The UK market has been at large flatlining for six weeks with investors seemingly unsure whether company valuations should appreciate further or not, as the case may be. Short term traders haven’t had much to get their teeth stuck into accordingly. The environment remains difficult to navigate and decipher especially for the central bank (Bank of England) presiding over sluggish economic growth, below target inflation and high general levels of debt but with limited firepower left in the monetary tank i.e. little scope for further interest rate reductions. This scenario has in particular markedly impacted the banking sector (to the downside) which until January this year was looking forward to some profit growth (margin expansion) on the back of a forecasted increasing base rate; now there is even talk of ‘negative rates’ in some quarters : the opposite of good news to a lending business. The value of sterling has also significantly weakened over the recent past in sympathy.
The US Federal Reserve faces a similar challenge in the face of contracting productivity levels but with a behind the scenes (mounting) inflation issue. Infact increasing rates on both sides of the Atlantic to some economists remains a distinct (sensible even) possibility but the risks of such action are also apparent. It is actually fair to say that many in the markets have lost confidence in the actions and projections of the central banks and this is far from ideal.
Although equities are trading sideways for now, it is worth pointing out that both the Dow Jones and S&P 500 have rallied near 15% from the February lows and are now not far from their respective highs once again. The UK FTSE 100 is up 11% over the same period but remains 1000 points from the highs of a year ago. To an extent some relative weakening in the value of the dollar (based on the view that US rates are now unlikely to rise near term) has assisted the share prices of export focused US multinationals. It is also helping the share prices of mining and oil companies whose dollar denominated commodities have become cheaper.
But the recovery back to 7 year highs, the charts and valuations here are again on the toppy side in my view. If the US markets falls, we will not be immune even if our valuations are less stretched. Throw into the mix the genuine uncertainty regarding the upcoming vote on the UK’s membership of the EU, the ongoing apprehension regarding Chinese growth rates, terror threats and I do suspect all things considered, another dip may be on the horizon short term.
“Sell in May and go away” has thus once again presented itself as a possibility. To readers unfamiliar with this stock market adage, it goes back years and relates to the statistical likelihood that shares perform less well through the summer than they do through autumn and winter. Thus an investor would do better to hold cash through this (underperforming) period, perhaps looking to re-enter the market in September. The reality now is that over time, with technological advances and the ability to trade shares much more easily, the time of year now brings little by way of seasonal constraint to stock market participants. With the internet able to provide information up to the minute, quiet summers are not what they used to be and thus lulls and periods of
underperformance are not as easily predictable. Nonetheless, for the purpose of the current market dynamic as described and outlined above, I still believe markets may fall away somewhat over this period, not that I am overly bearish or thinking about a long term negative trend. Time will tell as usual.
Stock Specific Comment
My inclination if investing new funds currently would be to keep a ‘defensive’ bias and to seek out companies with reliable cashflows (funding secure growing dividends) and to probably avoid anything overly exposed to Europe. In the event that Britain leaves the EU, the fallout is likely to be more detrimental to Europe as a whole than to Britain in isolation. In terms of sectors to be sensitive to however, UK focused property companies (to include housebuilders), possibly retailers and UK focused recruitment companies are logically implicated. Indeed we have already seen some price weakness in these areas. As a general observation, the FTSE 250 companies are more UK centric and in theory are thus more vulnerable to a Brexit than the more international FTSE 100. Nonetheless I do not personally believe that we will leave the EU ultimately but fully appreciate the need for caution.
On the investment side, the pharmaceutical sector is an obvious possible investment pick. Now Pfizer has called time on its proposed takeover of Allergan, we have unsurprisingly seen some speculative interest in the UK listed drugs majors. GSK (1470p) may now look expensive on 17 times this year’s earnings with some question marks regarding the security of the dividend also. My preference from a valuation point of view would be to look at AstraZeneca (4000p) on 13 times forward earnings and yielding a respectable 5%. While Pfizer failed 18 months ago to acquire Astra (and I find it hard to believe they will table a new offer now), my suspicion is the stock has the most appeal in the sector for growth and M&A activity in some form.
Another relatively defensive play might now include BT Group (438p). Revenue and cashflows are predictable in the telco space and ongoing corporate activity in this sector also seems likely. Mobile network EE was acquired at the end of January which should add to earnings momentum. A new FD in Simon Lowth (formerly of BG Group and before that Astrazeneca) will start in July and I note with interest that Deutsche Telecom is BT’s largest shareholder with a 12% stake. A 2016 PE ratio of 14 with a growing and secure 3.5% income yield rates attractive with the stock down from 500p in early March.
In the small cap space, UK logistics operator Wincanton (168p) warrants a look. The £200 million market cap has significantly reduced debts over the past few years, something that has been weighing on the valuation. An “in-line” trading statement at the end of March has allayed any concerns in my view and the stock looks cheap on a forward PE multiple of just 8 with the potential for a re-instatement of the dividend in the near future. A takeover cannot also be ruled out should the share price remain low.