Thursday, 2nd September 2010

City Insider

The Age of Austerity

28 May 2010, by Galvan Research and Trading, the UKs leading CFD advisors.

With the new coalition government bringing in an Age of Austerity on Monday and markets switching from fearful to exuberant in a matter of days, the small matter of an upwards revision of quarter one GDP got lost in the drama. But the 0.3% rise, although bang in line with forecasts, spoke of an economy making modest progress out of a huge recession, driven by the manufacturing sector. This was in the face of a VAT hike and snow at the beginning of the year. Quarter two is expected to be even more robust, although this week's retail sales numbers suggest that there isn't going to be much backing from the services sector.

But looking for any forward looking indication from the markets is proving tricky in these volatile times, and the main indices appear to be purely a play on the wider European debt crisis, with any unexpected developments such as Korean military tension ratcheting up the pain levels. The OECD waded into the debate on the state of the UK economy by emphasising the danger of inflation and urged a "normalisation" of interest rates if the right level of fiscal punishment is dealt out by the LibCons. Closer to the monetary levers and Bank of England MPC member Adam Posen raised the spectre of a Japan-style "lost decade" for the UK, warning that the new government has less room for manoeuvre than it might think.

With the FTSE 100 once again showing volatility this week - a 128 point fall on Tuesday was followed by a near 100 point rise on Wednesday and 157 point rise on Thursday - the list of risers and fallers was mixed to say the least. There were no losers among FTSE 100 shares on Tuesday and only one (United Utilities - UU) on Thursday. Consistency was easier to locate among the week's losers, notable amongst them the once reliable dividend play and safe haven National Grid (NG.L). Last week's bombshell, that the company needed to fund a rights issue, had further ramifications this week as the shares went ex-rights, knocking the price down from 560p to 500p at the start of the trading day on Wednesday. On a day when the FTSE 100 rose 3%, the shares were unchanged at 479.4p.

Chocolate maker Thorntons (THT) saw its shares slide from 100p at the start of the week to 85p as it issued a profits warning and revealed that chief executive Mike Davies would be leaving. The company said that own-store sales had suffered after a decision to sell the firm's chocolates in supermarkets, an idea that Mr Davies had driven through when he first took the top job. JJB Sports (JJB) was also punished heavily for poor numbers, sliding nearly 14% to 17.5p on news of a 40% slide in sales to £372m in the year to 31 January. After a tumultuous year of restructuring, an OFT price-fixing investigation and change of leadership, new chief executive Keith Jones said: "We have to get much, much better at the basic business of retailing."

In a week of wild swings, the usual suspects - banks and miners - tracked the FTSE 100's movements - so familiar names like Rio Tinto (RIO), Xstrata (XTA), Anglo American (AAL) were at the top of the leaderboard as the week drew to a close. But it has been another painful week in the spotlight for oil major BP (BP.), with rolling news channels showing live coverage of the Deep Water Horizon oil spill as the company tried extreme measures to stem the flow of crude. The shares looked set for another downward lurch, with the price falling from 500p to 480p at the start of the week. But as the "top kill" approach appeared to be working according to BP, though the White House was sceptical, and the shares jumped back to 520p. In the top tier, expectations of the AIA deal falling through lifted shares at Prudential (PRU), while fellow insurers Legal & General (LGEN) and Aviva (AV.) also put in strong performances towards the end of the week.

Man Group (EMG) has also been in the news recently for its takeover of US-based hedge fund GLG, which is being sued by a shareholder who claims that the deal undervalues GLG. Despite revealing a fall in profits on Thursday - 27% down to £374m - and a near-10% drop in assets under management to $39bn, Man’s shares were dramatically re-rated on the same day, leaping over 10% to 238p as the damage was less than analysts had feared. Like the miners, Man seems to have become a touchstone stock for a moody market - resurgent on the good days and heavily punished on the bad.

There was a more straightforward cause-and-effect at fashion brand Burberry (BRBY), whose record profits of £215m were received with a 7% rise in the shares to 659p, and a 5% rise on Thursday to 692p. Talk of store openings in Europe and expansion in emerging markets like Brazil and India also helped the cause, and analysts gushed about the firm's potential to outperform from its current position at a discount to its luxury peers.

Sir Stuart Rose presented his last set of annual results at Marks & Spencer (MKS) this week to a largely underwhelmed City, and once again the retailer delivered solid but not stellar numbers. At £635m, profits were 4.6% higher than a year ago as the outgoing executive chairman said the "worst of the recession is over". He also said the company is "well set for growth" under the leadership of ex-Morrisons chief Marc Bolland. It is a growth that has been rather hard to come by after the comedown from the retailer's golden year when it broke through the £1bn profit mark in 2008, and the near-800p share level last seen in 2007.

Commentators have been quick to point that the shares, around the 300p mark when Rose was appointed and fought off Sir Philip Green's advances, have made little progress - from a buy-and-hold-perspective - if the current level of sub-350p is taken into account. Those patient long-term small investors have seen little reward for their loyalty in recent years apart from strong and rising dividends. With the dividend yield at 4.5% (15p) and the dividend covered more than two times, perhaps it's best to see the share as a reliable yield play in the next few years before Rose's successor gets a chance to move the company into its next phase. With tough competition from Waitrose and a potential rights issue to fund in the pipeline, it would be hard to imagine fireworks from the share price any time soon.

On the commodities front, gold resumed its upwards path after options expiry, while fears of Korean military conflict pushed the metal’s safe-haven credentials to the fore. It was also a better week for crude oil as it proved the extent of its alignment with both equity markets and economic recovery hopes.

In the currency markets, what has been interesting is the way that sterling has been itself strengthening against a recovering euro, hitting a new high for the year at 84.22p, as well against the US dollar, where further evidence that it is leading western economies out of recession was at hand.

In terms of this week’s share recommendations, the Galvan Research Team have changed their stance on Rolls-Royce as shares have retraced since the AGM and the disruption from the volcanic ash cloud now appears to be factored into the price. Elsewhere, we rate brewer SABMiller as a sell after it missed profits forecasts. And we reiterate our buy recommendation on Compass Group after a solid trading update.

You can read our in depth view on this stock and a raft of research to help with your trading by visiting the Galvan website.

City Insider - a weekly column from Galvan Research & Trading, the UKs leading CFD advisors. Galvan’s research coverage focuses on Equities but also extends to Indices, Commodities and Currencies.

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