Renewed uncertainty about the outlook for global growth and concerns over US Federal Reserve policy provided a negative backdrop for equities this week.
Following the release of last Friday’s unambiguously strong US employment report, the futures market rushed to price in a 70% probability of the US central bank raising interest rates in December, compared to just 35% a month ago.
The dollar index, a measure of the US currency against a basket of peers, jumped to within close proximity of a 12-year high after the Government's US non-farm payroll report showed a rise of 271,000 last month, far exceeding the 180,000 new jobs for October economists had predicted.
Such a clear indicator for a December rate hike, from such influential data, contrasted sharply with speculation that the European Central Bank could unveil further stimulus measures next month. Media claims that ECB policymakers could act more aggressively than previously thought, cutting the deposit rate further into negative territory in December alongside intensifying its quantitative easing programme, limited investors’ anxiety over monetary tightening in the US.
Markets, however, remained cautious following gloomy comments on global growth from the Organisation for Economic Co-operation and Development and Moody’s, the ratings agency. Both reports suggested that global economic stability is at risk from financial shocks in the face of a greater than expected slowdown in emerging markets.
Poor data from China highlighted the headwinds facing the world’s second-largest economy after weak trade data showed exports fell 6.9% in October from a year earlier, against a 3.7% decline in the previous month, while imports fell a further 18.8%.
Soft Chinese inflation figures were also quantified by consumer prices only rising 1.3% last month, although of greater concern was a 5.9% drop in producer prices, its 44th successive month of deflation. Low inflation, however keeps alive the hope of additional monetary and fiscal stimulus.
Concerns about growth in China and other emerging economies, combined with the impact of the strong dollar, weighed on commodity prices. Copper sank back towards a six-year low, while zinc hit a five-year trough and Brent Crude Oil remained under steady pressure.
It was a quiet week on the domestic front, although strong jobs data revealed Britain’s unemployment rate was the lowest since the 2008 financial meltdown, while the employment rate was the highest since records began in 1971. Retail sales growth, however, slowed last month, marking the weakest performance for the month of October since 2008, according to a survey from the British Retail Consortium.
Technical analysis of the FTSE 100 illustrates the significance of historical resistance at 6460, sending the blue-chips back to the lower-band of its recent trading range at 6260. Some support was encountered from the 50-day moving average at 6260, although the oscillators are trending lower and have some way to go before becoming oversold, indicating further downside risk. Additional support levels are seen at 6170 and 5930, while a close above 6460 could reinvigorate the bulls.
In conclusion, US central bank policy remains at the forefront of investors psyche, inflating the dollar, while weighing on emerging economies and industrial commodities. The markets subdued reaction to the almost certain interest rate hike in December was more down to hope of further stimulus from other central banks, rather than acceptance of tighter US monetary policy and I fear further weakness may unravel as the realisation sinks in.
Investors and fund managers have been positioning their portfolios on a low interest environment for a number of years, yet I have concerns they could be ill prepared by the speed of market reactions. Investors have flocked into utility shares due to their inflation linked dividend income, yet many of these companies have large debts and their profits will come under pressure when rates begin to rise.
National Grid (LON:NG.), the UK’s largest listed utility company, owns and operates gas and electricity distribution networks in the UK and some parts of the US. The company’s control of the UK’s energy infrastructure is a natural monopoly, generating steady revenue, but also requiring costly long-term infrastructure investment.
The company has benefitted over the past six years from record-low interest rates, with results on 10th November, revealing pre-tax profit for the six months to the end of September rose to £1.34 billion from £1.17 billion a year earlier, as revenue increased to £6.85 billion from £6.36 billion. The solid results prompted the utility to raise its interim dividend in line with its policy to 15.0 pence per share from the 14.71p a year earlier, producing a current dividend yield of 4.8%.
Net debt at the end of September rose to £24.6 billion from £23.7 billion at the end of March 2015, resulting in a high debt/equity ratio of 2.168. As the cost of servicing this debt starts escalating, margins will be squeezed, limiting earnings per share growth going forward.
The shares are trading within close proximity of record highs on a highly-rated price to earnings ratio of 15.5 times, which given analysts are only expecting earnings growth of 1.2% next year, puts the company on unappealing PEG ratio of 13.
It also seems timely that CEO Steve Holliday has chosen to step down in March next year after nine years in the role, with the appointment of John Pettigrew, who is currently head of the company’s UK division. The stock has gained 40% since Holliday took the helm, but has failed to break to new highs over the past year.
The chart of National Grid illustrates the significance of resistance at 940p, with the shares currently trading within 2.5% of its recent high. The 50-day moving average recently offered some support, although a series of lower lows suggests a new downward trend could be underway. The mid-range oscillators offer little insight, although the descending RSI indicates momentum is dwindling.
At the time of writing the share price is 916.9p and I am cautious about further gains as interest rates start to rise. Traders might consider short-selling the shares, as a tight stop-loss above the recent high at 949p offers an attractive risk / reward bias, with targets seen at 880.2p, 848p and 801.5p.
This report was written by Mark Allen, equity and derivative specialist. The writer does not hold a position in National Grid, but client accounts may. The material in this report has come from web-based data sources and National Grid’s corporate website.