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INVESTMENT INSIGHTS
Originally posted in March 2018
Most volcanoes typically go through several stages before the well-known magma eruption finale. From gas emissions, steam and ash venting and lava build-up beneath the surface, the signs are there, but the timing is never clear for the endgame.
Of course, my analogy is with the state of affairs in the world’s financial markets, no doubt to the disgust of most scientists and perennial bulls. But there are also signs of impending problems, not just of the highest valuations in history in the stock markets, but also of the already moving changes in the bond markets after the largest money printing experiment ever.
The three-day stock market ‘collapse’ in early February that saw billions wiped o! the short volatility sectors reminded us how wealth does not have to be transferred, it often just vanishes, far quicker than it took to accumulate.
Despite the FTSE index’s ‘strong’ recovery from the 2016 Brexit lows, aided by a weak sterling currency, the UK stock market is really going nowhere, barely 500 points higher than a decade ago. Arguably, dividends have been paid in this time and the largest UK indices have benefited more. But my concerns lie in the fact that if a 500-point increase in the main index is all there is, as the result of the most aggressive monetary easing in history with an incredible low unemployment rate and huge advances in technology, we are in a very precarious situation.
Fragility is the word that often comes to mind when I browse through the headlines, not just in the retail sector (as discussed in the overview) but in general. And, of course, complacency.
Most people are aware that the FTSE 100 is made up of some very large companies, especially in the top twenty. They don’t come much bigger than Shell or HSBC, whose weightings are roughly 10% and 8% respectively. In fact, banks and oil producers are currently about 25% of the index. It is these sectors that have recovered from the lows that are, in many ways, holding the index up. They have benefited from higher interest rates and higher oil prices, but unfortunately, most companies don’t benefit from those two factors. For most firms these factors are, in effect, input costs.
When we look at the number of profit warnings over the years, it’s easy to accept the regularity. “Move along sir, nothing to see here.” However, we should not expect to see average profit warnings in a strong market, and we are regularly seeing profit warnings with quite small profit analyst misses that are leading to 25-30% down dra"s in single stock prices. We have, unfortunately, recently seen some in our own portfolio, such as Aggreko and Greencore. No matter how cheap we believed these stocks to be, a small profit miss saw the emergence of fragility and weakness in spades. We hold very few stocks in our portfolio, the least in years for exactly this reason. We believe the market is showing clear signs of potentially much lower prices across the board in the coming months. The usual bullish winter period was very muted, and despite the ‘Beasts from the East’ cold spells, spring is upon us and summer seasonality is never good for equity markets, even in good times.
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