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All posts for the month June, 2016

We highlighted in our blog on Tuesday about the high number of directors within FTSE 350 companies who were actively buying their own shares in the wake of the market sell off post Brexit vote, a trend which has continued in subsequent days.

Perhaps it is not enough just to commentate on insider transactions without looking a bit further into the detail and offering some context.

Lets consider the total monetary value of ‘post vote’ trades versus historical norms.
When looking at the FTSE 350 specifically, comparing the last week of purchases(net discretionary transaction value of $17m) to the net over last two years you can see that they seem relatively small in comparison. However, this may not offer a true reflection of the actual overall sentiment in the market.
insid1

Our analysis shows the histogram is skewed by a number of large asset purchases/sales in just a few individual names historically. A good recent analogy for this would be how a small number of large cash bets were made at the bookies for ‘Remain’ in the EU Referendum which swayed the market(incorrectly). There may well have been the equivalent cash laid out in £1 bets by ‘Leave’ individuals but was lower in impact due to the breadth of speculator.

We need to look at the distribution of purchases and it is here that we pick up something quite interesting. There have been 86 individual purchases and zero sales by UK company directors since the vote. The last time we saw purchases anywhere near this magnitude(62 buys vs zero sales) was in August 2011.

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The performance chart of the FTSE 350 from that August makes interesting viewing. Similar peaks in insider purchases are also identified at the end of 2008, close to the market bottom during the height of the credit crisis.

Purely Coincidence Or Business Confidence ?

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Here is a breakdown by sector of total dollar value invested since Brexit. chart

The seniority of individual and size of trade does not always guarantee success. Within each sector there can be company directors who produce consistently reliable results when looking at timing and performance of past transactions. OTAS provides a unique ranking system based on historically placed trades by insiders. Here are the top ten companies who have had director(s) purchase stock since Brexit and are most highly ranked based on previous performance. We can determine these aren’t just speculators….ins4

With the recent global market selloff, the probability of a US rate hike has reduced substantially and therefore the investors are seeking safe haven and chasing for yields during the selloff episode. The REIT names in Hong Kong such as LINK REIT has just made record high in its share price today. Similarly, most of the names on the list of REITs in Hong Kong (https://www.hkex.com.hk/eng/prod/secprod/reit/reitlist.htm) are also flagging positive indications on OTAS.

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Link Real Estate Investment Trust (823 HK)

This high yield defensive stock has just made record high in its share price with decent trading volume after recent earnings and dividend. In fact, an MACD (-) contra BUY signal was fired on OTAS just a few days ago, accurately indicated to us of the positive return in the following days.

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Link REIT on record high today

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Fortune Real Estate Investment (Hong Kong) Trust (778 HK)

Other than the outstanding performer above, Fortune is another REIT stock that we can keep an eye on. Market is expecting its Q1 2016 Earnings Release coming up soon on July 25th 2016. EPS momentum of the name is also among the top 10% of all the positive performers in the industry group, with 12 months forward EPS momentum up by 1.5% and 0.7% over both one and three months respectively.

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Moreover, an OTAS Fast Stochastic (-) contra BUY signal was just fired upon yesterday’s close with a fairly high win rate of 72%, indicating a positive return of 2.8% in the coming days.

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In the wake of the UK vote to ‘Brexit,’ the domestic UK stock market has encountered a torrid few days to say the least. However, if ever you wanted a gauge on just what the leaders and company directors of the UK’s largest 350 companies think of the recent sell off, you only have to look at the OTAS alerts feed this morning.

Below is a screenshot showing a raft of company insider transactions yesterday. It is worth noting there were only stock buyers and dispersion was across a whole range of sectors. Moreover, our analysis shows that historically these aren’t all just speculative buyers, these guys actually possess a high degree of timing and market nous !

Interestingly, the largest single transaction was in one of the most beaten up sectors, house builders. Residential led property developer Berkeley Group saw its Executive Chairman Anthony Pidgley purchase of just under£1m worth of stock, his first purchase for exactly 8 years ! Take a look at his previous transactions, he called the bottom nicely before….

insider

What this does suggest is that company directors consider the market is overstating the impact of Brexit on big business in the UK and are prepared to back the long-term resilience of their own firms. Proof indeed that they believe they can thrive even outside of the European market……

Today under the Hong Kong Main Cap names, we see that four out of the nine largest decreases in % of free float shares on loan have their next dividend dates either on today or coming up within a week. This shows that the market has some short covering, or recall of highly shorted large cap stocks before their upcoming dividend date.

