Figure 1 Asset rotation: the hard decisions have yet to come
Source: BofA Merrilll Lynch Global Investors October Survey
Warnings of volatility are issued too often and I try to avoid them. Nevertheless, looking at the London Stock Exchange’s Risers and Fallers these days can make one’s eyes water. Today at one stage, all 10 of the top risers were up over 7% (5 FTSE 100 companies by 5% or more) and the bottom 10 down by 6% or more. Increasingly the same names appear in the top and bottom 10 in the same week if not on consecutive days. Last week ended on a rather scary note with yet more global equity markets correcting (i.e. falling by 10% or more from a 52-week high). Human investors seem to be hyper-sensitive to news flow (macro or stock-specific) and, even worse, to rumour flow and then the algorithms take it from there. However, the bigger story is about rotation on a potentially massive scale: rotation between asset types, between markets, between sectors and between individual stocks. So far in 2018, the easier moves are being made: de-risking by selling Emerging Market equities and currencies, Italian equities and bonds, UK equities, commodities and the euro. Now more difficult decisions have to be made about Oil, Gold, the dollar, bonds vs. equities, US vs. rest of the world equities and, above all, value vs. growth stocks. Figure 1 suggests that investors are still very reluctant to abandon growth stocks. Rotation is not the same as volatility and is most definitely initiated by humans: the impact will be much greater than 5% daily moves or even 10% corrections.
Alastair Winter Chief Economist
Figure 2: Warpaint London PLC: Volatility ‘resistant’
Source: Google Stock Images
Warpaint London (LSE:W7L) supplies affordable cosmetics and is benefitting from the trend of consumers’ spending less through trading down from major to more cost-effective brands. Cosmetics is a competitive sector but Warpaint seems a well-managed business that understands its market niches. The interims for the 6 months ending June 30th showed a 38.7% increase in sales to £18.4m and there is some potential to reduce costs through more efficient buying, following the successful integration of the Retra acquisition. The business is cash generative and debt-free with net cash £4.6m in June 2018, after taking account of dividend payments and acquisition costs. The market cap is £165m and the shares are trading on 16 times prospective December 2018 earnings, before falling to 13 times in 2019. Schroders recently increased its stake to more than 11%, while the Joint Chief Executives each own one-quarter. Warpaint plans to continue growing through both building existing brands and investing in new product development, ecommerce and selective acquisitions (including a US distributor in August). A significant increase in the Christmas order book will help with the expected jump in full year pre-tax profit from £7.7m to £12.4m. All in all, Warpaint prospects seem favourable despite these uncertain times.
Jon Levinson Corporate Broking
Figure 3: EIS for ABC, OK?
In the September 26th edition of Signals we wrote about the disruption being creating by a new breed of stocks called ABC: Artificial Intelligence, Blockchain and Cannabis. These companies are often obtaining EIS advanced assurance. EIS investors are increasingly focusing on ‘knowledge-intensive’ companies, encouraged by the doubling in the 2017 Autumn Budget to £10m in the amount that can be invested in such companies. The Government’s intention is to stimulate expenditure on R & D and the EIS angle helps to mitigate the risk element. Knowledge Intensive companies now have an EIS funding limit of £20m, whereas other companies have up to £12m. Artificial Intelligent companies are particularly benefiting from the new legislation with many having IPs to qualify. EIS offers investors the opportunity to offset 30% against personal income tax as long as the shares are held for 3 years: i.e. up to £300,000 per year if the maximum of £1m is invested and £600,000 if the maximum of £2m is invested in knowledge-intensive companies. No capital gains tax is payable on disposal of shares after 3 years while Deferred Capital Gains Tax Relief is available if new EIS shares are subscribed for during the period one year before or three years after selling or disposing of the original assets. Furthermore, there is loss relief against an investors’ personal income in the year of disposal or previous tax year or against an investor’s capital gains. Finally, the shares generally qualify for Inheritance Tax (after two years). Our Corporate Broking team has just received notice of EIS Advanced Assurance (i.e. HMRC approval) for a consumer product Cannabis company seeking initial funding prior to a £3M IPO in Q1 next year.
