Reports » UK

UK stock market weekly fundamental and technical outlook (January 15, 2010)

By Mark Allen (Simple Investments)

… The retailers have taken centre stage this week after a string of upbeat Christmas trading reports capture the headlines.

A glance at the above chart of the FTSE 100 highlights the optimistic start to 2010.

China continues to drive the rally, with impressive trade data assisting the blue chips to touch 5600, before retreating due to fears of earlier than expected central bank tightening. China’s imports hit a record high in December and exports also rose strongly.

This was reflected by the Vix volatility index, a closely watched gauge of risk aversion, dropped below 17 earlier in the week to its lowest level since May 2008. However, it jumped by 7% later in the week, as investors were concerned by the start of fourth quarter earnings season in the US.*

Alcoa, the aluminium company, unofficially kicked off earnings season this week, with a disappointing lower than expected profit figure. Chevron also added to the caution after announcing that it would miss forecasts due to weaker refining margins.

Over the coming weeks analysts are hopeful that fourth quarter earnings will show profits rising from gains in revenue and not just aggressive cost cutting. Due to the strong performance of equities recently, expectations have been lifted. Many companies are now forecast to nearly triple earnings on a year-on-year basis, which could increase the risk of disappointment.

Technical analysis shows the fresh peak traded this week and a break-out above previous resistance at 5400 and the important 61.8% Fibonacci retracement level of 5495 suggests that the trend remains higher. However, it is worth noting that the DOW or the S&P 500 in the US have reached their respective Fibonacci levels. The relative strength index (RSI), which is a momentum indicator, has failed to trade a fresh high and this divergence from the underlying index is a concern as any selling could trigger a rapid move lower.

In summary, the trend remains strong, but many analysts are becoming increasingly unconvinced on the justification for this move in economic terms. Markets tend to over-react and last years record bounce could be an over-reaction to the banking crisis. 2010 is likely to be challenging and all eyes should be on corporate earnings and economic data, with a view to taking profits rapidly on any short term selling below 5400.

The retailers have taken centre stage this week after a string of upbeat Christmas trading reports capture the headlines. The likes of Marks & Spencer, John Lewis, Next, Sainsbury, Tesco, etc have all reported a rise in like-for-like sales over the festive period.

Recent data confirms this, as this week’s report from the British Retail Consortium (BRC) suggests that retailers enjoyed their best December growth rate for eight years. Like-for-like sales rose 4.2% during the month after a late buying spree by shoppers.* Figures were also helped by comparison with the dreadful figures of December 2008.

Shops reported a strong final week’s trading, which continued into the post-Christmas sales as shoppers rushed to beat the New Year increase in value added tax (VAT). Research from Experian showed that footfall on the 27th December was up nearly 18% on 2008. *

However, the BRC has warned that retailers could face a tough 2010 as uncertainty about the economy continues. The sector was one of the top performers in 2009, rising around 60% versus the underlying FTSE 100 that has gained around 16% in the same period. *

The stock market is a forward looking barometer and many investors now fear that the good news may be priced in and that there are several headwinds to face in 2010. Official data later this month is expected to show that Britain emerged from six quarters of recession in the fourth quarter of 2009.

However, many analysts still fear a double dip recession this year. The central bank is nearing the end of its ?200 billion quantitative easing (QE) program and interest rates, which were kept at a record low of 0.5% for most of last year, are likely to start rising due to inflationary pressures.

Recent reports showed the UK is running one of the highest inflation rates in the developed world, in part thanks to widespread rises in energy and commodity prices. December’s consumer price index (CPI) came in above forecast at 1.9%, which was the highest in the G7 and a recipe for weaker consumer confidence.

Furthermore, the public sector is likely to come under pressure after the general elections in May/June as the government may seek to cut the stretched budget deficit, by raising indirect taxes and reducing government spending. The retail sector is facing a particularly tough time, as VAT has already reverted back to 17.5% on the 1st January and a second increase could damage the sector.

The excessive Christmas spending spree also has to be funded. Consumers now face considerable credit card bills and depleted bank funds in the early part of this year. The bitterly cold weather and snow disruptions in January are likely to cause a poor Q1, with little reason to spend until Easter.

Next (Epic: NXT) is currently my least preferred of the major retailers for 2010. The group released an impressive trading statement on the 5th January, reporting a 4.6% rise in total retail sales, excluding VAT, in the 22 weeks ending December 24th. It now expects full year pre-tax profit to be between ?490 million and ?500 million, which is well above consensus of ?475 million.*

However, the good news is now priced in and Next warned that the outlook for the year ahead is particularly hard to gauge at this point in the cycle. Despite consumers generally being more financially robust than last year, the company does not expect the year ahead to be as good as the previous six months. Partly because the fall in interest rates will annualise in the first quarter and the impact will be less significant.

Next is currently trading on a forward PE of 11.2x earnings, which is marginally cheaper than main rival Marks & Spencer that trades on a respective 12x earnings. Although, growth is only forecast to be around 2.5%, which is only a quarter of that at Marks & Spencer and puts Next on an unattractive PEG ratio of 4.16, compared to 1.55 at Marks.*

The group’s property director, Andrew Varley has also recently sold around ?180,000 worth of his shares, which represents 13% of his original holding.*

As can be seen from the above weekly chart of Next the shares have gained over 160% from their 2008 lows. They are now only 17% away from all time highs, compared to Marks & Spencer, which is still half of its previous highs.

The trend has been steadily higher since September 2008, with both moving averages pointing upwards. The shares are now approaching significant historic resistance at 2210p, which is likely to prove tough to break.

The weekly timescale is often preferred as it is easier to signify a change of trend. The moving average convergence divergence (MACD) histogram has stepped into negative territory and the moving averages have crossed over, which could indicate the end of the upward trend. Meanwhile, the RSI has remained relatively flat at this stage, so the momentum remains stable.

In light of the headwinds faced by the sector, the lacklustre outlook at Next and the close proximity of major resistance I am bearish on the stock and any further weakening in the technical indicators will reinforce my views.

At the time of writing the share price is 2040p and my short term opinion is negative. Near term targets are seen at 1935p, 1892p and 1754p, with a stop loss marginally above major resistance at 2230p.

*Source – Simple Investments Internal

This report was written by Mark Allen – Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Next, but client accounts may. The material in this report has come from Simply Charts and Next’s corporate website.