Europe, China could still spook the markets
Apple stocks take a tumble, despite strong figures.
UK and US rate rises top the agenda.
China scare opens up opportunities.
Volatility expected to remain through August.
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Looking ahead to August, Apple’s share price falls, the woes of China and Greece, interest rates rise and sanctions on Iran lifted are top of the agenda.
“Whisper Numbers” and why Apple took a tumble
Nicolas Ziegelasch, head of equity research, Killik & Co, says:
We sometimes get asked to explain a company’s share price reaction to an earnings report or trading statement: for example, if the reported numbers were ahead of analyst consensus expectations, why did the stock go down? Often that question is easy to answer, as in many cases we are able to point to the fact that the company has lowered guidance for the following period or the next financial year. In other cases, however, it is not as simple as that.
A recent case in point was Apple, which despite beating consensus forecasts for both revenue and earnings, saw its share price fall 7% in after-hours trade. While revenue guidance for the next quarter was slightly below consensus, Apple is known for being conservative when communicating to the market and therefore this is unlikely to be the main reason for the share price fall. What is more likely is that Apple results missed the “whisper number” that differs from the stated consensus.
This “whisper number” occurs when sell-side analysts suspect that reported numbers may be better or worse than their published expectations but don’t actually adjust their forecasts publicly, so as not to move too far away from other analysts or company guidance. The problem is that they don’t keep this to themselves – they mention it to their clients (such as fund managers and buy-side analysts), for example saying, “I am not changing my numbers, but I suspect earnings could be 5% better”, hence the “whisper” terminology!
This now becomes the number that the institutional market, who actually trade the shares and determine market prices, comes to expect. So in the case of Apple’s latest earnings, it seems likely there was some element of this phenomenon, where the buy-side allowed their expectations to run too far ahead of company guidance and became unrealistic. With a stock like Apple, there is a huge focus on its ability to grow against a maturing industry and any indication of a declining growth rate gets magnified in the future expectations and can drastically affect the stock valuation. So despite beating the headline expectations and delivering robust guidance, the market was actually expecting something even better. This mismatch is the real reason shares took a tumble.
Head of equity research, Killik & Co
Interest rate rises and the importance of timing
Jonathan Marriott, Chief Investment Officer at Vestra Wealth, says:
Governor Mark Carney has said that the Bank of England may be ready to raise rates around the end of the year, but he expects rates to peak at a lower level than previously. We do not think that conditions will be right for a rate rise this year but agree that eventually interest rates will rise slowly, to a lower peak than in previous cycles.
The Conservative victory in the election will mean continued austerity in the UK. Austerity and continued low inflation encourages our view that the Bank of England will wait longer before raising rates despite suggestions from the Governor that they could move sooner. We expect this will allow a re-rating of equities to higher multiples of earnings in the long run. Market liquidity is less than it has been in the past, particularly for bonds, and with higher valuations we may expect a rise in volatility. We look to take advantage of these periods, but will importantly also have to learn to look through the short-term moves.
Janet Yellen, the Chair of the US Federal Reserve, and other Fed officials have also clearly indicated their desire to raise rates but have so far remained cautious. Stronger employment and wage data has encouraged the view that rates will rise sooner, but other data such as retail sales continues to disappoint. Dollar strength has hurt US company earnings. With the ECB and Bank of Japan continuing to push their currencies lower, this makes raising rates in the US more problematic. Our view is that a US rate rise in the last quarter of 2015 is likely, but further rate rises will be very gradual with the Fed erring on the side of caution.
So, while we expect rate rises in the next year in both the UK and the US, we expect rates to peak at lower levels than previously and to be very gradual. With clear signals ahead of such a move we expect financial markets to be able to avoid an excessive reaction.
Chief Investment Officer at Vestra Wealth
Opportunities abound, but tread carefully
Rosie Bullard, Portfolio Manager at James Hambro & Partners says:
Stability and certainty are in short supply at the moment so it pays to tread carefully across all risk markets, but this does not mean there is a lack of opportunities.
We see increasing downside risk in the bond market, so we remain underweight fixed income in our portfolios. Under normal circumstances, bonds would be used by investors to dampen volatility and as a source of income. However, compressed yields and uncertainty over interest rate rises in the UK and the US are causing nervousness and bonds are not currently performing their traditional role. Therefore, we must look elsewhere.
