would be worth more than the whole. My target is 4500p.
I have continued to research the unloved and contrarian area of the emerging markets. Brazil is on its knees and a cursory glance at a Brazilian tracker fund graph tells the story. Dominated by low commodity prices (Brazil is resource rich and skewed), a weak real currency and significant political, fiscal and economic challenges, the country is a long term investor’s option right now. The Rio summer Olympics should act as a draw for starters and commodities are moving higher. Consider the JP Morgan Brazil Investment Trust (36p) which although small (at £15 million total value) and illiquid, it is actively managed and has been buying back aggressively its own shares in the market. This bodes well in my view for the future. High risk naturally but fortune favours the brave as long as it is suitable for a client’s profile.