Market Musings 14/11/11

Concerns around the Eurozone show no signs of abating. Writing in last weekend’s FT, Merryn Somerset Webb perfectly captured the options policymakers are considering when she wrote: “Europe will get one of three things: a break-up leading to a systemic banking crisis and a global recession; or a commitment to an impossible level of austerity followed by recession and civil unrest; or a round of ECB-driven money creation and sovereign bond-buying that will make the UK’s extraordinary QE programme look like my children’s pocket money“.

 

Like Merryn, I suspect that the third option will be the one chosen by Europe’s political leadership. You only have to look at our main trading partners to see what will happen when the Eurozone’s monetary sluice is fully opened – as I note in the current issue of Business & Finance, inflation in both the US and UK stands at a three year high. This inflation tax will disproportionately affect people on lower incomes, and people need to move to protect themselves against it. My advice remains that you should increase your exposure to both gold and equities (at least, the ones with strong balance sheets) and reduce holdings of cash (whose value will be eroded by inflation) and government debt (given the state of public finances across much of the world).

 

Speaking of public finances, we recently got an overview of the Irish government’s medium-term fiscal strategy. Have a look at Table 3.2 (on page 28) in it – cutbacks in day-to-day spending between now and 2015 are expected to be mostly offset by ever-increasing debt service costs. This is the inevitable consequence of the dithering by the present government – and its predecessor – when it comes to right-sizing public spending.

 

Silvio Berlusconi stepped down as Italy’s Prime Minister, leaving behind a dismal track record. As this article notes, it’s easier to do business in Albania than in Italy.

 

I was not surprised to read that 2011 is likely to be the third highest year for S&P buybacks on record. We’ve seen a lot of share buybacks in Ireland too (e.g. Ryanair, Abbey, United Drug, Dragon Oil) this year, which partly reflects companies’ reluctance to invest capital in M&A and development at a time of such economic uncertainty.

 

(Disclaimer: I am a shareholder in Irish Continental Group plc) Turning to corporate newsflow, today brought trading updates from both Kingspan and ICG. Kingspan reported that it rate of increase in sales is slowing, but falling input cost pressures are giving a boost to margins. I am a long-term admirer of Kingspan for its structural growth qualities and excellent management (CEO Gene Murtagh is one of the most impressive executives I’ve met) but given the weak macro outlook it’s one that will struggle to reach the valuation it deserves in the near term. ICG released a trading update earlier this afternoon which revealed that 9 month EBITDA has declined by €5m yoy (from €45m to €40m) as fuel costs have increased by €8m over the same period. While, as ICG says, “the economic backdrop remains challenging”, I note that its strong balance sheet (net debt was only €13m at the end of Q3 – and the company paid a dividend of €8.2m during that quarter) gives ICG the staying power to consolidate its position while weaker competitors such as DFDS and Fastnet take capacity out of the market.

Market Musings 16/10/11

The demands of college work have kept me away from this blog in recent days, which is a pity given how much newsflow there has been. In this entry I’m focusing on the financials in particular, along with some troubling (and inter-related) European macro indicators.

 

As I said in the introduction, we’ve seen a lot of troubling macroeconomic indicators. S&P downgraded its credit rating on Spain by one notch, while its negative outlook suggests that there’s more to come. Turning to the UK, in terms of the housing market, a survey revealed that more and more British homeowners are cutting asking prices, while average selling times are lengthening. Hardly something that recommends UK-focused financials and housebuilders at this stage of the cycle to investors I would think.

 

Speaking of recommendations, legendary investor Jim Rogers warns that bonds are in bubble territory and that the US is in for a period of stagflation. I would concur with that – see this blog post of mine from late August in which I warned that bonds were overvalued and argued that equities were too cheap – while that trade has been playing out in recent weeks, in my view it has further to go. Speaking of which, my fellow Irish equities’ blogger John McElligott sees value in some ISEQ stocks.

 

(Disclaimer: I’m a shareholder in Bank of Ireland plc) One sector that I’m very cautious on is the financials. And why shouldn’t I be, with research such as this note from Credit Suisse. After taking a chainsaw to the Chinese financials a few days ago, Credit Suisse sees two-thirds of European banks failing a renewed EBA stress test. It should be highlighted for my domestic readers that Bank of Ireland scores quite well, which is as expected given that it was recently recapitalised. Interestingly, that the French and German banks score particularly badly tells you all you need to know about why Merkel and Sarkozy have been so unwilling up to now to contemplate haircuts for bondholders.