We still see value in equities, although a similar measured approach is required. Growth is getting harder to find and markets are more expensive, so it is even more important for us to ensure that companies are meeting analysts’ expectations and justifying their valuations. We expect volatility to remain during August as the flow of economic news slows down and volumes are smaller. Under these conditions, movements can be exacerbated and, of course, there remains the potential for Greece or China to further spook the markets.
As far as Greece is concerned, the worst is probably over. The solution will likely be a muddle through and there is a recognition that it is, after all, only a small part of Europe. That said, we remain aware of the risks of contagion. In China, it appears the government allowed domestic stock markets to run too far too fast, dominated by retail investors who were easily panicked. Ultimately, with China managing a controlled slowdown of all parts of its economy, there will be additional potholes in the road ahead so investors need to take a measured approach.
We have also been aware of currencies. With sterling up 10% against the euro year to date, we have been monitoring the companies in our portfolios with profits in euros to assess the potential impact of currency movements. We don’t try to be too clever with currencies, but being conscious of the issues a strong pound can have helps reduce the possibility of surprises.
Portfolio Manager at James Hambro & Partners
Look long term at implications of Iran deal
Ben Kumar, Investment Manager at 7IM, says:
Some events require a dress code to get into – “no trainers” – and the international community is seemingly no different – “no nuclear weapons” (with exceptions made for those who already have them). It looks as if Iran is finally going to be allowed back onto the global party scene following the agreement signed on 14 July. Although there are troubles flaring up in many other parts of the Middle East, we believe that the easing of tensions with Iran could be one of the more significant events of the first part of the twenty first century – both for geopolitics and for financial markets.
Geopolitically, it is another example of the United States’ growing reluctance to be involved in the Middle East in the manner it was during the Cold War period, largely due to a combination of drawn-out and inconclusive military conflicts, combined with increasing domestic shale oil resources reducing US reliance on Arabian imports. Whether the US retrenches entirely to its own shores, or instead moves its focus towards Asian expansion (read: Chinese containment) is probably going to be a second defining trend of the next few decades.
In financial markets, the re-arrival of Iran provokes a couple of interesting thoughts.
First, of course, comes energy; Iran has 9% of global oil reserves, but produces at far less than peak capacity. Within a short space of time, expansion of production could bring nearly 1 million extra barrels a day into the market – with further potential for exploration. In natural gas, Iran could eventually eclipse Russia as Europe’s key provider, something there certainly would be appetite for at the moment!
Secondly, Iranian demographics make for an attractive equity market story. There are 78 million people in Iran, with relatively high education levels and living standards, despite 50% of the population being under the age of 30. Having missed out on 30 years of exposure to global development, there are certainly opportunities for businesses to discover and expand using new technology and trading links. The equity market capitalisation is only $100bn, but investors are already starting to think about potential access.
Investment Manager at 7IM
China scare presents plentiful opportunities
Patrick Armstrong, Chief Investment Officer at Plurimi Wealth, says:
The biggest uncertainty in markets at the moment is whether the Chinese economy is stabilising or it is in the beginning of a hard landing. This has significant impact on global trade, the global economy and equity markets. The Chinese slowdown has also impacted commodity prices, and this has rekindled fears of global deflation.
We do expect Chinese growth to slow, but we do not expect a hard landing. China has already put in place significant monetary stimulus and has also added pro-equity market policies. We expect to see a significant jump in fiscal stimulus, and more policies to encourage consumption from the middle class in China. This will lead to a much needed rebalancing of the Chinese economy, so it is not as reliant on exports and fixed capital formation: Chinese growth of 6% with greater domestic consumption is more sustainable than 7% growth driven by exports.
We believe Asian equities now offer good value and we remain pro-growth in our investments globally, but are short US equities and are avoiding UK equities as we expect to see headwinds from rising interest rates from both the Fed and Bank of England in the coming quarters. We continue to short fixed income, as global growth conditions will remain positive despite current fears around China. This will lead to a rotation to equities and the end of record low interest rates.
Chief Investment Officer at Plurimi Wealth
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