Join our community of smart investors

10 large caps with momentum

Predictably, resources stocks are a particular focus for our quarterly blue-chip momentum screen
10 large caps with momentum

According to efficient market theory, share prices accurately reflect all the relevant available information about a company. What this arguably understates is the degree to which this information is based on a combination of probabilities and judgements about the future.

Three months ago, investors were spending a lot of time thinking about rising inflation. Today, they are still thinking about rising inflation, but with three months’ more data to ponder. In other words, risks can emerge unexpectedly and violently – as they did at the end of February – or gradually, slowly shifting the size of a risk or opportunity in the process.

In December, plenty of people thought energy prices would continue to rise into 2022, thereby pouring extra fuel on the inflationary fire and raising the prospect of higher interest rates. As two of the three largest companies in the FTSE 100, Shell (SHEL) and HSBC (HSBA) were arguably the most high-profile beneficiaries of this trend, and indeed had been in the prior three months as well.

So with hindsight, their appearance as the two best-performing ‘long’ stocks in our latest quarterly Blue Chip Momentum Classics screen does not feel like a huge surprise. Both companies have the added quality of sitting in unloved, lowly-valued sectors in which sentiment doesn’t need to change much for prices to move dramatically.

Beyond that, it’s hard to discern much of a pattern from the screen’s most recent results, other than to note that the stocks with positive momentum underperformed both the benchmark index and the shorts for only the fourth time since 2017 – and the third time since the pandemic struck. Notably, it is also only the third time in the past three years in which the 10 best-performing FTSE 100 shares in each quarter haven’t made a positive return in the following three months.

Several of the ‘long’ stocks came unstuck by a mixture of moderating forecasts for growth stocks and a generalised risk-off move from equity investors. By contrast, seven out of the 10 ‘shorts’ saw their share prices erode in the period, although their aggregate performance was considerably improved by a mooted takeover for Pearson (see below) and two sudden rebounds in investor sentiment for cybersecurity group Darktrace (DARK) and financial bourse London Stock Exchange (LSEG).

3-MONTH PERFORMANCE

LONGSSHORTS
NameShare price return (15 Dec - 17 Mar)NameShare price return (15 Dec - 17 Mar)
Auto Trader-5.2%Admiral-16.2%
Bunzl-1.9%Aveva-21.7%
Diageo-6.0%Darktrace12.9%
Ferguson-13.9%DS Smith-11.7%
HSBC15.8%Flutter Entertainment-12.1%
Pershing Square-7.0%Johnson Matthey-3.3%
Rolls-Royce-16.7%London Stock Exchange15.9%
Segro-6.6%Melrose Industries-6.1%
Shell18.9%Pearson41.7%
WPP-1.1%Prudential-15.3%
LONGS-2.36%SHORTS-1.60%
FTSE 1001.69% 1.69%

Source: FactSet

Predictably, this quarter’s selections carry a strong weighting to resources stocks, several of which have climbed sharply higher on constrained supplies in many key energy and metals markets.

There is nothing unusual about this, as the history of this screen shows. Indeed, the ability to draw from an index with heavy weightings to resources stocks may be one of the chief qualities of our Blue-Chip Momentum picks. In good times, the inelasticity of supply means prices can march higher for several quarters in a row, while the inverse is often true when there is too much product chasing static demand (as was the case during the sector’s massive capital destruction between 2011 and 2015).

Just how much momentum mining and energy stocks might have this year will depend a lot on geopolitics and the reconfiguring of commodity trade flows in the wake of the Ukraine war. But unlike previous cycles, there is little sign that producers have over-invested in their output capacity.

Price performance  
 LongShortFTSE 100
Since June 2007198%-12%6.4%
10-yr106%12%21%
5-yr24%-22.6%-1%
3-yr18%-28%0.8%
1-yr5%1%8%

As ever, it’s necessary to attach a couple of health warnings to the results below. In the real world, both dividends and trading costs matter to investors. For this reason, the stock screens that appear in these pages usually look at total returns (returns assuming all dividends reinvested) and factor in the notional costs of rebalancing portfolios. This is done even though the screen results are themselves intended as a source of ideas for further research rather than off-the-shelf portfolios. 

For ease of comparison, our momentum is based only on share price performance (so-called capital returns) and does not take any account for quarterly costs. This all matters, because research into momentum strategies have repeatedly shown that costs substantially erode excess returns.

The timing of this quarter's screen also means it has been necessary to look at momentum over a slightly longer period than the normal three-month window. We will seek to correct this over the coming quarters.

The screen itself simply picks the 10 best-performing FTSE 100 shares from the past three months as 'longs' for the coming quarter and the 10 worst-performing as 'shorts'. Details can be found in the tables at the end of this article. Below, we take a closer look at the two of the longs.

PEARSON

Pearson (PSON) was the best performing FTSE 100 constituent in the first quarter of 2022, although this had little to do with a sudden about-turn in its profitability or the fortunes of its pivot to subscription-based online education services and resources.

