Momentum screen rocked by miners

To wit: of the 10 shorts selected by the screen in March, three were large diversified miners. Their resurgence alone was the sole reason why the wider group of shorts failed to decline, and instead comfortably outperformed the index benchmark by 3.5 per cent. Without the inclusion of Anglo, BHP and Glencore, the seven other shorts delivered a negative total return of 8.4 per cent, precisely as momentum investing would suggest. Indeed, so strong was the trio’s quarterly performance, that all three stocks have made it onto the resource-dominated selection of 10 longs for the three months to December 2017.

Source: S&P Capital IQ

Of course, the point of this screen is to pass the job of stock selection over to a broad investing principle; namely, to run your winners and short your losers. But the curiously persistent feature of this screen, as outlined in the capital performance table below and picked over by Algy on several recent occasions, is that the shorts have actually been performing very well. Over the past year, they have beaten not only the index, but the long picks, and by a handsome margin.

One explanation might be found in another strategy we were told was back in fashion at the end of 2016. Value investing – that is, buying stocks not for their recent growth, but because they are cheap compared with their fundamentals – was supposedly the new focus of earnings-starved institutional equity portfolios. The potential disruption to short-term momentum investing is clear: equities whose market value has recently collapsed can look good on any number of metrics favoured by value investors, such as a low price-to-book ratio, a high dividend or cash flow yield.

On this score, we might even expect a share such as Provident Financial (PFG) to show some signs of life in the next couple of months, even if the 73 per cent markdown in the doorstep lender’s shares in the last quarter looks like a terminal verdict from the market. Conversely, momentum believers will point to the inherent danger of this type of share buying: the difficulty of catching a falling knife. Indeed, most of the shorts selected by the screen did decline in the last three months. Top short pick Hikma Pharmaceuticals (HIK) dropped by another third, falling out of the FTSE 100 index in the process.

Still, whatever effect value investing might have in the short-term on UK blue-chip prices, the ascendancy of big miners – and their place in the momentum screen – is another matter. Price discovery may dictate the likely cost of the commodities on which miners are dependant, but the market is usually well guided on earnings, particularly when it comes to the largest diversified miners. Therefore, a bullish call on the fortunes of Rio, BHP and Randgold is to a large degree a bullish call on the commodities to which they are exposed, as well as a verdict on their ability to control costs and pick projects smartly. I cover a few of these themes in the write-up of the longs below.

A quick note on the screen’s criteria. The 10 momentum longs are based on the 10 best-performing FTSE 100 shares of the previous three months, while the shorts are based on the worst-performing 10. The shares picked for the coming quarter can be found in the table below, along with write-ups of the largest seven longs. Due to print production schedule, this screen has been conducted a few days ahead of the official end to the quarterly selection period. Future assessments of the screen performance will be based on stocks selected based on the full performance period and may therefore differ slightly from those listed below. This also explains why the performance table on this page includes stocks that supplanted a couple of the picks last time round.

TOP LONGS

There are a few reasons why Anglo American (AAL) has carried a higher beta than its large diversified peers. Higher costs, lower-quality assets, and a choppy track record of project execution, have all combined with a larger debt profile to move the group sharply in one of two directions. Add to this a high exposure to South Africa, where the spectre of high inflation and punitive legislative shifts continually looms, and you have the recipe for a volatile stock. Increasingly, however, sentiment seems to be returning to the group. Half-year results showed a 27 per cent drop in net debt to $6.2bn, an impressive $800m ahead of the year-end target. With lower interest payments, Anglo’s assets have less work to do. But productivity improvements mean they are doing more regardless, which is particularly helpful considering prices for core commodities such as coal, diamonds and iron ore are looking better than in 2016. Throw in a return to the dividend list, and momentum could be further buoyed by income-seekers.

Payments processor Worldpay (WPG) has had an excellent run since it floated in 2015. Soon, its strong position in the world of e-commerce will be subsumed within a larger machine. In July, management accepted a £9.3bn takeover bid from US rival Vantiv, in an approach billed as an attempt to build “a leading global omni-commerce payments provider”. The deal, which is expected to complete “in early 2018”, will reward Worldpay's shareholders with 55p in cash plus shares in the acquirer. That structure means any improvement in the US counterpart’s organic earnings forecasts – or a further fall in sterling against the dollar – could add a small boost to Worldpay's shares.

One of the lead indicators for this quarter’s stock screen will be copper. The price of the red metal has surged by around a fifth in the last three months, putting Chilean mining giant Antofagasta (ANTO) – the closest thing to a blue-chip pure play on the metal – comfortably among the FTSE 100’s top performers. A fall in the company’s tax rate and costs, as revealed in last month’s half-year numbers, provide encouragement that other forces are moving for the group too.

However, it is copper on which Antofagasta's shares are most reliant. That could be a worry, because there are signs the price rally is not entirely correlated to industry fundamentals. China, which consumes around half the world’s copper supply, has been importing a similar level of the metal over the last four months, while the year-to-date increase is only up by around 1.2 per cent. Antofagasta may then be more reliant on speculative ‘long’ positions by commodities traders, who think a supply deficit could emerge by the end of the decade.

The relative strength of copper could also partially dictate the performance of Glencore (GLEN), BHP Billiton (BLT) and Rio Tinto (RIO) in the three months ahead. All three miners have exposure to the metal; all three are considering copper additions to their asset bases. The balance of their performance will largely be determined by the weighting in each portfolio; zinc for Glencore, iron ore for Rio, and oil for BHP. In each case, any further increase in Chinese demand for coking coal should support momentum. That should spell out the varying degrees to which London’s largest miners can replace swap debt reduction and interest payments for selective project sanctions and shareholder returns. Any near-term signal from BHP that it has found a buyer for its US onshore business could provide another fillip to the shares.

Investors seized on two features when quality assurance and testing specialist Intertek (ITRK) posted its half-year accounts in August. The first was a big hike in the dividend. The second was an encouraging 110 basis point increase in the operating margin to 16.4 per cent at constant currencies – suggesting the 5x5 growth strategy announced last year is starting to bear fruit.