Newsletter No. 15 14/07/2017

Good Afternoon,

 

The UK

This week the FTSE 100 has rallied to its highest level in a month and is now trading around 7425. Sentiment has been affected by several factors including FX markets, commodity prices and some interesting comments from the Bank of England.

Yes it happened again. Members of the monetary policy committee opened their mouths to the media which incited a volatile 24 hours for GBP. Anyone would think they wanted to stoke up the VIX index (measure of volatility).

This week the chances of a UK interest rate rise appeared to dwindle when Ben Broadbent, the Bank of England’s deputy governor for monetary policy, said he was “not ready” to tighten policy. Mr Broadbent was seen as a swing voter on the BoE’s delicately balanced MPC. Until this week, his views on interest rates were unknown. But his comments all but eliminated the chance that a majority of MPC members will vote for a rate rise at the committee’s August meeting.

Mr Broadbent’s comments had an instant effect on the currency markets with the pound diving to 111.87 against the Euro, its lowest level since last November.

However up stepped Ian McCafferty. Mr McCafferty, one of three rate-setters who voted for an increase last month, spoke to the Times newspaper and stated he was looking to vote for a quarter-point rate rise again in August. He cited strong jobs data and 42-year-low unemployment as factors supporting a rate increase. This comment sent the pound straight back to where it came from. Chart lower down.

He also added that the Bank of England should consider unwinding its £435 billion quantitative easing programme earlier than planned (current policy; leave QE unchanged until interest rates are close to 2%).

 

Broadbent Speaks

boe

McCafferty speaks

 

I have used the above illustration to highlight the effects these comments have on the markets.

 

Oil

Crude oil inventories fell by 7.6 million barrels in the last week, compared with analysts’ expectations for a decrease of 2.9 million barrels; this has led to another move north in prices which is welcomed by oil companies and investors alike.

I’m still bullish on BP in this sector however I must mention after a little research this week I have taken a shine to Tullow Oil, they are a geared approach to the underlying commodity so if you share the view that oil will likely improve over the coming year then Tullow is a company that will benefit greatly from that. Tullow has now taken its place as my growth choice in this sector. BP is my choice for a more defensive portfolio as it can soften any adverse moves and will compensate with a healthy dividend.

 

Company Specific news

Shares in infrastructure and construction firm Carillion capitulated during this week’s trading following a profit warning.

In December, Carillion, which maintains railways, roads and military bases, said the pace of work had slowed in the second half of 2016 partly because of a pause in work from the Government following the Brexit vote.

This week the FTSE 250 company warned its annual results would be “below management’s previous expectations” (to clarify were talking £4.8bn to £5bn – lower than expected). The company said it would undertake a “comprehensive review” of the business. It also announced its chief executive, Richard Howson, would step down and be replaced by Keith Cochrane while the company looked for a permanent boss.

Hedge funds pocketed huge windfalls after more than 70% was wiped from their market capitalisation.

Carillion is the most shorted stock in the FTSE 250, with more than 25pc of its shares on loan to short-sellers. The reason the hedge funds went short (the opposite of buying shares, whereby institutions profit from a fall in price) was due to finds by forensic accountants. The likes of you or I do not have the means to send a firm such as KPMG in to tear a company’s balance sheet apart however this is what the players from around Berkeley Square did. What they found were signs of strain. The long-term nature of many Carillion contracts means revenues and costs are often recorded based on management estimates of when they fall due, something highlighted by auditors, this is an industry-wide risk. Trade receivables, a total for revenues recognised but where payment is yet to arrive, were rising even as sales declined. Like its peers, Carillion treated some estimated costs associated with bidding for work as assets that can be recovered, assuming probable success.

The chart below shows the extent of the drop, with the shares closing Friday at 195 and finishing Tuesdays session at a lowly 77.9p. Currently trading at 60p 08.45 14/07/17.

 

clln

 

It was actually a sad thing to watch as the company crumbled on my trading screen. One quote from the extensive media coverage that did raise a wry smile was from analyst Nicholas Hyett who likened the actions taken to rectify the situation as somewhat akin to “trying to bail out a super tanker with a soup spoon”.

Here is a list of the most shorted companies in on the market;

 

short

 

We all have access to the short-tracker. http://shorttracker.co.uk/company?sort=1&d=desc

It can make quite interesting reading when making decisions on potential investments. Everyone has differing views when it comes to investing however if all the smart money is betting against something you think will do well then it’s probably worth investigating their point of view and refraining from your own biases (I will cover some behavioural biases in the analysis section).

Just because a company is being shorted it doesn’t necessarily mean it’s going to do badly, shorts can be taken out for reasons such as hedging, whether that be against a specific long position or a hedge against a sector as a whole. If a company continues to perform well whilst under short pressure it can result in what’s known as a short squeeze, this is a situation whereby the shorters scramble to buy back the shares they sold as quickly as possible. This leads to a sudden sharp rise in the share price.

