Equity investors largely shrugged off disappointing global macroeconomic data and a warning from the International Monetary Fund, focusing instead on the prospect of the US Federal Reserve leaving interest rates lower for longer, following last Friday’s weak employment report. Furthermore, expectations continued to mount that both the European Central Bank and the Bank of Japan will increase their stimulus measures.
The Bureau of Labour Statistics said that the US economy added 142,000 jobs last month, below estimates for 201,000, while the August reading was also revised sharply lower. Meanwhile, US factory orders fell in August by the largest amount in eight months, as the strong dollar weighed on exports.
Federal Reserve chair Janet Yellen recently suggested the Fed was likely to raise short-term interest rates this year, but the market suggests poor recent data could push it back to 2016. Interest rate futures show the market is pricing in little chance of a rate hike this month and only 31% likelihood of a move in December. The odds of an increase do not rise above 50% until the US central bank’s meeting in March 2016.
The International Monetary Fund cut its global forecasts for a second time this year, citing weak commodity prices and a slowdown in China. At its annual meeting in Peru, the Fund forecast the world economy would grow at 3.1% this year and 3.6% in 2016, down from 3.3% and 3.8% projected only three months earlier. The biggest hit to growth will come in emerging economies where the IMF cut its growth forecast to 4% in 2015, due to a sharp slide in commodity prices.
Speculation that the ECB might increase its quantitative easing programme found further support from data showing German industrial output falling at its highest pace in a year in August. The 1.2% drop in output defied expectations for a small rise, while Volkswagen’s emissions scandal could weigh further on the economy in the coming months.
Yet despite the generally poor data, the Vix volatility index, often referred to as Wall Street’s fear gauge, fell below its long-term average of 20, after spending the past six weeks at elevated levels.
Technical analysis of the FTSE 100 captures the recent strength, breaking out of its recent trading range after gaining almost 10% in the past week. Historical support at 6430 is likely, however, to provide resistance, which combined with the acutely overbought oscillators, may constrain the rally on this attempt. The acutely overbought oscillators also show signs of fatigue, implying that momentum could fade as equities consolidate. Support is seen at 6350 and 6200, while the next upside target would be 6760.
October has proved to be a cruel month for investors, with the 1929 stock market crash, black Monday in 1987 and the credit crunch selloff in 2008, which culminated on Bloody Friday. Yet, central bank stimulus, which has been a policy tonic for stock prices over the past five years, appears to be back in vogue.
Investors appear to be overlooking the implications over the health of the global economy and it is the opposite of how markets felt last month, when equities sold off after the Fed chose not to hike rates. Yet near-term direction is likely to be dominated by the start of US third quarter earnings season, which may struggle to meet tough comparisons to last year.
The fall in British shop prices picked up more speed in September, underscoring the weak outlook for the country’s anaemic inflation rate. The British Retail Consortium said shop prices in September were 1.9% lower than a year earlier, a bigger fall than Augusts’ 1.4% decline. Food prices fell 0.5% and this downward pressure is likely to continue as supermarkets battle for the wallets of the Christmas shopper.
Yet shares in the “Big Four” supermarkets were given a boost after recent results suggested that performance might be turning a corner, following the siege from the discount retailers. Sainsbury (LON:SBRY), the UK’s second biggest grocer behind Tesco, said it had returned to growth, sending the shares in both grocers over 20% higher.
Total retail sales grew 0.3% excluding fuel and full year pre-tax profits are expected to be “moderately” ahead of market expectations of £548 million.
It is however, important to put this into perspective as profits are still forecast to be over £100 million lower than last year’s £674 million, while the driver behind the improved performance was cutting prices, which will further hamper margins.
The gap between Sainsbury’s prices and those of the discounters is thought to have closed by about 5% to 10% over the last year, although margins have been squeezed to nearer 2%, down from over 4% a few years ago and the discounters are still gaining market share. Any additional reduction in prices would further impact store profitability, leading to more write-downs in their property portfolio, which has already fallen by £900 million to £11.1 billion in the year to March.
Sainsbury’s trade on 12.5x earnings, yet analysts are forecasting no earnings growth next year and a 40% reduction in the dividend to 3.5% in the year ahead is unlikely to attract many investors.
The chart of Sainsbury’s illustrates the recent rise, with shares nearing one-year resistance at 280p. The acutely overbought oscillators, however, are at their highest level for some time and appear to be rolling over, suggesting momentum may be turning.
As food prices continue to fall amid fierce competition among the grocers, Sainsbury’s margins and property write-downs are likely to come under further pressure. It is expected to be a tough Christmas trading period and I believe the recent share price improvement to 274.1p has offered another opportunity to short sell the shares. A stop-loss above the recent highs at 285p offers an attractive risk/reward ratio, while near-term targets are seen at 260.4p, 251p and 235.5p.
This report was written by Mark Allen – Head of Derivatives at SI Capital Stockbrokers. The writer does not hold a position in Sainsbury, but client accounts may. The material in this report has come from SI Capital’s internal data sources and Sainsbury’s corporate website.