InterestingLeigh – Please, sir, I want some more (Charles Dickens, Oliver Twist)
In the book, the response to this request from Oliver is not encouraging: ‘I know that boy will be hung.’ Well, Oliver should have operated in today’s market, as he could have consumed as much as he liked!
Amongst many factors, some of the most important drivers of markets include valuation, earnings and liquidity. As I have been repeatedly highlighting, liquidity is not in doubt, either sourced through monetary & fiscal stimulus, excess capacity, or factors of production, (though, again, there remains only a very limited multiplier effect, as highlighted in the October US Loan Officer survey which stated ‘banks eased their lending policies for commercial and industrial loans and experienced little change in demand for such loans over the past three months’1). Earnings growth does currently exist, though the outlook for the main UK index is for just over 8% for next year2, which, given the current economic climate, remains attractive. The key factor that has changed over recent years is the valuation of the market, which has moved from a forward price to earnings multiple of 8.6x at the start of 2009 to 12.9 now – quite a significant re-rating of the market.3
For this multiple to expand further, earnings have to grow as fast as valuations are now at (or above) their long term average, but earnings revisions have been poor recently, especially outside areas receiving a direct stimulus, such as house building and construction. Indeed, most recently we have witnessed a string of cautious statements, notably across differing sizes of companies and a variety of sectors. The companies include Weir Group, Tullet Prebon, Anite, Meggit and Experian, to name a few. Perhaps there is greater value further down the market cap spectrum, with earnings growth forecast nearer 15%, as one might expect with smaller companies, given the prospect of economic recovery.
In my opinion, recent evidence suggests that it is liquidity that has the driving seat at present, as highlighted by the markets’ 4%4 jump in October, seemingly driven by the US agreement to temporarily raise the debt ceiling. A further fear that lends weight to this point is that, in the near term, the main market looks technically overbought on a relative strength indicator, RSI, of 67.89.4 The Small cap indices sit on a similar number. I hate to point this out, but this looks very similar to the point we reached in May!
Figure 1 – Bloomberg, Relative Strength Indicator UK Main Market Nov 2012 to Oct 2013
When you stretch the truth, watch out for the snap back, Bill Copeland
1) October 2013, Senior Loan Officer Survey on Bank Lending Practices, The Federal Reserve Board
2) Peel Hunt UK Market Valuations 4 November 2013
3) Peel Hunt UK Market Valuations 4 November 2013
4) Bloomberg 31 Oct 2013