 

Share analysis

 

Last week I wrote about technical analysis and took a closer look at chart patterns. This week I am going to take a look at investor phycology. Something I find very interesting as it can really help you become a better investor if you’re aware of what your brain is telling you.

 

There are two types of biases, cognitive and emotional.

 

Cognitive Bias

Think of a cognitive bias as a rule of thumb that may or may not be factual.

Confirmation Bias: Have you noticed that you put more weight into the opinions of those who agree with you? Investors do this too. How often have you analysed a stock and later researched reports that supported your thesis instead of seeking out information that may poke holes in your opinion?

Gamblers’ Fallacy: Let’s say for instance that the FTSE 100 finished down 5 days in a row, you put all your money into the market as you believe there is a good chance it will rise on the sixth day. There may be other reasons why the sixth day will produce a blue day; but by itself, the fact that the market is down five consecutive days is irrelevant.

Status-Quo Bias: Humans are creatures of habit. Resistance to change spills over to investment portfolios through the act of repeatedly re-visiting the same stocks as appose to researching new ideas. Although investing in companies you understand is a sound investment strategy, having a short list of go-to products might limit your potential.

Negativity Bias: Negativity bias causes investors to put more emphasis on bad news than good. Some might call this risk management, but this bias can cause the effects of risk to hold more weight than the possibility of reward.

Bandwagon Effect: Warren Buffett became one of the most successful investors in the world by resisting the bandwagon effect. His famous advice to be greedy when others are fearful and fearful when others are greedy is a denouncement of this bias. Going back to confirmation bias, investors feel better when they are investing along with the crowd. But as Buffett has proven, an opposite mentality, after exhaustive research, may prove more profitable.
Emotional Bias

You may notice some overlap between cognitive and emotional bias. An example of emotional bias would be something like “I bought XYG plc in 2007 and lost a lot of money. Why would now be any different?” Simply put, it is taking action based on your feelings rather than the hard facts. Here are a few examples:

Loss-Aversion Bias: Do you have a stock in your portfolio that is down so much that you can’t stomach the thought of selling? In reality, if you sold the stock, the money that is left could be reinvested into a higher quality company. But because you don’t want to admit that the loss has gone from a piece of paper to real money, you hold on in hope that one day it will break even for you.

Overconfidence Bias: “I have an edge that others do not.” A person with overconfidence bias believes that his/her skill as an investor is better than others’ skills. Take for example someone who works in a specific industry, they may feel their knowledge gives them exceptional skill when it comes to investing in this area. The market has made fools out of the most respected traders. It can do the same to anyone.

Endowment Bias: Similar to loss aversion bias, this is the idea that what we do own is more valuable than what we do not. Remember that losing share? Others in its sector may show more signs of health, but the investor won’t sell because he/she still believes, as before, it’s the best in its sector.

 

Ways to minimise the effect of biases

The only way to minimise bias is to set objective trading rules and never deviate. Overriding your emotions is a difficult task and takes time to develop.

There is no way to totally eliminate bias. It’s who we are, and those biases aren’t always liabilities. Take steps to minimise those biases by setting target prices and stop loss limits, then sticking to them.

 

Recommendation

ITV 

ITV has been trending lower since its special ex dividend of 9.8p per share in April; this has been due to several factors, namely CEO Adam Crozier’s departure and a slowdown in advertising revenue (which is industry wide). Now appears the right moment to buy TV stocks as advertising revenue starts to improve and June should mark the low point as year-on-year comparisons get easier. I also expect some positive news flow in the next few weeks regarding a new CEO. Morgan Stanley announced two weeks ago it was upgrading ITV, giving them a Buy rating and 230p target. Today Goldman Sachs reiterated its ‘buy’ rating was maintained on ITV’s shares — which are also liked for their M&A potential — target price set at 228p. ITV have a dividend yield of 3.6% and a consistent history or paying special dividends ranging between 5 & 10 pence per share (altogether a yield of around 6.5%).

 

Enjoy your weekend, thanks for taking the time to read my newsletter!

 

Karl Townsend ACSI

Stockbroker

For and on behalf of

Arnold Stansby & Co. Limited

Telephone: 0161 832 8554   Fax: 0161 834 7710

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A word about some risks: Investing in the bond market is subject to certain risks that fixed income securities will decline in value because of changes in interest rates, and the risk that the manager’s investment decisions might not produce the desired results. Bonds with longer durations tend to be more sensitive and more volatile than securities with shorter durations; bond prices generally fall as interest rates rise. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Derivatives may involve certain costs and risks such as liquidity, interest rates, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Diversification does not ensure against loss.

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors, and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.

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