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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.
Fully stretched valuation fashioned at ASOS
EU finance ministers confirmed at the weekend that Athens would receive the next tranche of funding under its current bail-out plan - news that sent the FTSE 100 to its steepest weekly gain for almost two years.
The absence of activity from the US on Monday where markets were closed for Independence Day and the general lack of global uncertainty produced a nervous week for investors.
Moody’s, the credit ratings agency, downgraded Portugal’s debt by four notches to “junk” status, citing an increased risk that the country may require a second funding package. The announcement sent Portugal’s five year credit default swaps, a measure of insuring against a sovereign default, to a record high.
Standard & Poor’s separately warned that the proposed roll-over of Greek debt might actually constitute a selective default, which could result in the ECB refusing to accept Greek bonds as collateral. Widespread rumours also circulated that other peripheral nations, including Ireland, were next in line for further downgrades, sending bank stocks sharply lower throughout Europe.
Global economic data has been mixed, with US manufacturing data picking up pace in June, hinting at an improvement in the economy, whilst the service sector slowed last month. The Institute of Supply management’s non-manufacturing index fell from 54.6 to 53.3 in June, although the employment index offered some improvement.
Doubts about the Eurozone economy were heightened after retail sales fell by 1.1% in May, which was more than forecast and data revealed that service sector activity in the region dropped to its lowest level since October 2010. The data did not prevent the ECB raising interest rates by a further 25 basis points to 1.5% this week, which emphasises the divide between countries like Germany and France to many of the peripheral nations who’s economies are under pressure.
UK house prices rose last month at their fastest pace since October, according to Halifax the mortgage lender, providing a glimmer of hope that the downward price pressure may be abating. The 1.2% rise was ahead of expectations for an unchanged reading, but still 3.5% lower compared to a year ago.
Risk appetite was also suppressed after China also raised its benchmark interest rate by 25 basis points to 6.56%. The third rate rise this year aimed at cooling its overheating economy, is seen as hitting the outlook for demand in the mining sector.
Technical analysis highlights the 400 point rise experienced last week and the FTSE 100 is now trading within close proximity of its 2011 high at 6100. However, with the oscillators deep within overbought territory, I don’t believe there will be enough momentum to enable the FTSE to push to new highs at this stage.
The major test is how far the FTSE retraces before finding a base. Support is seen at 5870 and 5800, which coincides with the 50 and 200 day moving averages and the June low at 5640. If 5800 holds it will create a solid foundation for the bulls to push the FTSE through 6100 to a new high, but a break below could trigger a sharp retracement to 5640.
In conclusion, it has been a great short-term rise for equities and despite the bad news this week, equities have remained relatively resilient. Volumes are low as investors struggle to navigate the swings in market sentiment, but I believe a pull back to 5800 is likely before the index is able to break-out to new highs.
Given my expectations of a short-term fall for equities, a stock that is back at its recent highs and looking vulnerable is ASOS (LON:ASC).
The global online fashion and beauty retailer has been one of the best success stories on the UK stock market, rising from 3p to over 2400p in the past decade. The market now expects perfection and for growth to continue at the same rate, leaving it vulnerable to a correction.
The shares currently trade on 64x forecast earnings for this year and 47x for next year, one of the highest ratings on the market and considerably more than peers. The retail sector trades on an average PE ratio of 12x and with a market capitalisation of double that of high-street retailer Debenhams, whilst annual sales are over 80% less, the valuation looks stretched.
Final results on the 2nd June showed profit before tax and exceptional items were up 41% to £28.6 million on sales of £324.1 million. Having experienced profits doubling each year from 2006 to 2010, earnings per share only rose by 46% last year and is expected to be even less this year, suggesting the pace of growth is slowing.
Aware the UK market has been exploited, management has recently launched websites in the US, France and Germany, which will now determine future growth at ASOS. International sales rose 142% last year, although expansion has been boosted by sales and free delivery, which reduces profit margins.
Abroad orders will be dispatched from the new warehouse in Barnsley, but it is likely to need warehouses abroad in the near future, which will require significant extra investment and a change in the way the business is managed.
ASOS’s rivals are also investing heavily in online growth, so competition is only going to intensify. Cost pressures from rising raw material prices and fuel are also squeezing margins and given the backdrop of the retail environment throughout Europe, it is a sector I am nervous of.
The one year chart of ASOS shows the strong momentum that the shares have exhibited over the past ten years, although since May the shares have failed to go higher with resistance at 2500p.
Perhaps it is just consolidating before pushing on to fresh highs, but given the earlier analysis of the FTSE 100, the extortionate valuation and wave of downgrades following the full year results, I believe the shares are a sell.
At the time of writing the share price is 2393p and with a tight stop loss above the all time high at 2512.5p, the trade offers an attractive risk/reward bias. Near term targets are seen at 2238p, 2160p and 2020p.
This report was written by Mark Allen – Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in ASOS, but client accounts may. The material in this report has come from Simply Charts and ASOS’s corporate website.
