Less than two weeks into his tenure and the initial positivity relating to the Trump administration is seemingly on the wane. Several executive orders have already been signed including travel bans for Muslim countries. This is seen as concrete evidence of Trump’s isolationist orientation and anxiety regarding the potential for trade wars is rife with an uncertainty filtering into markets. That the market is edging lower is not a complete surprise further to large gains through December and into the New Year. Buy the rumour sell the fact comes to mind. The Dow Jones index has recently been up through the considered important 20,000 level but has come lower quickly after. At least the Americans were able to wear their tailor made caps for a couple of days! To be fair and on the positive side, US consumer and business sentiment is holding up well and their macro outlook looks generally robust at this stage. I remain positive for the ultimate direction of shares this year but stand alert for opportunities when periods of stock specific weakness or volatility present. Shorter terms wobbles don’t mean the medium and longer term trends will change. Equities are considered the optimal asset class to be holding in a growing (inflationary) economy which may have to absorb increasing interest rates. The wall of money slowly migrating out of bonds should also provide an ongoing bid to the market.
Turning to the UK specifically, the BOE has today voted unanimously to keep rates on hold at 0.25% but encouragingly for a second time since the Brexit vote, has increased its GDP growth projections. For this year Carney & Co now expect a 2% rise in output, up from 1.4% mentioned in the November inflation report. At this juncture, the Brexiteers have been proved right about the (lack of negative) effect regarding exiting the EU but there is a long gestation period ahead.
Article 50 will now indeed be invoked formalising the 2 year Brexit process ending any uncertainty there. Of some concern, UK construction continues to slow more than expected which is a drag as the sector is a huge employer. It seems any increase in government infrastructure spend can’t come quick enough and investors in the sector are having their patience duly tested. Thin margins in contracting make business tough enough.
The weak pound continues to assist with the appetite for companies with an international earnings mix whilst simultaneously causing headaches for those having to consider price rises as import costs have risen. It is amazing to see the divergence in sector performance right now. As previously mentioned, it remains though unclear for how long current FX rates prevail and thus the forward performances of certain stocks and sectors is very difficult to predict.
National Grid (912p) has retraced a significant 20% from the share price highs (1150p) of last summer and I have a heightened investment case interest. The valuation was evidently excessive back then with the stock on a lofty multiple of 17.5 times 2017 profits with a sub 4% income yield to buyers. A single digit earnings grower, that was a full price tag but the PE ratio is now down to a more attractive 13.7 times forward earnings with a growing yield nearer 5%. Brokers are starting to upgrade. While an investment here won’t likely provide a quick buck bounce, it should represent a lower volatility growth and income option. There is always room in the portfolio for such opportunities especially in an environment where higher volatility (cyclical) names have been preferred. Importantly the sale of 61% of the UK gas distribution business has been announced which will bring about a special dividend payment in the spring / early summer for an overall return to shareholders of around £4 billion (subject to clearance from the European Commission). There will then be a new company focus on higher growth assets whilst maintaining dividend distributions and a strong balance sheet. My 6 month target level is 1000p
Vodafone (192p) has just confirmed it is trading in line with expectations in a quarterly update backing views for 2016. Free cash flow guidance has been reiterated if pretax earnings will be at the lower end of its previously stated range. Challenges in India have been well documented where the Reliance Industries backed Jio for example, is offering free voice and 4G to customers. Vodafone has responded with a deal to merge with Idea Cellular to create a business with near 400 million mobile customers. Highly competitive markets and some slippage in the UK business has meant the shares have traded flat today. The dividend appeal (6%) is strong but technically I believe it is important for the stock to hold above the 190p level which is a 3 year support line. I would now like to see directors buy shares and my fair value target is 220p.
Finally BT Group (305p) stunned the market last week with the revelation of a needed £530 million writedown from their Italian Business. There had previously been a £145 million provision for this problem and cash flow will take a hit of £500 million. In brief it is an accounting scandal based on improper behaviour. Questions are naturally been asked of the internal governance processes not to mention the role of the auditors. The company did also point to some softening in UK markets in serving up this profit warning. I drove home with a pet-lip that night. Bulls hope this will largely constitute a one off problem and take solace in the still increasing dividend that has been promised; the bears will ask what lurks beneath and show concern for the softening in some of the core markets. The stock seems to have found a new level near 300p and for now the shares are a hold until the dust settles.
As if we needed reminding of the risks associated with market investing and a reminder of the importance to have funds spread across different stocks and sectors in the portfolio.
This report was written by Philip Scott, Director at SI Capital on 2/2/17 when the FTSE 100 closed at 7140.