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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.
Growth concerns overdone at communications giant WPP
A glance at the above chart of the FTSE 100 highlights the extreme volatility experienced over the recent weeks, which shows no signs of easing.
Last weeks efforts by the European Central Bank to control the contagion in Europe was overshadowed by fears over the implications of last Friday’s US ratings downgrade by S&P.
Major stock indices around the world fell to multi-year lows, with many countries such as the UK, France and Germany moving into bear market territory, commonly defined as a 20% fall from cycle highs.
The ECB’s announcement to buy bonds in both Spain and Italy, in an effort to fight the Eurozone’s debt crisis, helped dramatically improve government bonds in both countries. Spain’s ten-year note plunged to almost 5% and Italy to 5.25%, down from the disastrous 7% level nearly traded last week and should in time help improve broader market sentiment.
The announcement was however almost dismissed by investors, as concern surrounding a recent deterioration in the fundamental backdrop for equities was fuelled by overwhelming nervousness following S&P’s decision to cut US debt by one notch from triple A to AA+.
The market is clearly in the midst of a significant growth scare, but this doesn’t immediately mean the economy is heading back into recession. Corporate earnings remain robust, interest rates are low and this could just be a correction on the way to what we already know is going to be a slow protracted recovery.
Comments from the US Federal Reserve following its August policy meeting, helped provide some support to the market after pledging to keep borrowing costs “exceptionally” low for at least another two-years.
The positive tone however, soon gave way to further selling as contagion spread around Europe. Fresh nerves centered on rumours of problems within the French banking system, specifically Societe Generale and worries over the country’s triple A sovereign rating, which echoed fears of the banking collapse in 2008.
The three major ratings agencies later reaffirmed France’s rating and Societe Generale denied rumours over its health, but the market remained concerned that France was overexposed to many peripheral Eurozone debts. The nervousness spread across to Germany, with stocks in Frankfurt experiencing their worst day for three years.
Technical analysis illustrates the extent of the recent falls, with the blue chip index declining over 1300 points (21%) at worst in the past month, eroding all the progress it has made in the past two years.
The index gained traction from historical support at 4800 before moving higher and appears to be attempting to build a base around 5000. The oscillators are extremely oversold, with the RSI at nine year lows, but all are showing signs of bottoming, suggesting a move higher could be imminent. Support is seen at 5000 and 4800, with resistance at 5400.
In conclusion, underlying sentiment is extremely fragile amidst constant doubts over the outlook for the global economy, but sentiment can often overshoot on the downside and the technicals are greatly oversold. A healthy corporate sector and proactive governments should provide some floor to equity markets and I believe the recent selling is overdone.
A beta blue chip company that has suffered more than others due to the concerns over global growth is WPP, the worlds largest communications services groups.
The above chart of WPP illustrates the recent falls, with the advertising and public relations giant losing over 30% of its value in the past few months.
Technical analysis, much like the FTSE 100, is showing signs of stabilising. The share price has found support at the key historical 600p level and having been dramatically oversold, the oscillators have started turning higher, emitting a buy signal. The MACD histogram has been stepping higher over recent session, with the faster K-line turning upwards, suggesting a new trend may be imminent.
The group is a highly cyclical business, so the recent weakness has been compounded by fears of a global slowdown. A weaker than expected start to the year from European rival Publicis Group also muddied the water, causing investors to sell WPP’s shares in anticipation of their update on 24th August.
Results earlier in the year, saw management lift full-year forecasts, with sales now expected to rise 6% compared to earlier expectations of 5% and margins to meet or surpass its target growth of 0.5%. WPP has a diversified geographical spread, with operations in over 100 countries, despite the likely impact of Euro contagion, I don’t believe the results will be as bad as has been priced in.
At current prices WPP trades on 9.7x earnings, considerably more attractive than the 13.5x multiple in March 2011. Yielding 3.4% and with near double-digit earnings growth forecast next year, I feel the recent weakness is overdone.
Next year should also be a good year for the group, with the US presidential elections, London Olympics and UEFA football tournament adding between 1% and 2% to global advertising spend.
In light of the earlier analysis of the FTSE 100 and WPP’s global mix, digital advantage and strong new business levels, I believe the shares are a buy ahead of results. At the time of writing the share price is 604.5p and near term targets are seen at 636.5p, 698p and 7.4p, with a stop loss marginally below the recent intraday low at 559p.
This report was written by Mark Allen – Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in WPP, but client accounts may. The material in this report has come from Simply Charts and WPP’s corporate website.
