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Trader Talk is produced by a team of active traders, analysts and various derivatives professionals from multiple organisations. Trader Talk provides comment on equities, commodities, and other financial instruments based on both technical and fundamental analysis.
Commodity weakness weighs on WEIRMay 20 2013, 2:00pm
A glance at the above chart of the FTSE 100 shows equities powered to fresh record highs, driven by the US, which continues to outstrip economic dynamics in the developed world.
Further positive news on the US economy came from data revealing that retail sales expanded faster than expected, despite fiscal tightening in the world’s largest economy. The Commerce Department said retail sales crept up 0.1% during the month, against forecasts for a modest decline, after a 0.5% fall in March, the largest in the past nine months.
Better data also prompted an improvement in sentiment towards Europe, after a larger than expected increase in industrial production raised hopes that the recession in the region has eased. Eurostat showed Eurozone industrial output rose 1% in March, double the rate expected and the biggest since July 2011.
Ratings agency Fitch even upgraded Greece’s credit rating, citing progress in the debt laden country reducing its budget deficit and the risk of a Eurozone exit receding. Fitch said it expected Greece to have a milder recession this year of 4.3% and a weak recovery in 2014.
The Japanese stock market also surged to a fresh five year high after the Group of Seven finance ministers failed to criticise the Bank of Japan’s aggressive monetary easing. The politicians and central bank have pushed the yen down against all its major trading partners, boosting the leading exporters’ shares. Data this week showed gross domestic product rose 0.9% from the previous quarter, against the median forecast of a 0.7% rise, providing the first hard evidence that Prime Minister Shinzo Abe’s sweeping stimulus is boosting the economy.
Concerns over the pace of global growth, however, remained in evidence elsewhere, with industrial commodities losing ground following disappointing economic data from China. The world’s second largest economy has faced a slowdown in fixed asset investment, worse than expected industrial production and disappointing retail sales. Brent crude fell back to $101.6 a barrel and gold moved below $1400 an ounce.
Growth data from Europe also disappointed after the region contracted more than expected in the first quarter of the year, weighing on the single currency. Official data showed growth in the Eurozone slowed by 0.2% in the first three months of the year, compared to expectations of a 0.1% fall, with both Germany and France growing at a slower than expected rate.
The German Zew survey of economic sentiment grew at a much lower rate than expected, while the gauge of current conditions dropped sharply, suggesting conditions are still deteriorating in Europe’s powerhouse economy.
Technical analysis illustrates the acute gains experienced this month, with the FTSE 100 nearing 12 year highs at 6750 and all-time highs during the technology bubble in 200 at 6930. Meanwhile, the oscillators are acutely overbought, suggesting the recent momentum could be nearing exhaustion. Strong resistance is likely at 6750, while support is seen at 6505, 6400 and 6240.
In conclusion, it has been an excellent run for equities, supported by an improving global economy that has strengthened the foundation for the stock market rally. That said, with the FTSE 100 nearing all-time highs combined with the acutely overbought technical suggests further short-term gains are growing increasingly unlikely.
Given the above analysis of the FTSE 100, I have been focusing on short-term selling opportunities and as commodity prices remain under pressure, I have concentrated my efforts on engineers with heavy exposure to the materials sector.
Despite recent improvement in the share price, the bears have still got their teeth into the company. Around 15% of its shares are currently out on loan to investors that are speculating the price will fall, making it the second most shorted stock in the FTSE All-share index.
An interim management statement on 1st May revealed Weir was trading in line with expectations, forecasting low single digit revenue growth and broadly stable margins, although the outlook highlighted a few concerns.
The mining sector represents 45% of group revenues, where capital expenditure is being squeezed by lower commodity prices. The company said first quarter trading was resilient, but the longer commodity prices remain weak, means margins will get squeezed.
Services to the oil and gas sector, including equipment used in the process of fracking, contributes a third of revenues, but with US gas prices near historical lows because of the Shale revolution, there has been less incentive for companies to invest in new drilling capacity.
The group’s performance over the first quarter was affected by a lower opening orderbook, particularly in the oil and gas division. Overall like-for-like order input fell 14% between January and the end of March when compared to last year, with analysts highlighting the likely implications on full year profits.
Weir offers a good geographical spread, but trading on a hefty 16.2x earnings, while only forecast to grow by 8%, leaves them looking fully rated on a PEG of 2 and a yield of 1.7%. Furthermore, a director recently selling £700,000 worth of shares at 2400p, doesn’t install confidence.
The above chart of Weir illustrates the rapid ascent experienced over the past year, although the shares appear to be running out of steam near the March highs of 2500p. The oscillators are showing early signs of rolling over in overbought territory, with the stochastics intersecting to the downside, implying a drop in momentum.
Given the earlier analysis of the FTSE 100 combined with the commodity related pressure at Weir, suggests the shares are vulnerable to a correction. At the time of writing the share price is 2470p and I believe a short trade with a tight stop-loss above resistance at 2544p, offers an attractive risk / reward bias, with targets seen at 2371p, 2252p and 2105p.
This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Weir Group, but client accounts may. The material in this report has come from Simple Investments internal data sources, Simply Charts and Weir Group’s corporate website.