What is the right multiple when the Fed is stoking inflation and says it will not withdraw accommodation? What price should stocks carry in a world of ZIRP and QE-4-ever? It’s very hard to say: the usual model for forming a judgment on how richly or poorly valued stocks should be – using interest rates and earnings – is becoming out of step with the reality of unlimited central bank support. How do you derive the right discount rate? We have always assumed that central banks will withdraw accommodation as the economy gets hot and inflation picks up. Or in other words, it’s always been there to take away the punch bowl whenever the party got a little rowdy. Indeed, often it was too quick to turn the music off just as people started to dance. For our free guide to Modern Monetary Theory, click here
Now the Fed says it won’t do that and the ECB and others are set to follow – where the Fed goes usually the rest of the world needs to follow. If it’s unlimited Fed support, who cares if the forward multiple on the S&P 500 is x25? If there is no hiking cycle on the horizon, then stocks could continue to rally from these already very stretched levels.
Of course, as repeated nearly every day, near term I worry that this extended rally is ripe for a pullback as the US election approaches, and I am not alone. Whilst retail investors rich on stimulus cheques still think ‘stocks only go up’, there are signs investors are worried about how far this has gone. Vix futures keep moving in an upwards trajectory that suggests investors are paying more for downside protection on the S&P 500. Vix futures settled above 28 and contracts expiring in Oct are north of 33, signalling a lot of uncertainty around the election. The race will be far closer than polls show. Our election tracker shows Trump narrowing the gap.
Such concerns about stretched valuations and ever-higher multiples are not a concern for UK investors. The FTSE 100 has rather majestically shrugged off the rally in global stocks and serenely plunged to its weakest since May. A stronger pound undoubtedly took the wind out of the sails and a bit of a catchup trade was in play after the market was closed for the bank holiday on Monday, meaning it didn’t take part in the mild sell-off across Europe yesterday. But the FTSE’s troubles are not a new phenomenon – a complete absence of tech and growth is a major problem. Dividend cuts have also vanquished income investors, albeit the yield of almost 4 per cent doesn’t seem too bad today. Last night the FTSE 100 settled on the 38.2 per cent retracement of the March to June rally which has offered near-term support for today’s bounce – dollar strength this morning is helping too.
UK Company Announcements
| Barratt Developments (BDEV) | Completions tumbled almost 30 per cent during the year to June, which together with £74m in Coronavirus-related costs, meant pre-tax profits fell by almost half. However, forward sales at the end of June were ahead of the same time last year, although no dividend was recommended. |
| Hammerson (HMSO) | Shareholders yesterday approved a share consolidation and plans to dispose of its stake in European retail outlets, in order to raise £825m. The shares rose almost 350 per cent in early trading but are still down more than 80 per cent over the past 12 months. |
| Alpha FX (AFX) | Though a non-cash impairment takes the shine off half-year numbers, the forex risk management group says it is confident about the second half of 2020. Client numbers have also grown despite all staff transitioning to remote working. |
| IntegraFin (IHP) | Ian Taylor, one of the co-founders of the Transact investment platform, is to step down as executive director early next year. He helped start the company in 1999, before becoming chief executive in 2002 - a position he held until earlier this year. |
| Mattioli Woods (MTW) | The wealth management firm appears to have breezed through the early stages of the Covid-19 crisis, with results for the 12 months to May showing a 39 per cent rise in operating profit before financing. That was helped by cost-cutting, which will now be partly reversed, though a rise in recurring revenues suggests customers have stuck with the group through a rocky period for markets. |
| The Gym Group (GYM) | The gym operator tumbled into a pre-tax loss of £27m from profits of £5.6m in last year's comparable period, as membership numbers fell by almost 100,000 over the same period. The Gym Group did open four gyms during the period, taking its total estate to 179 sites. |
| Ted Baker (TED) | Ted Baker announced yesterday that it has restored ties with its founder Ray Kelvin, appointing Colin La Fontaine Jackson as a non-executive director who will act as a bridge between the two parties. Ted Baker says it will benefit from Mr Kelvin's "unique brand experience and insight". The founder resigned as chief executive last year over allegations of workplace impropriety. |
| SSE (SSE) | In line with its plan to dispose of £2bn of assets by the autumn of 2021, the group has agreed to sell its 25.1 per cent stake in the Walney offshore wind farm to Greencoat UK Wind (UKW) for £350m. The cash proceeds will be used to support SSE’s £7.5bn capital expenditure plans over the next five years. |
| Johnson Service (JSG) | With volumes in the ‘hotels, restaurants and catering’ (Horeca) segment dropping by 97 per cent in April and most processing plants being closed during lockdown, the group swung to a £19m pre-tax loss in the six months to 30 June, versus a £15m profit a year earlier. Following the lifting of hospitality restrictions, Horeca volumes had recovered to 45 per cent of normal levels in August, benefitting from a rise in ‘staycations’. |
European stocks rallied in early trade on Wednesday, including the FTSE 100, after the S&P 500 and Nasdaq both hit fresh records. Apple rallied another 4 per cent, seemingly unstoppable. Tesla declined 5 per cent after it announced a $5bn stock sale - which though a bit of a surprise is not a complete shock given Tesla’s vast capex requirements and share price accretion – as it did in February, Tesla is taking advantage of favourable market conditions to raise fresh cash early on in the cycle. Meanwhile, we are not getting much further on stimulus - US Treasury Secretary Steve Mnuchin rejected the Democrats’ latest $2.2tn coronavirus relief package, but we are set for more spending, more printing until inflation becomes a problem.
The dollar came back fighting with DXY back above 92.50 as both GBP and EUR retreated off key resistance levels. Could be a dead cat bounce for USD. GBPUSD made a run to 1.35 but failed this test and backed off further this morning to take a 1.33 handle. For those interested in how currencies can affect a portfolio, read our recent Portfolio Clinic on how to understand currency risk in your portfolio. Watch for the Bank of England’s Andrew Bailey, who will be giving oral evidence to the Treasury Committee in Parliament on the economic impact of coronavirus. Obviously it’s bad, but house prices have hit a record high so that is good if you own one, not so good if you don’t. Messrs Haldane (he of the V) and Broadbent are speaking later, too.
The euro – has a line in the sand been drawn? EURUSD pushed up to have a run at 1.20 but got knocked back as the US ISM manufacturing came in better than expected at 56. This could be a line in the sand for the euro bears defending the roaring 20s? Eurozone inflation turned negative in August – a clear signal of the disinflationary pressures wrought by the pandemic. Inflation fell to –0.2 per cent from +0.4 per cent in July. It lays bare the mountain the ECB needs to climb and simply tells us that the central bank will need to keep monetary policy exceptionally loose for a very long time. It’s worth noting that the much-hyped EU rescue deal has yet to be delivered. EURUSD pulled back under 1.19 in early trade on Wednesday as the dollar caught a bid.
Today, we are looking ahead to the ADP nonfarm employment report ahead of Thursday’s weekly claims count and Friday’s main nonfarm payrolls print. The ADP number is expected to show a gain of 1m jobs from a paltry 167k in July. US factory orders and crude oil inventories on tap this afternoon, expected to show a draw of –2m barrels. Later we also have the Fed’s Beige Book, while the Fed’s Williams and Mester are speaking.
Neil Wilson is chief markets analyst at Markets.com