Instead, the group’s shares have surged higher on takeover speculation. Earlier this month, the former Investors’ Chronicle owner was forced to disclose it had rejected two tentative cash bids – one in early November at 800p a share, and another on 7 March at 854p – from the US private equity group Apollo.

In both cases, Pearson’s board deemed that the unsolicited and “highly conditional” proposals “significantly undervalued the company and its future prospects”. Apollo, which has until 8 April to make a formal offer to the company’s shareholders, continues to weigh its options for a cash bid.

A few details regarding the current situation suggest a short-term momentum trade in Pearson shares might have legs. For a start, the shares sit 5 per cent below Apollo’s second bid price, meaning one important actor already believes Pearson is undervalued. Second, the second bid was made (and rejected) after Russia’s invasion of Ukraine, suggesting both Apollo and Pearson’s board believe that a clearly heightened market risk premium is already in the price.

Third, it is only natural that Pearson views the first two offers as low-balls. The stock changed hands for 859p as recently as July, before fragile investor sentiment once again cracked following a mixed trading update in October. On balance, it seems likely that Apollo would sweeten its offer.

Nor should investors assume that Apollo is the only interested party. Disclosures of high-profile approaches for UK companies have a track record of weeding out new suitors, particularly when private equity is involved. Activist shareholder Cevian Capital – which has continued to build a stake it first acquired in Pearson in 2020 – shows there is plenty of outside faith in the turnaround story.

GLENCORE

It has been a frenetic and often strange few months for listed resources firms. We are all paying a lot more for basic materials than we were at the end of 2022. But just because commodity prices have broadly climbed – and often lurched – higher doesn’t mean shares have followed.

Russian gold miner Polymetal International (POLY), for example, was the worst-performing blue chip in the period – despite witnessing a bump in the dollar price for its key product and a cratering in its local cost base. Huge questions hang over the company’s ability to distribute dividends or transact, but at least the stock was trading at the time of writing. The same cannot be said for the Roman Abramovich-backed Evraz (EVR), now suspended and hence absent from our ‘shorts’ table below.

As one of the largest producers and traders of key commodities, Glencore (GLEN) is a key interlocutor in a market beset by dislocation. In its annual report, published last week, the group highlighted spikes in volatility in a raft of markets it is involved in, including oil, natural gas, coal, grain, aluminium and nickel.

For traders, volatility tends to be a good thing. But when it leads to disorder and violent price shocks – as happened when nickel futures briefly touched $100,000 a tonne this month – volatility risks creating serious liquidity mismatches for the brokerages, producers and banks on which markets depend. While Glencore should thrive in a volatile (and largely rising) commodity price environment, trader calls for central banks to support the energy markets via “time-limited emergency liquidity support” show the situation is unpredictable and fluid.

The company also has a habit of unveiling major risks that were hitherto poorly understood.

Although it has no operational footprint in Russia, and limited trading exposure to the country, Glencore will need to work out what to do with equity stakes in En+ and Rosneft. Both investments serve as unhelpful reminders of the limits to the company’s swashbuckling risk appetite, especially so soon after making a $1.5bn provision to settle long-running fraud probes in the UK, US and Brazil.

LONGS
NameTIDMPriceMarket cap3mth mom*NTM PEDY
PearsonPSON808p£6.1bn41.7%202.5%
BAE SystemsBA723p£22.7bn36.2%143.5%
GlencoreGLEN479p£63.2bn32.6%73.6%
Anglo AmericanAAL3,685p£49.3bn28.3%88.4%
AntofagastaANTO1,627p£16.0bn27.4%196.6%
InformaINF595p£8.8bn25.2%24-
ShellSHEL1,942p£147.1bn23.3%74.3%
Standard CharteredSTAN506p£15.3bn21.0%71.8%
InterContinental HotelsIHG5,252p£9.7bn18.2%261.2%
Rio TintoRIO5,621p£70.2bn17.9%810.3%
Average---27.2%144.7%
SHORTS
NameTIDMPriceMarket cap3mth mom*NTM PEDY
Polymetal InternationalPOLY121p£0.6bn-88.7%159.5%
OcadoOCDO1,189p£8.9bn-32.4%--
Coca-Cola HBCCCH1,705p£6.2bn-29.8%15-
Croda InternationalCRDA7,582p£10.6bn-28.3%301.3%
Scottish Mortgage ITSMT1,005p£14.5bn-27.5%-0.3%
JD Sports FashionJD151p£7.8bn-27.0%130.2%
Royal MailRMG371p£3.5bn-24.8%64.5%
Barratt DevelopmentsBDEV561p£5.7bn-22.5%75.9%
AvevaAVV2,611p£7.9bn-21.7%231.4%
HalmaHLMA2,417p£10.4bn-19.9%430.6%
Average----32.3%179.2%

*15 Dec to 17 Mar

Source: FactSet