 

I’ve written about the myth that is austerity in Ireland before. Now you can read of the myth that is austerity in Greece. But moving from myths into reality, I was struck by a really good piece by Mark McCutcheon a few days ago which illustrates the tax advantages to employers that arise from hiring unemployed people in Ireland. This is something that really needs to be highlighted at this time. Speaking of Ireland’s unemployment issues, I note that Ajai Chopra, our IMF Viceroy, says that Ireland will not be able to pop the champagne corks until after it gets its jobless crisis under control. Might I suggest that one way that the Irish government should not attempt to achieve this is by recycling privatisation proceeds into job creation efforts – you only have to look at Fás to see what happens when Irish politicians attempt to create employment. Reducing the tax and regulatory burden on businesses is the best way forward.

 

A couple of times this year I’ve been accused, not undeservedly (!), of being extremely bearish. To mitigate against the above economic doom, gloom and ka-boom (to use a line from an email I sent to my MBA classmates earlier this week), here’s a video that shows that not everything is bad, at least in Ireland.

 

Finally, looking ahead, it’s going to be a busy week for Irish corporate newsflow. The main highlights are First Derivatives’ H1 results (Tuesday), C&C’s H1 results (Wednesday) and Dragon Oil’s IMS (Thursday). If I can tear myself away from the books I’ll provide you with some “musings” on them.

Market Musings 21/8/11

Activity on the blog has been quiet this week as I had to finish two articles for the new issue of Business & Finance magazine, in which I look at the outlook for global markets and also talk to two of Ireland’s brokers, NCB and Dolmen, about the options they have for investors looking to diversify out of Ireland and the eurozone. Sadly, this meant that this blog remained quiet while the markets were anything but that!

 

There was panic on the global equity markets as investors rotated out of shares and into “safe haven” assets such as gold, which continues to shoot higher. At the time of writing it is just under $1,852 an ounce, having surged 14% in the past 30 days (it’s up 47% in the past year). Another “safe haven” that has seen massive inflows is government bonds, and we’ve seen some chunky moves here, with yields on US Treasuries at levels last seen when Eisenhower was in the White House.

 

While there is no denying that the catalyst for the slide in equity markets – fears of a ‘double-dip’ recession and deleveraging slowing the pace of a future recovery – is real, the market reaction to me looks excessive. Concerns have been heightened by weak GDP readings across many of the world’s leading economies, however, low growth and high debt are hardly new concerns, and I believe that markets have more than moved to compensate for a more adverse scenario playing out. Moreover, given the hysterical tone of much of the financial commentary I’ve recently read, my view is that we are in and around the point of maximum bearishness (recall, however, the old stock market adage that nobody rings a bell at the top and bottom of the market!), and that shares will rebound significantly between now and the end of 2011.

 

While there’s no denying that the economic outlook is gloomy, things are nowhere near as bad as they were in 2008 (comparisons with 2008 have been repeatedly made this week) and it shouldn’t be forgotten that corporate balance sheets have dramatically improved since the onset of the global financial crisis (one article I read this week said that US and European corporates are sitting on $3trn in cash). Furthermore, with government bond yields at record lows and sovereign balance sheets in rag order, minuscule returns on cash and gold looking frothy (in the short-term, as it has spiked well above trend, however, the long-term fundamentals remain intact), I would submit that bluechips with strong balance sheets and well-covered dividends (dividend yields for many large corporations stand at a multiple of their countries’ bond yields) are looking particularly attractive here to people with money to invest. 

 

It takes guts to step in when panic like this sets in. Perhaps the market has further to fall. But when sentiment turns, and the huge sums of cash that have been parked at near-zero returns in the money markets in recent weeks rotate back towards riskier assets, the rebound in equity markets (I can’t see the funds rotating into government bonds or precious metals, given where they are trading at) will be an extremely violent one.

 

Turning away from the overall market and to specific companies, I was amused to see stockbroker Peel Hunt use the recent UK riots as one of the reasons why it recommends Domino’s Pizza UK & Ireland plc to investors as a buy:

 

“We would also take seriously recent social developments, which even after calm has been restored, may result in a subtle shift between the considerations for going out as opposed to staying at home. This cannot be bad for the delivery business”

 

I was pleased to see solid interim results from Kerry Group during the week. Growth was led by its world-class Ingredients division. The company  “remains confident of achieving its growth targets for the full year and delivering 8-12% growth in adjusted EPS” as previously guided.

 

I recently commented about how there has been a spike in share buybacks. On Thursday Ryanair disclosed that it has bought back a further 1% of its shares. I wonder if any other Irish plcs will follow the lead set by it, Abbey and United Drug given the recent market falls.

 

Finally, looking to the week ahead, the main scheduled Irish corporate news will be the interim results from Kingspan (Monday), Tullow and Glanbia (both Wednesday) and Independent News & Media (Friday). Doubtless they will provide plenty of talking points.