Many global stocks and shares lifted +20% or more in 2017. Corporate earnings surged. The US saw strong growth and low unemployment. Timely synchronicity from developed and emerging economies all helped. A stellar year.
But 2018 is a blank sheet of paper for traders. Where will volatility – which was unusually low in 2017 – and opportunity come from? Which economies look weaker around the knees? What sectors look vulnerable to falling out of fashion with potential chunky share price shifts?
If there’s one sector that has ‘Avoid’ stamped all over –for longer term investors though not for traders – it’s retail. Danny Cox from Hargreaves Lansdown fingers Sports Direct for starters.
Ambition versus fundamentals
Sports Direct recently claimed a “spectacular trading performance” in its latest trading update. But investors, fretting about mediocre sales and debt levels, plus tangled corporate governance worries, were underwhelmed, forcing shares down.
“Do you believe Mike Ashley’s strategy to become the ‘Selfridges of Sport’ amid the corporate governance issues?” asks Cox. Boss Ashley wants Sports Direct to have a shinier, more ‘premium’ image.
But the Midlands-based firm still has to get real distance on its grubby working practices reputation. Sports Direct shares are down more than -9% in the last quarter (and -43% down in the last three years).
Sch… Beware of bubbles
Food and drinks retailers also look tricky. “Everyone wants to identify the next Fever-Tree,” says Jon Horton of Chamberlain de Broe financial advisers.
“That’s been the wonder stock and is causing some players such as Schweppes to up their game.” Fever-Tree, an upmarket tonic and mixer company, “has barely any overheads and is now out-sourcing practically everything,” says Horton.
- Fever’s performance fizz means tricky times for competitors, including Britvic and IRN-BRU maker AG Barr
- “Yet there is a huge amount of hope in Fever-Tree’s share price,” warns Horton, citing a capitalisation now worth more than Britvic’s
- Fever-Tree’s turnover and profitability is a fraction of that of the 7UP, Robinsons and Purdey’s owner (Britvic). In the background lurks sugar tax worries
Bet on bookies?
Financial adviser Martin Bamford of Informed Choice is similarly bleak on retail. Does that stretch to bookies like William Hill (up +28% Sept-Dec) and Ladbrokes Coral (+45% up, Sept-Dec), exposed to the government’s regulatory clampdown on fixed odds betting terminals?
“Yes, there is a regulatory backlash,” he says. “But at the same time that sector is often stronger when there is an economic downturn. So if we have a tough year next year from Brexit and rising interest rates and a squeeze on household earnings, that, unfortunately, may see some drown their sorrows.”
Their surging share price in the last quarter though appears to have shrugged off worries – for now. Bamford adds that shopping habits are switching incontrovertibly to online. “Fixed costs, staff costs, rent…The way we interact with retailers has materially changed.”
“Compelling opportunities” – autos look vulnerable
Goldman Sachs says disruption in 2018 is an ongoing driver of risk, wherever you look. “In our view, the disruptive impact of technology is likely to be even bigger in emerging markets, creating compelling opportunities.”
Goldman says that after consumer staples, car makers look the next big vulnerable sector. Big share price lurches look impossible to avoid. Much of the anxiety is premised on the democratisation of electric vehicle (EV) take-up. Tesla’s share price surged from a little over $200 at the start of 2017 to $338 before Christmas.
“We expect Tesla shares,” wrote Morgan Stanley analyst Adam Jonas in an investor note entitled ‘Tesla 2018: $400 then $200?’ in November, “to be extremely volatile in 2018.”
- Tesla’s volatility could come in two stages: “(1) The alleviation of production bottlenecks,” warns Jonas, “with strong cash inflow, and (2) mounting concerns over the sustainability of the competitive moat”
- More auto makers are beefing up their EV offerings. How long Tesla can withstand super-high operating losses is a concern, though the higher spot oil price has given the energy and battery player insulation (the share price relationship to the price of oil is coarse but a factor)
- Watch for any unwinding of government EV subsidies that may hit EV demand temporarily
Dollar up, pound down?
As far as currencies go, Goldman Sachs is positive on the dollar. Interest rate differentials should increasingly favour the US, it predicts. "Should it occur, we would sell into such strength, since the power of rate differentials is likely to eventually fade as other central banks get closer to the quantitative easing exit.”
Sterling will offer more risk-reward vulnerability as corporate UK grinds through the Brexit gears. Until recently there an itch for the pound to push higher following the promise of Brexit Stage II agreed in mid December.
Despite the agreement in principle to move to trade, talks have been tortuous. EU Brexit negotiator Michel Barnier has warned the real negotiation grit is yet to come. But the Tory party is almost shattered. There is little agreed common ground in any direction. Expect political and business confidence to remain highly vulnerable.
- Emerging market currencies should gain from more global growth plus low inflation – but the volatility could be extreme, says Goldman Sachs
- Watch for a knock-on effect for commodities (think iron, coal, especially) especially if China’s property market – there is an over-supply of rented homes – continues to weaken
- Political risk – national politicians and political unpredictability are increasingly dominant – plus geopolitical ructions will dominate
Banking on Brexit
Watch for price swings on banks. Danny Cox from Hargreaves Lansdown isn’t keen on RBS. “The road to recovery remains long and the government’s majority ownership weighs further on the shares,” Cox told Capital.
In the same sector is Lloyds. Both Lloyds (up +4.6% in the last year) and RBS (up +21% in the same period) are uncomfortably reliant on the outcome of a Brexit agreement. More than 95% of Lloyd’s revenues come from the UK.
Volatility set to return?
Overall, 2017 volatility was low (though boardroom and geo-political face-offs were super-abundant). The placidity stretches across multiple asset classes. Simon Hinrichsen from First State Investments warned in the FT recently that going short in 2018 still looks tough.
“In 2017 investors have seen high equity returns but also very low volatility of those returns. This can be seen both in realised and implied volatility, where markets are currently pricing for a continuation [our emphasis] of this low volatility environment.”
Yet interest rates are rising globally (US, UK and Europe). The simultaneous growth rates seen across much of the world in 2017 can’t last. Higher volatility may be back sooner than some think.
NB. Past figures do not influence future performance.
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