Market drifts as spectre of monetary tightening impacts


Current Overview

 How confused do UK investors (and savers for that matter) currently feel courtesy of our central bank.  Firstly we have heard that 3 out of a depleted 8 member MPC voted in mid-June for an interest rate rise. This was a big surprise for many. Then top dog governor Mark Carney quickly verbalised his own personal position, that a rate rise now would be premature.  A few days later he then suggested investors should probably prepare for a rise and on that same day, his deputy (governor) Jon Cunliffe made clear his case for no rise.   

Ideally the central bank provides forward guidance for markets; it seems we are back to misguidance, not that rate setting policy right now is a straight forward business.

To add to the confusion, Andy Haldane the BOE chief economist has also recently signalled he favours a rate rise possibly later in the year.

Needless to say, the pound is up and down like a yoyo and bond traders must be on beta-blockers.

Bond prices (in simple terms) react inversely to changes in (perceived) interest rates.

So do share prices depending on the mood. That said the market has continued to trade fairly resiliently as a relatively weak pound continues to favour companies that earn internationally.

For the record though, as I write the FTSE 100 is around 2.6% down on its early June highs near 7600.

The interest rate normalisation debate sits firmly in the context of surveys now demonstrating diminishing business confidence as a result of the domestic political backdrop and somewhat worryingly, evidence that households are tightening their belts.  Households (consumers) have been the engine for recent economic growth and there is concern that the meagre growth of 0.2% seen in the first quarter of the year may be seen again.  It is not surprising that business leaders have witnessed a change in sentiment since the election.

In terms of general (international) monetary policy, there seems to be an ongoing move towards ‘tightening’ (and removal of stimulus) as opposed to accommodative loosening. The US Fed has now raised rates 3 times from the 2015 lows amidst ongoing chatter about their desire to shrink the size of their balance sheet (i.e. to sell down the bonds bought as a result of massive stimulatory unconventional QE). Even the European Central Bank (ECB) should have started to raise rates according to some economists.  Naturally there is a systemic pressure for the BOE to be thinking along similar lines: to move markets off life support systems.  The big questions remain though centering around whether actually the economy is strong enough to weather a rate rise.  And if one throws into the melting pot the current sense of relative market calm (which translates to low volatility), are we building a case for a pull back at some point soon.  I think we most possibly are. Rate rises may be the factor that finally upset the market even if (thus) far the US has taken them in its stride.

To conclude if any rate rises ultimately lead to or are followed by recession or (god forbid) any further market crisis, central banks may find themselves having to cut rates as quickly as they have been increased.

Stock specific comment

Dixons Carphone (261p) is an international, multi-channel electricals retailer with a sensible diversification strategy. Over 20% of profits are now coming from outside of the UK.  Results on the 28/6/17 were robust and consensus beating yet the shares have fallen 13% from the 300p level at that time. It seems all things retail and under the cosh right now. Dividends were increased by 15% on the year as solid growth was seen in the UK amidst a tough consumer environment but one that they described as “holding up”. Of particular interest is their significant Nordics exposure which accounts for around 30% of group turnover (£10.5 billion). It is also worth mentioning the continuing recovery being seen in both their Spanish and Greek operations and as well as their after sales businesses to include Team Knowhow and Geek Squad.  There is also a fast growing financial services business. Their overseas interests bring currency benefits to bottom line profits as a result of the continued relative weakness of the pound which assists the diversity and quality of the earnings mix. Net debt at around £270 million is not excessive and manageable.

At current levels, the shares trade on a PE ratio of just 8 based on 2018 projected profits, yielding a well-covered and growing 4.35%. Granted the chart is not looking particularly attractive (many charts are looking the same) and whilst the forward outlook for their core UK consumer market might be challenging, my suspicion is there is (contrarian) value in the stock.

As a deviation from my usual larger market cap stock thoughts, for a change I mention now

Hurricane Energy (30p) listed on the AIM.  Despite a weak oil price ($48 per barrel) the company has impressively just raised $500 million to finance the development to production one part of its North Sea proven assets. With the financial power now on their balance sheet, the company has a much strengthened hand if it were to choose to partner (or farm in) perhaps a larger sector player to assist it with its progression.  Patience will be required (the new shares as part of the fundraise have not been admitted to trading yet) but with a steady recovery in the price of oil, I believe sentiment will turn more positive for the group in the near future. Not for widows or orphans, a move back to 50p would not seem unreasonable assuming management keep their focus! The market capitalisation (before the completion of the fundraise) is £355 million.

This report was written by Philip Scott, Director at SI Capital on 12/7/17 when the FTSE 100 was trading at 7416.