Rocket or damp squib in the Week Ahead?

Tuesday, 6th November 2012 08:41 - by David Harbage

Yes, irrespective of current purse tightening, it would seem that fireworks aplenty can be expected again this year - based on queues at supermarkets’ designated desks, and by looking up into the sky.

Increasingly, the popularity of large bonfires featuring near-professional firework displays in a safe environment persuades most to discard the historic DIY back garden effort. It seems that a similar investment comparison could be made between the collective event and the more personal attempt to deliver a sparkling outcome.

The opportunity to outperform

The reader can make a judgement about whether the management of fireworks and an investment portfolio (by reference to factors such as cost, hazard or reliability) is best served by entrusting a well-known, local or City of London institution or by following a Do-It-Yourself option. Certainly the ability of professionals – including both traditional fund managers, who seek to outperform a bond or equity index benchmark, and hedge fund managers who typically try to deliver a return in excess of cash – has been called into question again. In particular, we have seen large hedge funds ‘capped’ (closed to new monies) or closed in recognition of a paucity of opportunity to deliver their objectives or add value.

Perhaps it is getting tougher

When there is no discernible trend in the equity market (say the FTSE100 index), accompanied by historically low volumes of trade and relatively low volatility (which measures the magnitude of daily movement), the fund manager who seeks to outperform – typically by identifying apparent anomalies in pricing – may struggle to justify their existence, and achieve any performance fee. That many hedge funds, like MAN Group’s flagship AHL, which, aided by impressive computer technology, have the aim of profiting from the elimination of anomalous valuations, have struggled to deliver real absolute returns over the past three years bears testament to a tougher - if not a more efficient - market place.

The rear view mirror cannot help when looking forward

With the benefit of hindsight, one can always see the missed or lost investment opportunity. As it happens, the UK equity market has made very significant progress over the past three or four years; essentially recovering from the fears of a global recession, emanating from the financial crisis. A ‘wise after the event’ observer could say that markets over-react (probably true, on both the up and downside) but, in most big economic or political dramas, the events could always have turned out differently and often one can see that only a small marginal factor prompted success or prevented greater failure. It is easy to explain why a share price has performed very well or badly, over say a twelve month period, but to confidently predict success or failure is something else. For example, dear reader, attempt to forecast the total shareholder return on each of the FTSE100 constituents on the first day of the new calendar year. Or, try to select two winners, along with two likely underperformers, out of this universe of one hundred (well-researched and known) companies – over the next twelve months, or just three months if preferred.  

Markets invariably offer rewards, but at a price

When writing quarterly reports on stock market developments, invariably some would prove to be more interesting (in terms of political, economic or other events) or exciting (by reference to bond, equity or currency movement) than others. However, surprises, both positive and negative, would be an ever-present. In share price terms, it would be normal for half a dozen blue chip stocks to have risen or fallen by 20% plus over any three month period. Indeed, one can look at a weekly summary of share price movements and expect to see a double digit gain or fall for a big company; last week the equity of BG Group fell 18.3%. Which FTSE100 constituent is likely to provide a surprise of that magnitude (be it adverse or pleasing) in the coming week? Because probably one will and, if not one of the top hundred businesses, a FTSE250 index constituent will almost certainly produce a move in excess of 10%. BG Group disappointed the market when announcing slower than expected production, but it may not be a company with a scheduled trading report than produces the next surprise. The institutional fund manager who focuses on domestic equities will probably own almost every FTSE100 stock – albeit exercising  a deliberate considered view, evidenced by the extent of his or her under or over weight (relative to the index’s natural value) position – but the private individual investor will almost certainly possess a much more concentrated portfolio. The personal DIY or self-execution investor will simply focus on owning the positive surprises and avoiding the weak spots. 

It may not be a company announcement that drives the share price

We will look at some of the companies due to report this week later in this article, but the prime news set to impact the stock market is likely to be a wider economic update or a political development – often termed a ‘top down’ event. Having deliberated for the previous two days, the Bank of England’s Monetary Policy Committee pronounces at noon on Thursday: interest rates and any change in money policy. In previous (near-monthly) meetings, the latter typically surrounds the budget for further monetary stimulus in the form of gilt (or other high quality bond) purchases known as Quantitative Easing, or QE for short. Recent data on the health of the domestic economy has been more encouraging, notably a 1% rise in GDP in the third quarter of 2012, prompting a revision in the consensual expectation that a further increase in money supply was inevitable before the year-end.

How HM Government’s Treasury and the Bank of England decide to treat the redemption proceeds of the purchased gilts that now near maturity is an interesting issue – cancellation, recycle or another policy, (probably merits a separate blog) – suffice it to say that the gilt purchases, taken overall, currently represent a significant ‘paper profit’. The European Central Bank is also due to publicise its views and any action an hour later. Whilst hampered by Germany, whose conservative view of policy and financial, cum economic, health is clearly at odds with much of the rest of the Euro zone countries, there is a general belief that the ECB should and will be more proactive in the support of its ailing southern partners.

