Market retrace probable as investors take a holiday

Current Overview

As measured by the FTSE 100 index, the market has traded strongly over
the past month post Brexit showing near 5% gains. The FTSE 250 (more UK
centric index) is also now back to pre-Brexit levels. Much noise and concern
had been voiced regarding the weakness of this particular area of the
market. We have seen significant rallies in globally exposed blue chip stocks
particularly in the pharmaceuticals and until recently, the oil majors space.
Tobacco and Mining stocks have also traded well. Dollar earning capabilities
as a result of the now much weakened pound can probably now give rise to
definitive increases in earnings for many such companies; at least that is
the theory – it is not clear for exactly how long the current FX rates will last.

In the pharma area, ongoing M&A rumour and reality has provided a further
shot in the arm. It has been interesting to hear the AstraZeneca CEO saying
their improving pipeline could make them an attractive takeover target!
Sector valuations here look high to me (20 times forecasted earnings) and
we have been prudently reducing for clients, taking some strong profits.

One notable observation over the past four weeks has been the swift 20%
slide in the price of oil. This has naturally led to falls in the prices of oil
companies; I had actually thought the sector looked too high recently when
oil was steady around $50 per barrel even with the strong dollar. This
disconnect has been belatedly recognised with the sector coming under
some renewed pressure. Oil is currently at $43 per barrel and I have
previously suggested that $50 looked like a resistance. I continue to believe
the black stuff will remain in the $40’s for the second half of the year;
nonetheless I am starting to look for opportunistically re-entry points in
both BP and Shell. These shares are down over 10% from recent highs.

We have essentially been gifted the option to take profits in specific sectors
over the past few weeks. While other areas have traded (and remain)
lower, most have rallied from their immediate post Brexit nadir levels. Here
I refer to property companies, retail stocks and to an extent banks. Airlines
though continue to wane impacted by a toxic mix of unmanageable and
unpredictable risks.

The net result of these cross sector performances is that there has been a
marked improvement in the level of market indices not just in London.
The S&P 500 in the US for example is at an all-time high. This has made it
difficult to be overly bullish from current levels, that the market will simply
continue to rise. Thus I am in general cautious, having to be very selective
if I am buying anything from recently raised cash balances on portfolios.

August could yet become an interesting month and I suspect we will see
some slippage especially after today’s bounce fuelled by the first BOE
interest rate cut in 7 years. Certainly historically it has often been a bad
month for markets. The August 2007 credit crisis, the August 2011 Eurozone

debt crisis and just last year, the Shanghai (Chinese) market fell significantly
as retail investors became spooked, again in August. The US presidential
election nears. The prospect of Trump winning with his protectionist
orientation and strategic isolationism is likely not favourable for global
growth. The troubles in Eurozone banks are worrying: Italian banks may be
bust and the prospect of a German bank getting into difficulty is real:
Deutsche Bank is at a multi-year share price low for example.

The ambiguity of US Central Bank policy is unsettling also in the context
of some very mixed analyst views relating to the real health of the US
economy. Will interest rates now rise further and if so, will the risk of a
recession increase? Is there a growth risk now and are the equity
markets simply too high either way?

Turning to the UK, will investors simply begin to de-risk in the face of
the still potential negative impact of Brexit? Or will they just see more
clearly (or differently) the reasons for record low rates and further
stimulus and take action?

In simple terms, markets are relatively high and it is holiday season
which will bring a natural decrease in trading volume. I will be
monitoring with interest.

Stock specific comment

I have been revisiting Laird (314p), the global technology mid cap further to
some weakness in its price. Its specialism is in electromagnetic interference
minimisation and it is no surprise the smartphone sector is a big market
(Apple is a customer). Interim results on the 29th July were “disappointing”
in the CEO’s words but they anticipate margin improvement in the second
half. The dividend yield is a well covered and growing 4.5%, the valuation a
reasonable 12 times forward earnings and the company has stated broadly
unchanged expectations for the full year. Debts are under control and
directors have also been buying. The possibility of a takeover cannot be
ruled out either in my view. Laird has world class technological capabilities
across markets and customers and having seen ARM Holdings (in the FTSE
100) receive a bid recently, it has heightened for me some speculative
appeal in the sector in general. My target level is 350p.

Sainsbury (224p) is an interesting consideration now further to a 22%
decline in its price since May. Tangible (property) assets are significant, the
income yield is a reliable 4.5%, they have bought Argos which should bring
earnings enhancement, the Qataris remain a 25% shareholder and possible
bidder and directors have been buying. At near 10 year lows, despite being
more vulnerable now to discretionary consumer spend post Brexit, I suspect
value has appeared in the price. One to pop in the shopping trolley perhaps.