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Momentum reverts to mean

A number of themes have emerged in this quarter's blue-chip momentum portfolio, as well as mixed signals on the market's take on Brexit
March 22, 2017

Reversion to the mean is a powerful concept in investment. Therefore, it's not surprising that, following a strong run, stock screens often experience a reversal of fortune. The underperformance of my blue-chip momentum screen, while relatively modest, can be viewed in this context given the knockout results achieved last year.

Over the first three months of 2017 (to be precise the period from 15 December 2016 to 15 March 2017) the momentum longs produced a total return of 5.0 per cent, compared with 5.3 per cent from the FTSE 100 index. On a number of occasions I've felt minded to caution about the erratic behaviour of the short portion of the strategy, and the past three months once again proved this point. The 10 'shorts' - losers that are on average meant to continue to underperform the market - enjoyed bumper gains, rising 15.1 per cent - well ahead of the index.

 

Three-month performance

LONGSSHORTS
NameCapital Return (15 Dec 2016 - 15 Mar 2017)NameCapital Return (15 Dec 2016 - 15 Mar 2017)
Glencore20%Hikma Pharma31%
Antofagasta18%Fresnillo30%
Carnival10%Randgold Resources 27%
Rio Tinto8.4%Polymetal Int22%
Ashtead Group5.4%DCC20%
Anglo American3.5%Capita18%
Barclays-0.8%AstraZeneca 10%
BHP Billiton-2.1%Mediclinic Int4.1%
Royal Dutch Shell-3.5%Babcock Int-3.4%
Tesco-7.6%Royal Mail-8.8%
Longs5.0%Shorts15%
FTSE 1005.3%-5.3%

Source: S&P CapitalIQ

 

The shorts' recent spell of misbehaviour builds on some other noteworthy recent periods of outperformance and these stocks are now actually showing outperformance of the index since I started monitoring this screen at the height of the last bull market in mid-2007. That's not good, especially given that this covers almost a decade. What is good, however, is that over the same period the 'longs' have performed far more strongly. The performance of the screen since inception, based on capital returns, can be seen in the chart below, as well as in the accompanying table, which also details performance over five years, three years and one year.

 

Blue chip momentum

 

Capital onlySince inception (15 Jun 2007)5 years3 years1 year
Longs140%66%23%35%
FTSE 1007.6%22%13%20%
Shorts14%45%40%29%

Source: Thomson Datastream/S&P CapitalIQ

 

The results of this quarter's blue-chip momentum screen serves as an illustration of just how vexed the question of Brexit is for investors. Many of the 'longs' selected by the screen, based on the 10 best-performing FTSE 100 shares of the past three months, are companies that continue to bounce back following ugly Brexit-related sell-offs last year.

But anyone taking solace about the outlook for the UK economy from the longs, may find equal cause for alarm from the 'shorts', the worst-performing 10 FTSE 100 shares of the past three months. These are dominated by domestic plays and especially retailers. Many fear this sector could face the double whammy of rising overseas sourcing costs caused by sterling's post-Brexit weakness together with the possibility of falling demand should the start of Brexit negotiations hit consumer confidence. The sector faces other domestic pressures on costs too, though, as well as structural issues, including the challenge of increased online shopping.

Both the long and short portfolios, which are detailed in the tables below, are characterised by a number of themes. As well as the table, I've provided a write-up of stocks in the long portfolio and, where a clear theme exists, I've looked at the stocks together in this context.

 

BLUE-CHIP MOMENTUM PICKS

Longs

NameTIDMPriceMarket cap3-mth momNTM PEDividend yield*
Hikma PharmaHIK2,297p£5.5bn42%211.2%
Fresnillo FRES1,453p£11bn36%321.7%
Unilever ULVR4,040p£115bn34%232.7%
Randgold ResourcesRRS6,960p£6.5bn33%281.2%
International Cons. AirlinesIAG562p£12bn31%73.9%
BurberryBRBY1,785p£7.7bn28%222.1%
Taylor Wimpey TW.190p£6.2bn28%106.3%
Mondi MNDI1,912p£9.3bn27%152.6%
Smurfit KappaSKG2,204p£5.9bn27%--
Persimmon PSN2,073p£6.4bn26%106.5%

 

Shorts

NameTIDMPriceMarket cap3-mth momNTM PEDividend yield*
NextNXT3,897p£5.6bn-18%910.2%
PearsonPSON653p£5.3bn-14%138.0%
Dixons CarphoneDC.304p£3.5bn-11%103.2%
Royal MailRMG406p£4.1bn-11%105.5%
BTBT.A332p£33bn-10%124.2%
TescoTSCO189p£15bn-9%22-
Marks and SpencerMKS330p£5.4bn-9%115.7%
WPPWPP1,700p£21bn-8%133.3%
CentricaCNA219p£12bn-7%135.5%
BPBP.456p£89bn-6.3%157.2%

*Includes special dividends

Source: S&P CapitalIQ

 

Meet the longs

Shares in generic drugs company Hikma (HIK) have been rebounding strongly since the start of the year. Full-year results earlier this month, although somewhat mixed, provided grounds for the market's enthusiasm over the past three months. The key worry for investors in the sector is that the huge opportunity presented by the 'patent cliff' - whereby a raft of blockbuster drugs lost patent protection from copycat versions - has led to a surge in competition between generic companies trying to muscle in on the market. However, Hikma's 39 per cent constant currency revenue growth last year helped calm investors' nerves. What's more, the group's balance sheet looks stronger than analysts had expected and its focus on 'injectables' has served the group well.

