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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.
Wide discount appeals at HeraldAugust 30 2014, 7:00am
A glance at the above chart of the FTSE 100 illustrates the strong recovery in equities as the markets continued to focus on the prospect of further policy accommodation from the European Central Bank, with the S&P 500 closing above 2,000 for the first time.
Easing geopolitical developments improved sentiment as Vladimir Putin, Russia’s president, held talks with his Ukrainian counterpart and EU representatives, while Israel and Hamas agreed a ceasefire in Gaza.
In a speech last week at the Jackson Hole gathering of central bankers in Wyoming, ECB president Mario Draghi delivered some dovish comments on inflation expectations, commenting that he was prepared to use all available tools. The ECB holds its next policy meeting on 4th September and the market is anticipating a dose of quantitative easing, although the market could voice its disappointment if nothing happens.
Sanctions on Russia and other international conflicts are weighing on Europe, with recent data from powerhouse Germany pointing to stalling growth. Consumer morale fell for the first time in more than 18 months heading into September, its biggest drop in more than three years. The conflict also contributed to a drop in business sentiment for a fourth straight month in August, while GDP unexpectedly contracted by 0.2% in the second quarter.
In contrast to the ECB, the US Federal Reserve is expected to end its quantitative easing programme in October and raise interest rates in early 2015, with little to alter that view in a balanced speech by Fed chairwoman Janet Yellen on the labour market. Meanwhile, recent US data releases pointed towards a steady economic recovery, with consumer confidence reaching a post-recession high and durable goods posted their biggest gain on record. Orders for long lasting US manufactured goods were flattered by a huge increase in aircraft orders, yet the underlying trend also remained firm.
On the domestic front, the economy looks set to grow at its fastest rate since 2007 this year, according to a report from the British Chambers of Commerce, as retail sales grew this month at the fastest pace in six months. Britain’s economy is expected to grow by 3.2% this year and by 2.8% in 2015, although renewed economic stagnation in the Eurozone, Britain’s main export market, could weigh on demand.
Technical analysis of the FTSE 100 shows the strength of the recent rally, with the blue-chip index gaining over 300 points in the past three weeks. The oscillators appear to be rolling over into acutely overbought territory, which combined with the close proximity of major resistance from the multi-year highs at 6880, indicates the rally could be running out of steam. Support is seen at 6745, 6695 and 6640.
In conclusion, the underlying strength of equities throughout August indicates the markets narrow-minded focus on central bank support, choosing to ignore many of the volatile geopolitical risks that remain and slowing Chinese and European economies. Quantitative easing in Europe is regarded as positive for equities in the short-term due to the creation of additional liquidity, but others argue the Eurozone is posing a real threat to global growth, as many nations slip back into recession. I believe equities are overdue a period of consolidation after a strong rally, with a move back towards 6700 seen as a healthy correction.
Investment trusts, companies that invest in other companies, providing a diversified ready-made portfolio of investments managed by an experienced investment team, are an asset class that investors should consider when creating a portfolio.
They follow a wide variety of investment policies, usually specialising in a type of investment or particular geographic region and recent data reveals their price discounts to net asset value (NAV), the total value of the investments it holds, have widened by 2% over the past six months. In February 2014 the average discount across all investment trusts was 4%, compared with 6% in July 2014, with many small/mid cap trusts underperforming more defensive higher-yielding sectors this year.
Of particular interest is Herald Investment Trust (LON:HRI), which seeks to achieve capital appreciation through investments in smaller quoted companies, in the areas of technology, communications and multi-media throughout the world. The trust is well managed by Katie Potts, who has been at the helm for over 20 years and has grown in value by 700% since inception in 1993.
Herald Investment Trust is now trading at an astonishing 16% discount to its NAV of 803.10p, despite the Nasdaq composite in the US and the Numis Smaller Companies index, which represents the bottom tenth of the UK main listed market by value, nearing all-time highs.
The trust is mainly split between the UK and the US, with 68.7% of assets employed in the UK and 19.2% invested in North America. Many of the trusts biggest holdings also happen to feature on my watchlist, with Diploma, IDOX, Toumaz, Imagination Technologies and Telit Communications among its largest five holdings.
The chart of Herald Investment Trust illustrates the steady upward trend, with the price climbing off the support line again in August. Meanwhile, the moving averages have bottomed and are both pointing higher, with the 50-day about to intersect the 200-day to the upside, indicating a new uptrend could be underway.
A 16% discount to NAV looks too wide and with the chart recovering off the long-term support line, I believe it is a good investment. At the time of writing the share price is 672p, with medium-term targets seen at 712.3p, 739.4p and 787p. Traders might consider a stop-loss at 631.6p to minimise potential loses.
This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Herald Investment Trust, but client accounts may. The material in this report has come from Simple Investments internal data sources, Simply Chart’s and Herald Investment Trust’s corporate website.