Melissa Griffiths Corporate Broking
Chart 4: Goldman Sachs Group Inc: happy returns
Goldman Sachs (GS.NYSE) reported its latest quarterly earnings on Tuesday with a somewhat self-congratulatory headline quote from CEO David Solomon:
‘…… solid results….. from across our diversified client franchise. Year-to-date earnings per share is the highest in our history and year-to-date return on equity is the highest in nine years, notwithstanding our continued investment in growth opportunities. ‘ Goldman is usually one of the first to report each quarter but not the first and this has served it well this time round. Despite the Q3 earnings season kicking off rather well investors were in no mood to celebrate but this week is turning out differently. 2018 has been tough for Goldman’s share price, opening at $256, peaking in March at $273 and falling ever since to a low of $213 last Friday. Figure 4 shows the tide turned on Tuesday in an unusual instance of ‘selling on the rumour and buying on the fact’. In fact, the figures really were better than forecast by the 22 analysts polled by Thomson Reuters. Group Net Revenue of $8.65bn was up 4% on Q3 in 2017 and within it Investment Banking was up by 10% and Investment Management up by 12%. Operating expenses of $5.57 billion were also 4% higher than Q3 in 2017 ‘due to higher non compensation expenses, partially offset by slightly lower compensation and benefits expenses’. As a result earnings per common share rose to $6.28 for the third quarter of 2018 vs. $5.02 last year. Tangible book value stood on September 30th at $186.62 per common share. In yesterday’s morning session the share price passed $228, thereby recovering last week’s losses.
Steve Shelley Investment Hub
Chart 5: Ariana Resources plc: Talking Turkey
Source: Google Stock Images
On Monday Ariana Resources (AAU.L) reported third quarter gold production of 7,588 ounces (Q2: 7,171 ounces), representing another quarterly record. The Company now expects to exceed ‘by some margin’ its full year production guidance of 20,000 ounces. In the twelve months to June 30th the average cost of production was $612 per oz and this stands to fall further as a result of Turkish lira weakness. So far all operations have been in Turkey, which is Europe’s largest gold producer, and are managed by local joint venture partner Proccea Construction Co. The main mine is at Kiziltepe, which also produces silver, with exploration targets in and around the mine that are all truckable to it. Recent exploration points to yet more reserves at Kiziltepe. So far, the production figures have been well received, taking the market cap to around £13M. No doubt, the very recent rally in the gold price has also helped.
Charles Madden Investment Hub
Chart 6: Normality returns….well, sort of
For some time now ‘normalising’ has featured prominently in the minutes of the FOMC and in the speeches of various Fed luminaries. Integral to any central banker’s concept of normality are positive real interest rates. This sounds like something that can be objectively established by subtracting the Inflation Rate from the Nominal Interest Rate but, of course, it is both complicated and debatable. Since the Fed seeks to influence interest rates generally it seems reasonable to start with the Fed Funds Rate but it has to be said this is an interbank rate and not directly applicable to loans and deposits for companies and consumers. Then there is the question of the inflation measure used. The Fed prefers not to use the official CPI but instead the equally official Personal Consumption Expenditure Core Price Index. Arguments rage in the US (and elsewhere) over the composition and reliability of these indices. Be that as it may, the fact is that is that for the first time in 10 years the Fed has set a target interest rate that is higher than its preferred 2% level of inflation, thereby creating a positive Real Interest Rate. This is an important moment, all the more so for the wrath that President Trump is now directing at the Fed. The end of ‘easy money’ is not supportive of his drive for 5% annual growth in GDP as the interest rates that borrowers ‘really’ have to pay such as LIBOR or coupons on corporate bonds and US Treasuries are going up too with all sorts of effects that the he does not like. Not least is the threat to the US equity boom, which Mr Trump has claimed as his own. Fed Chair Jerome Powell has so far shown remarkable indifference to both Wall Street jitters and White House rants. We may soon find out how normal things are.
Alastair Winter Chief Economist
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By Alastair Winter
Cheif Economist at Daniel Stewart