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Now let’s take a closer look into some of these names:

China Construction Bank (939HK)

The ex-dividend name today has its implied volatility gone up by 8.83% while its price was soared by 14.4% in just a month. The stock has been doing very well recently and general consensus is still a BUY, with positive EPS momentum over the next three months. Perhaps a stock to hold in a shorter term?

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Industrial and Commercial Bank of China ‘H’ (1398 HK)

CCB (Price change +14.04%, EPS change -0.44%)

ICBC (Price change +10.85%, EPS change +0.64%)

Even though the recent price change of CCB has been weaker than its peers, its 12 months forward EPS momentum has been pulling strong. Perhaps a pair trade of long ICBC and short CCB would be applicable to some.

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Link Real Estate Investment Trust (823 HK)

Not only that the EPS momentum is strong, Link REIT is also trading at 16 months high. Cash dividend is out, we may also expect to see some pull back on the stocks coming soon.

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With little over a day to go before the UK referendum, we present a last look at the state of play across equity markets using the multi-asset analysis within OTAS.

The pattern for the valuation of the STOXX 600 is established. At above 16.5x 12 months forward earnings the market is stretched beyond its normal range and has reverted in fairly short order. Much below 15x and the index attracts buyers, especially around 14x.

STOXX Jun 2016

This narrow range of values has persisted for many months and means that the Brexit vote in the UK is having little impact on investors’ views on the prospects for European equities. Rather investors should focus on 12 month EPS Momentum and the stocks being upgraded. A two-step filter within OTAS reveals nine shares in the STOXX 600 where upgrades were at least 5% in the last month and 10% in the past three months. Eight of these nine companies have EPS Momentum in the top decile across their respective sectors. Contact us for details.

STOXX CDS Jun 2016

The average cost of credit for European companies has been rising since March of last year, most likely to be when economic growth momentum was at its best. This is in spite of the ECB announcing and now launching purchases of corporate debt. Unless the cost of credit falls there is unlikely to be any change in productive investment across the continent’s listed sector, although recycling new debt into buybacks is one probable consequence of ECB action.

STOXX IV Jun 2016

Risk, as measured by three month implied volatility in the shares of Europe’s largest companies, has been rising gradually since September 2014. Even if we allow that the most recent spike to over 30 was Brexit related, the peak was no higher than the August 2015 move that took far longer to dissipate, and was well below the February 2016 period. At this time investors were focused on the risks of a global slowdown, so for all the publicity surrounding the potential damage Brexit could do to growth across Europe, equity option investors are dismissive of the risks.

The prevailing trends in European equities are a declining valuation, punctuated by central bank induced temporary recovery, mirrored by rising risk recorded in both credit default swap and equity option markets. This speaks to a gathering economic slowdown as a far more important trend than anything Brexit could cook up for European shares.

This is of course what the calm voices have been saying throughout the fractious UK debate, but calm voices don’t sell in the media and hence are easily drowned out by the ranting and raving of those using economic and market predictions for other ends.

‘I think you know,’ said Miss Marple. ‘You are a very well educated woman. Nemesis is long delayed sometimes, but it comes in the end.” ― Agatha Christie, Nemesis

I am indebted to the work of Jared Dillian who, as well as being a highly entertaining writer, shares a similar world view about how investing works to that deployed at OTAS. Jared likes to focus on anti-consensus ideas, picking on trends that appear to have run out of road, in a similar fashion to OTAS flagging extreme moves from the norm across the multiple factors that influence equity prices.

A typical Dillian argument will throw out an investment thesis, while recognising that the timing may not yet be perfect for the trade. These ideas can be of use to active managers who require a portfolio of ideas at different stages of the investment cycle, so that as one great investment comes to an end, there are already several others lined up to take its place. Jared’s latest bête noir is the low volatility trade, which has seen big, safe, high yielding stocks outperform, and the evidence from OTAS entirely supports his claims.

