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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.
Market Overdosed On GSK
A glance at the above chart of the FTSE 100 illustrates it has been a mixed week for equities ahead of this week’s highly anticipated summit of the EU’s 27 members in Brussels.
Ratings agency Standard & Poor’s eroded some of the optimism earlier in the week, after warning that it could cut the credit ratings of nearly all 17 Eurozone countries, including Germany and France, if EU leaders fail to agree on a comprehensive solution to the regions debt crisis.
The impact of S&P’s warning was however softened by investor’s optimism that Eurozone authorities will announce meaningful measures to resolve and the combat the problem. As a result, European sovereign bond markets improved, with the yield on 10-year Italian notes falling back below the 6% threshold, just a week after it was trading above 7%.
Rumours circulated that officials were considering expanding the Eurozone rescue fund amongst a series of other measures to ease contagion in the region, although a senior unnamed German official said the country’s government would not support the idea. Germany also opposed the proposal for Eurobonds because it would lead to a rise in German borrowing costs, highlighting the clear divisions that remain between EU members.
Economic data remains weak, with global growth figures losing momentum. Brazil reported its economy suffered its lowest quarterly annualised growth reading for Latin America’s largest economy since the first quarter of 2009. EU GDP data confirmed the region only grew by 0.2% in the third quarter, with the final quarter of 2011 widely expected to slip back into negative territory.
The Organisation for Economic Co-operation and Development warned that Britain would slip back into a modest recession early next year, slashing its growth forecast to 0.5% in 2012 from the 1.8% it forecast in May. Nomura also reduced its estimate for China’s economic growth in 2012 to 7.9% from 8.6%, as forward looking indicators revealed deterioration in demand.
US consumer confidence, however, climbed in November by the most it has in more than eight years. The Confidence Boards index increased to 56 from a revised 40.9 in October, the biggest gain since April 2003, as Americans grew more upbeat about employment and income prospects.
Technical analysis shows the FTSE 100 remains rangebound between key support and resistance levels, with recent strength pushing the index back up towards three-month highs at 5600. The oscillators are back in overbought territory and show signs of rolling over, with the faster stochastic line crossing over and MACD histogram stepping lower. Support is seen at 5412, 5102 and 4945.
In conclusion, it has been a strong recovery in equities as investor sentiment improves ahead of this week’s highly anticipated EU summit. Should a comprehensive solution be announced, the FTSE is likely to break-out above 5600, with 6,000 seen as the next target. However, with division still evident among the regions key nations, I remain sceptical that the summit will meet investors elevated hopes and with the blue chip index within close proximity of major resistance, I believe a move lower is likely.
Given the vulnerable technical outlook and that the risks are skewed to renewed downside, I have been focussing on equities that have performed strongly and are exhibiting similar characteristics. Due to its defensive qualities, the pharmaceutical sector has outperformed over recent months. GlaxoSmithKline (Epic: GSK), Britain’s largest pharmaceutical company, has gained almost 30% this year while the FTSE 100 has fallen over 5%.
The above chart of GSK shows the relative outperformance, the shares pushing towards five year highs, where significant resistance is likely to be encountered. The oscillators are also nearing overbought territory, with the stochastic starting to roll over and the faster %K line intersecting the slower %D line to the downside, indicating momentum behind the rise is deteriorating.
Glaxo now trades on 12.4x earnings, considerably more than sector peer AstraZeneca on 6.5x earnings and with only 5% growth forecast next year, Glaxo offers an unattractive PEG of almost 2.5. The share price appreciation has also reduced the relative income attraction of the stock. The projected yield is 4.8% and this can be contrasted with other defensive blue chips like AstraZeneca and Vodafone, which offer over 6%.
In the current environment, the outlook for big pharmaceutical companies is tough. As patents expire, new blockbuster drugs are harder to come by and simultaneously generic drug manufacturers are stealing market share.
At the time of writing the share price is 1440p and given the vulnerable technical outlook combined with the less-attractive fundamentals, I believe the shares are too high. A stop loss above resistance at 1563p also offers an attractive risk / reward bias, with targets seen at 1358p, 1312p and 1266p.
This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in GlaxoSmithKline, but client accounts may. The material in this report has come from Simply Charts and GlaxoSmithKline’s corporate website.
