Business investment figures provide encouraging signs

In this week’s bulletin:

  • US stocks hit record highs on soothing noises from the Federal Reserve, positive signals from China, and strong figures for domestic home sales.
  • European stocks scale six-year highs as European Parliament elections provide a wake-up call for mainstream parties.
  • Business investment figures provide encouraging signs that the UK economy is on track to exceed its pre-crisis size this quarter.
  • Struggling flotations of UK companies put the spotlight on over-optimistic valuations and suggest that investors are finally putting the focus on fundamentals.

High peaks

Investors clocked off early ahead of a long weekend break in the US and UK, but amidst very light trading volumes US stocks closed at a record high on Friday. The S&P 500 ended a fraction above 1,900, surpassing its previous closing high on 13 May. The market was buoyed by reassurances about continued policy accommodation from the Federal Reserve, a more optimistic view on prospects for the Chinese economy, and a rally in housing stocks after the release of better-than-expected figures for US home sales.

The release on Wednesday of the minutes from the Fed’s April meeting made clear that the US central bank was in no hurry to raise interest rates. “The Fed wants to be happy that when it does start to raise rates, the market will absorb this and there will be no undue rise in volatility, or increase in long-term interest rates, that could threaten the US housing market,” observed Chris Iggo of AXA Framlington.

News that China’s manufacturing Purchasing Managers’ Index rose to a five-month high in May was perhaps the most significant of the week, suggesting the clouds hanging over the economy are parting, whilst in the eurozone the same measure showed that Germany’s economy remained buoyant. However, manufacturing and services activity in France hit a three-month low, signalling contraction rather than growth and prompting renewed references to the country’s reputation as the ‘sick man of Europe’. For the region as a whole though, the latest reading was the second strongest in the last three years. The FTSEurofirst 300 index rose 0.6% to finish the week at a six-year high, although concerns over the outcomes of the elections in Ukraine and for the European Parliament kept investors on the sidelines.

The ‘free hit’ for the Eurosceptics duly provided a wake-up call to the mainstream parties, the leaders of which will meet in Brussels to discuss the results and the need for reform. However, the longer-term impact of the vote is unclear. “Nothing changes in my view,” commented Stuart Mitchell of S. W. Mitchell Capital. “The mainstream pro-European parties won 70% of seats and this healthy majority is supported by recent polling around membership of the EU and the euro, which can be most clearly seen in the good majorities for Merkel and Renzi.”

“The only major economies to vote for more Eurosceptical parties were the French and, of course, the British. In my opinion these were protest votes. Despite UKIP’s success, recent polling suggests that the majority of the electorate would like to stay within the EU. ‎The French anti-vote is possibly more serious, but this is a country facing economic stagnation and desperately needs economic reform. I think that economic data in the next six months or so will be more important. Our view is that recovery will surprise the consensus and with that the anti-Euro vote will dissipate.”

Elsewhere, the prospects for growth in the US and China drove Japan’s Nikkei 225 Stock Average to a three-week high, closing the week up 2.6% at 14,462.

Solid foundations

Closer to home, confirmation from the Office for National Statistics that the UK economy expanded by 0.8% in the first quarter indicated that, on an annualised basis, growth is at its fastest level since the end of 2007. Added to figures showing that business investment is enjoying its longest period of sustained growth in 16 years, the signs are that Britain’s recovery is broadening and that the size of the economy will exceed its pre-crisis peak this quarter. Despite the more positive outlook, the FTSE 100 suffered its worst weekly decline in more than a month, falling 0.6% to 6,815 as news of its rejection of Pfizer’s increased offer triggered a decline of more than 10% in AstraZeneca’s share price. Monday brought confirmation that Pfizer had finally turned its back on the deal, at least for the next six months.

In a further assessment of the UK’s recovery, minutes from the May meeting of the Bank of England’s Monetary Policy Committee revealed that it may not be long before one or two members start to vote to raise interest rates, although the majority still thinks that there remains scope to leave interest rates on hold for some time to absorb the slack in the economy. Markets currently expect the Bank to keep rates at 0.5% until the first quarter of next year, but Capital Economics cited a weak inflation outlook as an indicator that rates may be kept on hold until the end of next year.

Reflecting on the passage of markets so far in 2014, Richard Rooney of Burgundy Asset Management observed, “There is no clear trend or direction in equity prices. The markets appear range-bound and volatility is extremely low by historical standards. The macroeconomic and geopolitical issues are keeping risk appetites under control; but after being so momentum-driven, the markets needed this ‘time out’ to give the fundamentals a chance to catch up. I think we are due some volatility, maybe triggered by earnings disappointments, and that should present more opportunities for value investors such as ourselves – although I’m not anticipating a significant market down-draft. The global recovery is slow, but it has substance. A build-up of inflation would upset the apple cart, but that appears to be a distant prospect.”

Float fatigue

It seems that the market is beginning to pay heed to Warren Buffett’s words of wisdom: “Price is what you pay. Value is what you get.” Since the start of the year, a number of companies have pressed ahead with stock market flotations after a prolonged period when investors’ nervousness about the economy made most such plans impossible. There have been more than 40 listings, raising £6.9 billion, according to Thomson Reuters, up from £2 billion at the same point last year. However, there are clear signs that investors’ appetite is waning and of a sense of ‘float fatigue’ setting in, amid fears that new arrivals are overpriced and on the back of poor performance from some of the more expensive IPOs.

John Wood of J O Hambro has long expressed his concerns about current market valuations. “We see elements of both 1999/2000 and pre-crisis 2007 in today’s stock markets. The ludicrous valuations which technology stocks reached earlier this year, that surely reached their zenith with the bonkers valuation achieved with the AO IPO, certainly were redolent of the tech mania from the end of the last century. The subsequent savage sell-off in tech stocks since early March was swift and painful, but the fact that valuations were able to achieve such levels was a reminder of this industry’s predisposal to amnesia.”

AO’s shares rose 33% on their first day of trading in February (the biggest first-day rise of any IPO in London since Royal Mail’s debut), giving the company a market capitalisation of more than 150 times its underlying earnings last year. The shares are currently 20% below their float price. Other retailers gambling on improving consumer confidence were Boohoo.com, McColl’s and Pets at Home; but, other than Poundland, every retailer that has floated this year is trading below its debut price.

Fat Face, the fashion retailer, last week abandoned its listing plans, citing “current equity market conditions” for its decision. Saga, the insurance-to-cruises group for the over-50s, was also forced to drop its price aspirations as it struggled to drum up enthusiasm from institutional investors for more than £800 million of shares on offer in its £2 billion flotation. However, four more companies last week announced plans to press ahead with listings, including Zoopla, the property website, Wizz Air, the low-cost airline, and the fashion chain Blue Inc, in the belief that there is still appetite for good companies that are fairly priced. “There is still enough demand,” said Fred Walsh of Panmure Gordon. “There just needs to be two or three successful IPOs now to re-establish the new level.”

Richard Rooney of Burgundy offered this timely perspective: “Value investors are not concerned with getting rich tomorrow. People who want to get rich quickly will not get rich at all. As Warren Buffett observed, there is nothing wrong with getting rich slowly.”

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