DVY June 2016

The chart shows the performance of the iShares Select Dividend (DVY) ETF against our index of the top 500 shares in the US. As the shares in this fund deliver a higher percentage of total return in the form of dividends, the returns are more stable and predictable than for other stocks, and hence the shares exhibit low relative volatility. Lower risk should equate to lower return, but as the chart shows this is patently not the case this year.

Similar outperformance can be seen in the Consumer Staples Select Sector SPDR Fund (XLP). As with DVY, the break above the normal trading range came around the turn of the year and the subsequent outperformance has lifted the fund to an extreme level.

XLP June 2016

We have written before about the desire of the world’s central banks to suppress volatility and the success with which this has been achieved. Interest rates are the return received for uncertainty about the future and by pushing multiple rates negative, central banks have created situations where the future appears more certain than the present. This is the logic-defying macro environment that our guardians have created for us and Jared, for one, is calling them out.

There are reasons to conclude that it is central bank action, rather than real macro trends, which is creating today’s investment extremes. Much has been made about German ten-year rates going negative this week, but inflation-adjusted bonds in Germany have not followed suit. This clearly suggests that it is the actions of the ECB and not imminent deflation that is determining bond prices.

OTAS shows that the cost of credit for the average German company has risen this month and is safely ensconced in the normal range over the past four years. A situation where the debt costs for companies stays stable, while risk-free rates fall, drives up the relative cost of investment for the private sector and creates a slow growth economy with falling productivity.

German CDS June 2016

The outperformance of low volatility ETFs illustrates that the equity markets are now captured by the cult of the central banker in the way that other asset classes have been for some while. The question is for how long this can continue, or how much more money can back these trend following strategies. Political events may shake the faith in the establishment and there are a number of upcoming events that may do just that between now and the year end. Or, like many other bubble trades, there may simply come a day when fewer new buyers show up in the morning and commentators are left scrabbling for ex post reasons to explain a major price reversal.

As Jared Dillian says, “Up on an escalator, down on an elevator.”

Every day OTAS flags extreme positioning in stocks across markets, in a neutral, unbiased fashion that brings your attention to trends and possible turning points and assists in your decision making process. The analysis may be tailored to your personal portfolio and thereby reduce the risk that your next crowded trade is to the downside.

One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute – William Feather

The media is alive with lurid stories of volatility back at seven year highs. This refers to foreign exchange volatility and it is hardly surprising, as central banks have done their level best to dampen volatility for seven years, but everyone knew that this would last only as long as market participants chose to believe. If Brexit is indeed the reason why currency markets are aquiver, then this should be no surprise as the campaign for the UK to leave the EU has risen in defiance of central bank warnings, along with those of the rest of the establishment.

Back in April we published a post arguing that there was no evidence of Brexit related volatility in equity markets. OTAS implied volatility (risk) analysis centres on three-month single stock options and so April was already discounting expectations for the post referendum period. The prevailing consensus, however, may well have been that there was no way that the UK would vote to leave, and it is this consensus that is being shaken with reports of nine out of ten recent bets placed with bookmakers anticipating Brexit.

UK Shares Average Implied Volatility - Short Term

UK volatility, whereby options investors expect a +/- 16% move in share prices in three months, is at the top end of its two year range. This is +/- 1.5% more uncertainty than in April. Today’s level, however, remains below the peak in February, when it is worth remembering that the prevailing panic was about global growth, not politics. Last night US bond spreads were at nine year lows, which is a recession warning, and it would be a stretch to blame Brexit for concerns over domestic US economic growth.

UK Shares Average Implied Volaility - Long Term

It is also worth viewing UK equity volatility in a longer historical context. Compared with previous peaks in 2011 and 2008, the recent increase in uncertainty barely registers and remains well within normal bounds. Even during February’s market fall, when the prevailing wisdom was that there would be a recession this year and not one triggered by UK voters, uncertainty did not rise beyond the normal range. Investors should keep an eye on this measure over the next eight days to judge how far the Brexit hysteria spreads.

