A glance at the above chart of the FTSE 100 illustrates it has been another unsettled week for equities as a fresh surge in Eurozone government bond yields unsettled investors.
Italy remained at the heart of the problem after its ten-year government bond yields rose back above 7%, which is regarded as an unsustainable level and one that triggered Greece, Ireland and Portugal to seek international bail-outs.
Of intensifying concern is the increase in bond yields of non-peripheral countries, such as Spain, Belgium, Austria and France. Yields on Spanish bonds hit 6% for the first time since August and even Belgium, previously regarded as relatively safe paper, jumped to its highest level since 2009. Their sudden rise is a worrying sign that investors may be becoming less willing to invest in the Eurozone as a whole.
Even key policymakers at the heart of the crisis voiced their concerns. Bank of England Governor Mervyn King said conditions had deteriorated since August and that Britain’s economy could stagnate until the middle of next year, halving his near-term growth forecasts on the economy. German Chancellor Angela Merkel also admitted that Europe could be living through its toughest hour since World War Two.
Global economic data remained weak, with the Eurozone economy only growing 0.2% in the third quarter, despite relatively robust growth from France and Germany. Peripheral nations fared much worse and forward looking indicators suggest that the region is likely to drop back into recession in the fourth-quarter and beyond. Industrial production in the region fell 2% in September, pointing towards a sharp contraction towards the end of the year and reflecting its biggest drop since February 2009.
Confidence indicators often referred to as forward-looking gauges, also deteriorated, with consumer morale in Britain reaching a record low in October according to Nationwide and Germany’s ZEW institute economic sentiment index fell sharply in October for its ninth successive month.
The US economy has conversely had a week of broadly encouraging domestic economic data, with manufacturing in the New York area recording its first positive reading in five months and retail sales coming in marginally ahead of expectations at 0.5%. The world’s largest economy does however continue to be affected by the outlook for the Eurozone. Fitch Ratings warned mid-week that unless the Eurozone debt crisis is resolved in a timely manner, the broad outlook for US banks will darken.
Technical analysis highlights the range-bound trading experienced on the FTSE 100 since early August, although it is important to note that the price swings are getting progressively narrower, which typically indicates impending volatility. The previous range of 5620 to 4930 is now 5620 to 5340 and a break-out in either direction could trigger an exaggerated move. Until then traders are likely to buy dips and sell rallies.
In conclusion, the deteriorating macro-economic backdrop and rising bond yields in Europe suggest the risks of a negative shock are rising. Despite this dark cloud, the FTSE remains relatively resilient. Perhaps there remains a large amount of cash on the side-lines waiting to buy on weakness or maybe with the lack of clarity over the longer-term outlook, short-term traders are dictating the market and exploiting the tight trading range. Either way, European policymakers are struggling to get a grip on the crisis, during which time a number of core economic metrics continue to deteriorate and I believe there is likely to be further short-term weakness ahead for equities.
A company that has outperformed the general market over recent years is luxury international fashion brand Burberry (LON: BRBY). The retailer famous for its distinctive check design reported a 26% rise in profit before tax and exceptional items on Tuesday, to £162 million ahead of consensus forecasts of £160.3 million. Net profit rose to £117.2 million from £81.7 million and sales were up 29% to £830 million, in line with the update last month.
Burberry’s share price has fallen over 20% since July as fears surrounding a possible slowdown in China and economic uncertainty in Europe weigh on investor sentiment. The company however, made it clear that China only accounts for 10% of its global revenues and sales in the country still rose 30%. Shanghai and Beijing represent just two of its 25 flagship markets globally.
Stacey Cartright, chief financial officer, said “Clearly we are not immune or oblivious to the economic climate, but we’re not in the same place that we were three years ago.”
There has been no sign of slowdown in sales and gross margins for the whole group rose to 66.7% from 64.3% in the first half of fiscal year 2011. There was no change in full-year guidance, which caused the shares to come under further selling pressure, but given they had only raised the outlook last month, I don’t think this is unreasonable.
Chief executive Angela Ahrendts, said growth had come from all divisions, geographies and products and the company is starting to see the initial returns from the five years of investment in infrastructure and the pricing power which it in turn confers.
The above chart of Burberry illustrates the strong performance of the iconic brand over recent years, with the shares rising over 700% since late 2008. The 200-day moving average has underpinned the share price for some time, so support is likely to be encountered at 1267p and 1188p.
At the time of writing the share price is 1269p and by employing a stop-loss marginally below support at 1175p, I believe long-trade offers an attractive risk / reward bias. Near term targets are seen at 1348p, 1398p and 1485p.