Discretionary Investment Management | Ben Byrom
21 Jan 19

Ravenscroft weekly update - Where next?

This week’s update comes from Ravenscroft’s investment management team.

Trying to decipher what will happen in the coming days regrading Brexit, the US Government shutdown or even the ongoing Chinese/US trade negotiations is probably best left to the prophets and soothsayers of the blogosphere and national press - people who make it their business to be the first to tell you exactly how the future will pan out. Whilst we claim not to possess such ‘talent’, we can offer our readers a bit of insight into how the markets are grappling with these issues and what opportunities may lurk in amongst the chaos.

In the UK, it was an unprecedented week in British politics which saw Parliament crush Theresa May’s Brexit plan by an historic margin, yet a day later she was able to rally the troops and her government survived a vote of no confidence. Post her Brexit defeat, Mrs May was left just three days to come back to Parliament with her plan B. The likelihood that this plan will be sufficient to satisfy all parties is minimal and, subsequently, the odds of extending Article 50 or indeed having another referendum have risen. This, as far as the market is concerned, is ‘good news’. The continuation of existing business outlooks and economic activity offers visibility that can be priced in. The uncertainty surrounding a disorderly Brexit under a No Deal outcome cannot.

The FTSE 250 - a benchmark laden with mid and small size companies whose operational activity is very UK centric - has spent much of this month recovering from its December 2018 lows. Even during these lows, the index traded above its May 2016 pre-referendum high, yet on a PE basis, it is on just 13x one year forward earnings. Compare that to levels in 2016 of some 16x and an average over the intervening years of 15x, it’s not hard to see some meaningful upside should there be an orderly or no Brexit (just to get back to ‘fair value’ would require a 15% rise and a push to new highs!). Arguably there is even greater opportunity in amongst the weeds of this cohort of companies, especially within those whose operations are UK biased. With no benefit to international earnings derived from the slide in sterling following the referendum result, there won’t be that headwind either should a no Brexit outcome look more likely. Couple this with improving business sentiment and a return to undervalued businesses by the investment community, there is the possibility of some handsome returns on offer.

To blame the turmoil experienced by UK investors on Brexit alone would be unfair. In our global, interconnected world there is a great deal of correlation between financial markets. As we zoom out of Britain's microcosm and look further afield, the destruction to company values has been widespread with much of it coming in December, although volatility meaningfully picked up in the latter weeks of September onwards. Concerns over the health of China’s economy, and more poignantly its people’s appetite to continue consuming goods from around the world, have been at the forefront of most market commentators' and participants' thoughts.

So just how important is the world’s second largest economy? Well, according to Apple’s pre-earnings bombshell - very! The FT, in an article titled ‘Clouds loom over global business as Chinese economy falters’, reinforces this fact as it suggests flagging sales of multinational’s goods from phones to handbags and cars, even the downturn in its own domestic property market, point to a tapped out consumer hunkering down.

So, what will keep pushing markets higher? In the US, fair value is just around the corner thanks to a surge in short covering - a partial shutdown of the US Government doesn’t seem to have the same clout as a disorderly exit from the European Union when it comes to discounting asset prices. Nonetheless, the shutdown is hurting people and it's spreading to the broader economy with some predicting a 1% impact to growth. A speedy conclusion here would help. A positive conclusion on trade negotiations between the US and China would also buoy sentiment. However, it will be the health of company earnings that will ultimately determine asset prices and as earnings season accelerates this week, we will get a better picture on the quality of these earnings and the direction of travel. Time will tell how much of the December sell-off, and subsequent bounce back, has factored in what’s coming up!

Have a good week.


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