Happy New Year 2017: Markets riding high

Happy New Year clients and readers alike.

The blue chip FTSE 100 index has closed at a new all time high today (7290) having now risen for 10 consecutive sessions in a record not witnessed since its creation over 30 years ago.  The Santa Rally has spilled over into the New Year as the weakness in the pound (and the strength in the dollar) continues to boost the investment appeal of UK listed companies who earn significantly in the US. The FX boon to profits could indeed be significant assuming these foreign exchange rates prevail.  Whilst one might argue that it is difficult to see why the dollar would necessarily stop rising (indeed why the pound would stop falling), it is far from clear when and how the Trump administration will deliver.  As I write, his first press conference of 2017 is already proving heated with journalists.  Moreover, the medium term implications of his (as yet) non clarified policies could yet be detrimental to US (global) growth.  A strong dollar also reduces the competitiveness of US multinationals exporting product around the world.

Am I suffering from slight altitude wariness, yes to a degree.  It is my role to remain non complacent and cautious when risk managing the hard earned capital my clients have entrusted to me.  I am not bearish or significantly concerned a stock market crash is due or that a recession is possible, bringing the end to a 7 year bull market.  I am short term sensitive that equities are riding high and a pause is possibly on the cards. Markets do not normally go up in straight lines and while UK shares have been adding to their gains, I note the psychologically important 20,000 level on the Dow Jones is proving a tough nut to crack. For a month now , the US has been trading sideways.

The majority held view now is that the US Federal Reserve will continue to steadily increase interest rates through 2017. Such action will naturally be dependent on the US economy moving ahead in terms of job creation and overall output.  The now upward sloping yield curve is assisting with the share prices of cyclical sectors like banks (who make more margin when rates rise) and the continued slippage in fixed interest bonds where prices move in the opposite direction to (forecasted) rates.  The wall of money that has been parked in bonds through the extended low rates environment post credit crisis needs to go somewhere and equities may represent a logical new home.  I keep reading about the “great rotation” and naturally this factor is one market bulls continue to point to.  In an inflationary (growth) environment, equities ordinarily perform best.

What the Bank of England will do with interest rates this year is a trickier call.  While there is a growing transatlantic pressure to tighten, many would say in the uncertain pre Brexit world we now inhabit, it would be reckless to move.  Nonetheless many UK centric businesses such as Lloyds Banking Group (66.3p) are moving up, discounting such a move as likely at some point.  Time will tell whether buying the value (unloved, potentially mispriced stocks) and cyclical areas of the market (sectors that perform best when the economy is indeed growing) has been the correct call.  Over the past few months there has been a genuine appreciation in the share prices of these sectors while defensive, so called “bond proxy” stocks (consumer staples, tobacco and utilities) have faltered.

On balance, I am delighted to see valuations looking much improved.  In particular, the rally in the prices of mining and oil companies has been amazing to witness over the past year. This heavily weighted resource sector has been largely responsible for the record level of the market we see today.

Market specific comment

I have been primarily selling selective shares, taking some strong profits for clients over the past couple of weeks.  As mentioned,  I am comfortable to protect capital to an extent and most clients are holding cash balances around 30% of portfolio size and I am hedging myself short term in case a market retrace presents.

I am pleased to report that my advice to add oil services player Petrofac (930p), Vodafone (214p) and pharmaceutical shares last month have all delivered handsomely.  Petrofac is a high volatility share and I have banked profits.  I remain very comfortable running mobile giant Vodafone for yield and defensive growth but have been prudently reducing Astrazeneca (4650p) holdings.  Pharma shares looked mispriced and oversold in December but are now sitting in their mid to upper trading ranges.  Trump’s comments regarding drug pricing and the lack of competition in the sector hasn’t helped.

In terms of a prediction as to how the market might behave through the year, my thoughts are as follows: While further near term share price increases are possible, I suspect a correction lower presents at some point in the first quarter probably as US policy clarity emerges in tandem with further anxiety over US interest rate rises.  Heightened apprehensions regarding Brexit and the state of the Eurozone in general will also be on investor’s minds. The second half of the year will see improvement into year end (bar no Trump or macroeconomic catastrophes) and my FTSE 100 target level is 7650.

A stock specific idea at current prices might include Inmarsat (710p). The shares have fallen back to near 3 year lows with an associated significant contraction in the Price to Earnings valuation, certainly well down on the 1100p level of a year ago and making the stock look good value versus the sector peer group.  A former FTSE 100 company the market cap is currently around £3.2 billion on circa 13 times 2016 forecast earnings.  I am looking for improved performance going forward in particular within the marine segment t of their business which has seen a slowdown with the weaker oil price.  A 6% plus dividend yield brings additional attraction although cover is thin and a reduction in the payout is possible.  Growth markets in particular GX inflight broadband look promising. Lufthansa and Air New Zealand are already customers and IAG (parent of British Airways and Iberia) are expected to sign up 340 planes in the near term.  Contrarian as unloved, this is a speculative buy and my target is 800p over the next couple of months.

This report was written by Philip Scott, Director at SI Capital on 11/1/17 when the FTSE was trading at 7290.