Report on Q3 2014

Report on Q3 2014

4 Oct 2014

The stock market remained nervous, reportedly seeing below-average turnover in Q3. The trend that began in Q2, of the shares of smaller companies performing worse, continued. The FTSE 100 fell by 1.7% and the FTSE 250 by 2.9%.

For the third quarter in a row, yields on European government bonds fell to previously unimaginable lows. German 10 year Bund yields have fallen below 1% (now 0.93%). To put this in some context, 10 year Japanese bond yields were around 1.9% before the financial crisis bit in 2008. Japan is considered to be the reference case of a country suffering from long-term deflation. Its 10 year yield is now 0.53%. Since June 2008, Japanese yields have declined by 72% and German by 80%. As I have noted before, the bond markets are shrieking the news that global growth has made a long-term shift to lower levels.

Many will argue that this is bound eventually to be reflected in lower corporate profits. It is hard to argue with that but wrong to assume that share prices are consequently too high. When yields on all financial assets are falling, investors are paying higher prices for them. A dollar of corporate profit literally becomes more valuable than it used to be. Many stock market commentators, seemingly obsessed with short-term news and the aphrodisiac of growth, appear to be incapable of understanding this. Given that the cloud of deflation continues to hang over the world (see above), the traditionally nervous month of October will probably produce plenty of gloomy headlines.

In my post about the supermarkets, I pointed out that, when operating leases are included as liabilities, Morrison was much cheaper that Tesco and Sainsbury. Well, the gap has reduced but not necessarily as anticipated. Morrison’s price has fallen but the others have fallen further. Tesco’s accounting practices have caught up with it and I must say that, as yet, there is no price at which I would buy it. At last I have noticed the beginning of a backlash in the press against Lidl and Aldi – our nostalgia for the 1970s must surely be limited.

Sainsbury has promised a strategic review, a development that appears to have been taken completely negatively by analysts who nonetheless agree that a strategic review is needed. I find it amazing that the value of a company’s equity can be halved by a marginal loss of market share but the financial stability of Sainsbury will continue to be overshadowed by its own operating lease liabilities. The value currently offered by the shares is not clear enough to compensate for the risk of a messy restructuring.

Lightening the gloom for a moment, the performance of Go-Ahead shares has continued to surprise. They rose by 7.5% in Q3. They are up by 86% since I first recommended them in February 2013. FirstGroup shares have travelled absolutely nowhere.  

UBM continues to throw up surprises. Having delivered a new CEO it is now promising an acquisition and a rights issue. I have no problem with any of these and am still happy with what I understand to be the strategic direction of the company. I just hope that I have understood and that UBM executes its plans competently.

Talking of subjects that I don’t understand, the more that I hear about biomass the more confused I am. I am beginning to think that every strong opinion expressed in the energy debate is covertly backed by money and I don’t know whom to trust. My investment in Drax lies dormant in a fog of uncertainty.   

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