UK Company Aveage P/E - Short Term

UK average P/E valuation has fallen back into the normal two-year range, having reached a peak in mid-April. The valuation has moved, swung would be too aggressive a description, between 14x and 17x over the last two years and could fall another 8% before reaching that lower valuation. The drop since mid-April has been 10%.

A look at earnings also suggests that there is little to be overly concerned about in the world of equities. Analysts have been downgrading UK shares more often than upgrading for the last six months, but the ratio of downgrades to upgrades has fallen recently.

 Average UK Share

Upgrades over 1%

Downgrades more than 1%

Last 6 months

33%

59%

Last 3 months

30%

39%

Last 1 month

13%

18%

Source: OTAS

While it would be convenient to blame economic uncertainty caused by potential Brexit for the downgrades to earnings expectations, if this were the main reason for changes, then the downgrades would surely intensify as a leave vote became more probable. The opposite is true. We do well to remember that analysts almost always start a year more positively than they finish it, as reality bites into bonus-period optimism. Analysts are also notorious for not changing their estimates until guided to do so, thus there is a reasonable chance that company executives would use the cover of a leave vote to downgrade their outlook, whatever the underlying reason for caution.

With even Mark Carney admitting that the Chinese debt mountain is a greater concern than Brexit, there are plenty of excuses for corporate chieftains to cut themselves a little slack. Keep an eye on the OTAS measure of implied volatility for an early steer as to when this becomes a cliff edge issue, rather than the gentle undulation that it is at present.

This week started on a distressful note. The Hang Seng Index plunged 500 points this morning tracking overnight weakness from US and Europe, latest BREXIT poll result and domestic terrorism tragedy in Orlando. This morning the GBP weakened further and JPY strengthened 70bps which dampened investors’ confidence. OTAS has been flagging names that are under pressure with risks of further downside.

Hong Kong Main

List of stocks flagging negative warnings.

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Bank of East Asia (23 HK)

Insiders have sold total of $7.4mm in the past month. Valuation remains high and dividend trend is expected to decline as well. Its Price/Book valuation of 0.9x is very high relative to the valuations, whereas the 12 months forward yield of 2.9% is very low relative to its banking sector. According to TIM Indicator, sentiment on this stock is generally negative.

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Hong Kong Exchanges and Clearing (388 HK)

Implied volatility dropped significantly compare with ASX. Generally speaking, implied volatility decreases when investors believe that the stock price will rise over time. Perhaps an indication from the market on hope of Hong Kong and Shen Zhen connect to happen soon?

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Nevertheless, the stock remains to be very expensive – the 12 months forward P/E valuation of 33x is high relative to the past two years.

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China Mobile (941 HK)

Price to book is  shown to be the highest among the three giant telecom names in China.

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Within its telecom sector, China Mobile’s 12 months forward EV/EBITA valuation of 4.9x is on a very high level relative to the past two years.

 

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Debt markets have responded enthusiastically to the recovery in commodity markets, which began with the ECB’s last major monetary intervention. The average cost of credit for European materials companies has fallen from 160 to 115 bps in the four months since the mid February peak. This brings the cost to the lower reaches of the average range over the past four years, as shown in the chart below.

Eur Mat CDS Jun 2016

The fall in the relative cost of credit for material companies compared with the wider market has been just as marked. The next chart shows that while the sector is consistently more risky in credit terms than the broader market; it is a heavily leveraged industry after all; the relative cost is at the benign end of the spectrum measured over the past four years.

Mat vs Mkt CDS Jun 2016

The improved outlook for the sector on the back of higher commodity prices is hardly a surprise and thus a reduction in implied volatility (risk) since mid-February is to be expected. Equity investors, however, remain distrustful of the sector and the risk remains at the upper end of the normal range over the past four years.

Eur Mat IV Jun 2016

This means that on a relative basis, there has been hardly any improvement in the risk profile of the materials sector compared to the rest of the equity market. The relative risk is 20% greater than it was at the low point in early September 2015 and 15% higher than the interim low in mid-January this year.

Mat vs Mkt IV Jun 2016

The reduction in relative risk in the materials sector that credit investors have clearly identified, might be expected to spill over into reduced risk for the equity, which would typically mean higher share prices.