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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.
United Utilities: A defensive inflation hedge
Equities suffered further losses as rising Eurozone government bond yields and uncertainty over US budget deficit cuts offered additional concerns to the global economic outlook.
Contagion from the sovereign debt crisis continued to spread from the peripheral nations to affect even the continent’s economic powerhouses, as confidence in the future of the region wanes. Two credit ratings agencies, Moody’s and Fitch, warned that France’s prized triple A credit rating could be vulnerable to slower growth and higher funding costs.
A disastrous bond sale in Germany sparked fears that the Eurozone debt crisis was even beginning to threaten Berlin. Following one of the least successful debt sales since the single currency was formed, the Bundesbank only sold around half of a €6 billion auction, due to a shortage of bids by investors.
The yield on three-month bills in Spain climbed over 2% from last month, its highest for 14 years and was even higher than at recent auctions of equivalent Greek and Portuguese debt, highlighting the sense of disrepair in the region.
The impact of the debt crisis on the underlying economy was reflected in recent consumer confidence figures for the Eurozone. According to the European commission, the headline measure of consumer confidence fell to its lowest level since August 2009, its fifth consecutive monthly decline, increasing the risk the region will slip back into recession.
Even production in the German manufacturing sector, a recent ray of light in Europe, fell at its fastest pace since June 2009 this month. The Markit Purchasing Managers Index dropped to 47.9 from 49.1 in October, well below the 50-level that divides expansion from contraction.
Concerns over the US budget deficit added a fresh element of fear, after politicians failed to reach an agreement over measures to reduce the deficit, triggering $1.2 trillion worth of automatic spending cuts in 2013. No plans on how to lower the deficit in the long-run will damage sentiment and could put downward pressure on the country’s already fragile credit rating. US third-quarter GDP also disappointed investors after growth was revised down to 2% from the initial estimate of 2.5%.
The mood in markets was further unsettled by evidence of a dramatic slowdown in China, after HSBC’s flash manufacturing PMI, an early indicator of China’s industrial activity, slumped to 48 in November from 51 in October, its lowest since March 2009. Comments from Vice-Premier Wang Qishan, compounded global recession fears after saying the world is likely to experience a prolonged economic recession.
Technical analysis highlights the recent slide with the FTSE 100 falling over 600 points in the last few weeks. Having broken down below the moving averages and key support at 5410, the index has moved dramatically lower and is now trading within relatively close proximity of minor support at 5105 and the 2011 lows at 4940. The oscillators are also in oversold territory, with the stochastic at its lowest level since May 2008, indicating the selling momentum may nearly be expended.
In conclusion, it has been a disturbing period for equities as the global economic backdrop continues to deteriorate. Macro and fiscal policies are almost exhausted, so the need for politicians to rapidly agree on a comprehensive solution to the debt crisis and limit the contagion, is urgently needed to settle the global economy before it almost inevitably slips back into recession. Investors will be hopeful of an announcement at next weeks meeting of Eurozone finance ministers in Brussels, otherwise the drift lower is likely to continue.
Much like the safer nations in Europe, even defensive equities have fallen as the FTSE hits its worst losing streak in nine years, but with low interest rates and soaring inflation, where should investors put their money?
Utility groups are perceived as a good way of protecting your income. United Utilities (Epic: LON:UU.), the UK’s largest listed water company reported robust results this week, with pre-tax profit rising to £124.4 million in the six months to September 30th 2011 from £122.2 million in the same period last year, as revenues rose 4% to £792.7 million.
The water group based in the North West of England, said it plans to deliver greater than inflation returns by increasing its dividend by two percent above the retail price index between now and 2015. As a result, the interim dividend was increased 6.7%, generating a current yield of 5.4%, rising to 5.7% in 2013.
Ofwat, the water watchdog, also published its consultation document on setting future price limits for the sector, which was less arduous than many industry experts had feared. The regulator wants to see increased retail competition and more water trading between suppliers.
United Utilities currently trades on a comparatively full 16.8x earnings, falling to 14.8x next year, but given the 15% growth forecast and the security of above inflation income, the group offers a relatively safe investment alternative to the fixed income market.
The above chart of United Utilities illustrates the recent increase in risk aversion amongst investors, with the shares falling almost 10% in recent sessions. Aside from this, the shares have been resilient against a background of a wider market retreat, with a steady upward trend over the last two years.
The price action is now forming a triangle pattern between the strong upward sloping trend-line and resistance at 635p, which looks likely to result in an upside breakout. At the time of writing the share price is 598p and with a tight stop loss below the trend-line at 569.5p, the risk / reward bias looks favourable. Near term targets are seen at 628.4p, 645.8p and 670p.
This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in United Utilities, but client accounts may. The material in this report has come from Simply Charts and United Utilities corporate website.