As the US electorate go to the polls to elect a president

The week’s biggest news, and not an easy ‘call’, will be the US Presidential election where Barak Obama is expected to get another term in the White House – aided by storm Sandy-induced back slapping. History suggests that the US equity market performs well in election years, irrespective of the winner (or, more pertinently, the winning party); intuitively, this suggests that political influence on the consumer (via lower taxes, for an instance) or wider economy has been brought to bear to an effective outcome. The Republican Party is perceived as being more pro-business, and accordingly success for Mitt Romney this week is likely to be positive for both the bond and stock markets in the US (and probably further afield). Romney would almost certainly be keener to address the burgeoning fiscal deficit – introducing tougher austerity measures – but may be kinder to corporate America. The outcome of another four year term for Mr Obama is very dependent on how much power the Democrats have in Congress, the other seat of political power; a strong Republican presence in the Senate and the House of Representatives over the past two years has almost certainly diluted the President’s power to effect legislation. In terms of making a stock call on this week’s vote, greater power for a re-elected President Obama is likely to feature further monetary easing and with it a lower US dollar and a higher prospective price for an alternative currency: precious metals, such as gold, silver and titanium.

Turning to UK company news this week, for potential surprises (rockets or damp squibs)

Monday 5th – HSBC is set to announce weaker headline profits for Q3 2012 as it writes down the value of its own bonds, takes greater provisions on mis-selling Payment Protection Insurance (PPI) and a likely charge from the US authorities surrounding a shortfall in its money laundering & sanctions practice. By contrast, the group’s underlying banking is in rude health, although analysts will be scrutinising the cost/income efficiency ratio to ensure management are keeping their eye on the core business. 

Elsewhere on Monday, the insurer broker Hiscox, telecoms satellite business Inmarsat and engineer Weir Group are due scheduled to provide updates.

Tuesday 6th – final results from Associated British Foods and interim results from Marks & Spencer are set to catch the eye. ABF’s budget clothing chain Primark is delivering impressive growth, beyond the UK into Europe too, with its pre-close trading update in September suggesting sales growth of 17%. This comes in complete contrast to M&S, whose UK non-food business is contracting; notwithstanding an appreciation that CEO Marc Bolland’s growth focus is on overseas and the internet, analysts are concerned about profitability of such expensive developments. However, in terms of any surprise – based on respective share price valuation – Marks & Spencer is more likely to benefit from a change in perception than AB Foods, whose premium-rated stock reflects high expectations and no scope for disappointment.

Engineering cum support services group Babcock International and the InterContinental Hotels Group are due to update investors.

Wednesday 7th – another clothes retailer, the upmarket Burberry Group, announces interim results which are set to represent another half year’s earnings progression. However, rather than reflect on whether circa £170 million profit, pre-tax (compared to £162 million in the comparable period of 2011) is an achievement worthy of praise, investors are increasingly viewing BRBY as a sentiment play on the health of Asia’s emerging economies and China in particular (akin to the mining sector). Somewhat inappropriate given this retailer’s customer niche, but like AB Foods, the stock’s rich rating anticipates significant above average earnings growth in the medium term.

FTSE100 constituents G4S, Old Mutual, Randgold Resources and Vedanta Resources are also due to provide trading updates, as are Capital & Counties Properties and the rail & bus operator FirstGroup.

Thursday 8th – a very testing day for investors’ digestion as management statements are due from more than 35 listed companies. Amongst those likely to provide an interesting update, we would mention insurers RSA Insurance Group and Lancashire Holdings (on the likely financial liabilities of storm Sandy), supermarket William Morrison (who have been losing market share over the past year in grocery, but are set to accelerate their non-food proposition via clothing in particular in 2013), life assurer Aviva (where further news of its strategic review - featuring asset disposals covering more than a quarter of its businesses, and a further reduction in its Delta Lloyd stake - is eagerly awaited), media group Trinity Mirror (post last month’s revelation that its newspapers have been drawn into the telephone hacking scandal), pub operator JD Wetherspoon (a view on the domestic consumer’s propensity to spend), coal miner BUMI (developments surrounding future ownership, notably involving Nat Rothschild and the Bakria family) and the building contractor Balfour Beatty (where investors are likely to hear of reduced dependence on a dull UK economy, via an increasing exposure to US infrastructure).

Friday 9th – Rolls Royce is set to deliver further respectable growth, together with advice of more recent developments which features collaboration with Hitachi to support its delivery of new nuclear reactors in the UK. This writer anticipates good news surrounding the dividend payout, with current three times cover set to contract as management adopt a more progressive policy; yielding just 2%, the shares appear ‘up with events’ on valuation grounds and is susceptible to profit taking on any easing in news flow. 

Elsewhere, support services group Rentokil Initial, the general insurer Beazley and interdealer broker Tullett Prebon are set to provide trading updates. 

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.