Tony Tassell: Pleasant surprises
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The first half of the year hardly proved a vintage period of large stock market shocks and shifts. But the market seldom runs true to the scripts of the strategists.
There were still enough surprises in the first half to defy consensus expectations. At the macro level, these included the unexpected strength of the dollar and the persistence of low bond yields. Here are a few others:
● The outperformance of electricity sector. The impressive first-half performance of this sedate and somewhat arcane sector has been largely overlooked. The sector was the best-performing in FTSE this year, rising a racy 22.63 per cent.
The rally has been driven by an unusual confluence of positives. Apart from a general investor appetite for yield, there has been a series of stock-specific factors, such the restructuring of British Energy, Scottish Power’s sale of PacifiCorp and International Power’s acquisition, late last year, of 13 power projects from Edison Mission Energy. Some companies also have seen margins boosted by high electricity prices, and distributors benefited from a favourable regulatory review last year.
The other big sector surprise was the rally in pharmaceuticals, which defied concerns over the paucity of drug pipelines, generic competition and regulatory burdens. The sector was the fifth best performing sector so far, with a 13.5 per cent gain.
● Disappointing mergers and acquisition activity. At the beginning of the year, the hype and rumours surrounding potential takeover activity reached fever pitch. An influx of private equity money had been expected to fund the takeover of a whole swathe of listed companies. It didn’t happen to quite the degree expected.
Thomson Financial figures show that the value of deals with any UK involvement in the first half of the year rose to $172.6bn from $105.5bn in the same period last year. However, the latest level was down from $272.5bn in the second half of last year. However, the performance of M&A targets also did not match the hype. Morgan Stanley tracks a basket of 50 potential targets for private equity players – companies with high cash flows, low price-to-book values and high interest cover and dividend yields.
This basket outperformed the market by 3.7 per cent between January 1 and Valentine’s Day. But there has been a correction since, particularly since mid-April. From then, the basket has underperformed by about 4 per cent, and, for the first half overall, it has moved basically in line with the market.
● The resilience of the mid-caps. At the start of the year, a consensus call was that, with economic conditions slowing, defensive and stable big companies would outperform the more cyclical, mid-sized capitalisation stocks. At the same time, the mid-caps were trading at the start of the year at a 20 per cent valuation premium to the big caps instead of their traditional discount. But the mid-caps have held on. The FTSE 250 index has risen 7.34 per cent so far this year, compared with a 7.2 per cent gain for the FTSE 100. The impact of weaker economic conditions has been offset by bid speculation and investors pricing into valuations the prospects of interest rate cuts.
● The strength of oil and gas. The FTSE Oil & Gas sector was the second-best performing market segment over the half-year as analysts played catch-up, raising earnings forecasts to match oil prices. Those investors that took profits too early, in the belief that the oil price “bubble” would soon burst, have suffered. Shell is a case in point, where UK fund managers appeared to have actually decreased their exposure recently. Merrill Lynch said this week that the top UK fund managers increased their holdings in Shell from around 104 per cent of its weighting in the FTSE All-Share at the start of the year to around 113 per cent. However, this exposure is less than a peak of 120 per cent during the first half.
● Stockmarket valuations remain compressed. The recent compression of the range of valuations for stocks has been slower to unwind than many thought. Growth stocks, identified by high earnings growth, have slowly started to outperform value shares, which have higher dividends. But it has been slower than some analysts had expected. The FTSE Growth Index has gained 7.02 per cent this compared with a rise of 5.58 per cent for the FTSE Value Index.