Musings on the Market

Wednesday, 25th November 2015 09:33 - by David Harbage

In scribbled form, a few thoughts about UK equities – both from a top-down or macro perspective, alongside comments on a number of company specific developments...

 1. Geo-political news flow, which undoubtedly immediately impacts investor sentiment, has been poor. Prompted by the atrocities in France, an escalation in terrorist and military action can be expected. While difficult to quantify or specify how this impacts on the value of different markets, heightened uncertainty is not appreciated by risk assets.

2. Market developments featured counter intuitive strength in equities; notably the key S&P 500 index which, driven by confidence in US retailers, delivered its biggest weekly rise since December 2014. Last week’s strong rally did not appear to have any particular fundamental driver – beyond value relative to cash and longer term interest rates (bonds) - and could be susceptible in the very short term to profit taking.

3. Economic news has been good at home, less so if taking a global ex-US perspective. This Wednesday, the Chancellor is due to deliver the Autumn Statement (which has become as important as the traditional Budget, in effectively indicating fiscal policy). Having secured political popularity by easing back on austerity measures, the gilt market keenly awaits evidence of any stiffening in Mr Osborne’s resolve to address the UK’s deficit. Recent data suggest that personal consumption and the service sector can maintain reasonable growth in domestic economic activity (GDP to be circa 2–2.4% in 2015), with employment and wage growth remaining strong.
 
4. Commodity prices of essential raw materials – such as oil (Brent crude below US$45) being in the doldrums - remain weak, not helped by economists’ downgrade of Chinese appetite. The historic expectation of gold benefiting from political or financial problems has not materialised ‘this time round’; the precious metal, valued at US$1,070 an ounce, has undoubtedly struggled against the backdrop of a strong ‘greenback’ (US currency).
 
5. Merger & acquisition activity, albeit more evident in North America than at home, has been a major support to market valuations. AstraZeneca shareholders may be relieved that Pfizer is looking elsewhere for a corporate partner, but its shares have struggled to get close to the £55 offered by the US pharmaceutical giant. Having said that, AZN has outperformed the wider UK equity market over the past year and – in the probable absence of any profit growth this year or next – the shares looks fully valued, beyond its 4.1% dividend yield.
 
6. Another income stalwart, Royal Dutch Shell is coming under pressure from a number of its biggest stakeholders to alter the terms of its acquisition of BG Group. Earnings from the Anglo-Dutch giant are barely expected to cover an anticipated 123pence dividend for calendar 2015; it is interesting to note that an increasing number of UK equity income funds do not feature the FTSE100’s biggest company. Irrespective of concerns about an ability to pay a dividend out of reported profits, such a position represents a ‘big’ exposure against almost any benchmark.
 
7. The merger of gaming software business Playtech with financial derivative newcomer Plus500 has been called off, ostensibly because the concerns raised by the UK regulator (the FCA) were unlikely to be resolved by the year-end completion date. With Playtech also struggling to persuade the Central Bank of Ireland to progress its other pending purchase of Ava Trade, the company’s strategy of diversifying into financial markets appears to have hit the buffers. These events have increased scrutiny of Mr Teddy Sagar’s past and the rigour of the business model, accounting and operational practices of both FTSE All Share constituent Playtech and AIM-listed Plus500. Both possess apparent growth capabilities, but neither would appear suitable for ‘widow or orphan’ investors.
 
8. Elsewhere in the technology sector, SQS Software Quality Systems announced an encouraging business update which highlighted the successful integration of three acquisitions made earlier in 2015 which has expanded the German based, AIM listed group’s reach into Italy and the North America. This specialist in software quality testing and project work reports strong demand for its services, but its shares appear ‘up with events’ having risen from 220p to almost £6 over the past three years. More pertinently, earnings estimates for 2016 indicate a PEG ratio of 1.1 and a 30% premium to the overall market. Containing the tide of high wage inflation in the sector (highlighted within domestic and European employment data this week) is a critical issue for the business.

9. Another stock that the writer has followed for a number of years also appears ripe for profit taking. Global recruitment business Empresaria has recovered well from patchy trading four years ago, and management’s efforts to restructure its portfolio of offices and industry specialism are to be applauded. However, equity valuations within this cyclical sector deserve to be on a significant discount – in the absence of a bout of industry consolidation - and evidence of slowing economic activity in emerging markets and across Europe prompts caution. The shares have risen from 20p three years ago, and 50p a year ago, to touch a new all-time high of 105p; broker research is scarce, but the stock is valued on an earnings multiple of 12 times this year’s likely £4.3m profit.    
 
10. Investor focus on the housing market has continued, with encouraging updates from Barratt Developments, Crest Nicholson, Inland Homes and Taylor Wimpey, but FTSE250 constituent Bovis was a notable exception. Its shares fell nearly 9% last Thursday on announcing planning delays and difficulties in finding subcontract labour. Sentiment towards this builder of homes in the commuter belts of London (but not in the capital itself) has taken a knock, and investors will ask themselves if contagion of such adverse factors will impact peers, continue/deepen at Bovis or are likely to be a temporary feature. The latter, according to CEO, David Ritchie. The CEO of AIM listed Inland Homes, Stephen Wicks, reduced his holding by 1.5m shares, post the brownfield developer’s update, but still retains a 7.27% stake in the company’s  equity. Fund manager Henderson may have been the buyer, as they now have a disclosable 5% stake.

 
Written by David Harbage for lse.co.uk on the 24th Novemeber 2015

 
The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.