There was relief, too, that following teething problems with last year's acquisition of West-Ward Columbus, the integration progress is now going to plan. It is hoped the deal will give Hikma the scale to prosper in a more competitive environment. Investors also have the upcoming excitement of an FDA decision about whether or not to approve in the US Hikma's generic version of GlaxoSmithKline's asthma drug Advair (last IC view: Sell, 2,126p, 15 Mar 2017).

 

The big story for Unilever (ULVR) over the past three months was a bid approach from Kraft-Heinz, which was quickly seen off. The offer, especially given Kraft's connection to the legendary Warren Buffett, does seem to have got the market excited about the value on offer at the consumer goods giant. What's more, the bid has had a knock-on strategic impact, with Unilever's management now looking at ways of increasing efficiency and shareholder value. The action being taken at Unilever may in part have been spurred by the success of cost-cutting measures at Kraft over recent years while it has been under the control of private equity company 3G and Mr Buffett’s Berkshire Hathaway (last IC view: Hold, 3,187p, 26 Jan 2017).

 

Shares in International Consolidated Airlines (IAG), the operator of iconic national carriers British Airways, Iberia and Aer Lingus, have now regained all the ground lost following the UK's Brexit vote and the company's profit warning that followed. The impact of sterling's weakness on demand has not been as severe as many had feared and some of the currency-related impact on ticket prices has been offset by lower fuel prices. During the three months under review, the company reported strengthening trading into the final quarter of 2016 and also announced a €500m share buyback.

Management has said an modest uptick in profits is expected in 2017 compared with the market's expectations for a flat year. That said, there is a considerable amount of uncertainty about the sector's prospects based on whether growth in demand can keep up with the industry's planned capacity increase (the sector's habit of overexpansion during good times is the chief reason behind its reputation for delivering bad long-term returns). Last IC View: Buy, 515p, 24 Feb 2017

 

The market has found a number of reasons to push up Burberry (BRBY) shares since midway through last year. The weakness of sterling is a positive for the group because it generates lots of its revenues in overseas currencies and also benefits from tourists visiting the UK on international luxury shopping trips. Indeed, trading in the UK has been strong recently. Significantly, the company has also reported a pick-up in its sales in Asia. Trading in other overseas markets, such as the US, is less encouraging.

Investors are also enthusiastic about the benefits of Burberry's move to speed up the process of getting its clothes from the catwalk on to its hangers - a process that traditionally has been subject to a delay of about three months. Finally, there is enthusiasm for the upcoming appointment of an experienced new chief executive in July, which will free up the incumbent, Chris Bailey, to refocus his attention on the creative leadership of the group (last IC View: Buy, 1,453p, 10 Nov 2016).

 

LONG THEMES

Precious metals

Fresnillo and Randgold

Anyone wondering why miners have a reputation for being geared plays on the commodity they dig from the ground should take a look at the accompanying chart of Fresnillo (FRES) and Randgold (RRS) shares relative to the gold price (Fresnillo is a big silver miner too). The graph covers the period from the gold price's $1,375 per ounce 2016 peak in July, through to the yellow metal's trough at $1,123 - which exactly coincided with the start of the latest three-month monitoring period for the momentum screen - and back to today's spot price of $1,233.

 

GOLD vs FRES vs RRS

 

Both companies have reported on 2016 trading in the period under review, too, and the themes have been similar, with the miners impressing on the cost front while opting to use strong balance sheets to invest in production increases rather than fund dividend largesse.

Last IC View: FRES, Buy, 1,463p, 28 Feb 2017/RRS, Hold, 7,105p, 6 Feb 2017

 

Housebuilders

Taylor Wimpey and Persimmon

What a time it is to be a housebuilder. Sales are strong and profits are soaring for the majority of the sector's major players (operationally-troubled Bovis being the exception). The government's recent housing review has also been seen as presenting few major challenges, while state-backed incentives for buyers remain in place for the time being.

Against this backdrop, both Taylor Wimpey (TW.) and Persimmon (PSN) have reported barnstorming results over the past three months. The strong trading has been accompanied by increased payouts to shareholders, underlining the sector's income attraction at the current point in the cycle. But this is a cyclical industry and valuations and returns are both currently high, which points to major risks should there be a switch to the industry's highly favourable trading environment. This has been attested to by bouts of extreme share price turbulence, most notably following the Brexit vote.

Last IC View: TW., Buy 177p, 28 Feb 2017/PSN, Buy, 2,016p, 27 Feb 2017

 

Paper and packaging

Mondi and Smurfit Kappa

The paper and packaging sector is rarely one to set investors' pulses racing. However a wave of price increases, notably higher kraftliner and recycled containerboard prices, have caused share prices to jump and both Mondi (MNDI) and Smurfit Kappa (SKG) have benefited. The price rises have served to highlight the attractions of the sector based on rising demand for packaging linked to increased online shopping.

Both companies have reported results in the past three months. Investors in Mondi received some reassurance that the group's new chief executive would continue the focus on assuring investment produced worthwhile returns while continuing to consider capital returns to shareholders. The company has outlined a major investment programme to boost operating profits by about €100m come 2020. Meanwhile Smurfit, which is billed by analysts as a bigger beneficiary than Mondi from recent price rises, increased its dividend for 2016 by a fifth as investment in higher-return projects helped it shrug off higher input prices and currency pressures.

Last IC View: MNDI, Buy, 1,877p, 23 Feb 2017/SKG, Buy, 2,176p, 8 Feb 2017