28 February 2018


by Peter Little

Global markets were jolted out of their complacency in February. The S&P 500 Index experienced its worst day since the haggling over their debt ceiling in 2011 cost the US a ratings downgrade. Though markets recovered some of the early losses into month-end, they still had their worst month in over two years. The catalyst for the February sell-off was January payroll data, which showed a continued march higher in the number of US employees, but this time finally accompanied by surprisingly strong growth in wages which had the market in panic about the prospects of rising inflationary pressure. Expectations for US rate hikes in 2018 continued to rise, with markets pricings in a 40% probability of at least four rate hikes in 2018 (up from a 12% probability at the beginning of the year).

The US dollar, which has been under pressure since early 2017, finally found some support in February thanks to its haven status and increasingly attractive yields. The spectre of upcoming Italian elections and Brexit negotiations (which remain fraught with complexity) put the euro and the British pound under pressure, but the Japanese yen was stronger – also a beneficiary of its haven status.

The VIX Index, a measure of implied volatility of the S&P 500 Index, loosely interpreted as the level of market uncertainty was perhaps the clearest indication of the violence of the market reaction in February. The VIX Index reached levels in February seen less than a handful of times in the last decade.

Data released in early February showed that the US is now producing more than 10mn barrels of oil per day, a similar output to the Saudi’s and not far behind the world’s biggest producer, Russia. The increasing US supply, along with some US dollar strength, was enough to derail the rally in crude oil prices, which ended the month almost 5% down.

S&P 500 companies wrapped up their 4Q17 earnings releases in February, with the remaining 40% of companies that reported during the month largely continuing the trend of the strong results released in January – leaving earnings up 15%, in aggregate, for the quarter. Some of the major US tech companies, including Amazon, Apple and Mastercard, were among the companies reporting surprisingly strong earnings. They helped the S&P 500 tech sector become the only sector with a positive return in February. The collapse in oil prices left the energy sector down over 10% for the month, while the rate-sensitive consumer staples and real estate sectors were also laggards. Real estate companies have had a dismal year, caught between rising interest costs and slowing growth as they approach peak occupancy levels. Emerging markets were also weak in February, with China and India worst affected, while commodity exporters, Brazil and Russia, fared much better, held up by their commodity companies which are starting to show decent earnings at current commodity price levels.


Over the month of February, bond proxy stocks sold off fairly dramatically in sympathy with US Treasuries as the market began to price in the increased likelihood of accelerated Federal Funds rate hikes by the US Federal Reserve (Fed). British American Tobacco (BTI) was no exception, with the stock sliding over 13% for the month. Notwithstanding the risk of further rate hike concerns, we believe BTI now offers compelling value – both relative to its peers and on an absolute basis. BTI currently trades on a 12M forward earnings multiple of just 13.4x and a 12M forward dividend yield of 4.9% – which we find attractive. Furthermore, the P/E relative between BTI and Philip Morris sits over 2 standard deviations below the 5-year mean – a valuation differential which we don’t believe is justified. In our view, BTI’s relatively diverse portfolio of nextgeneration products (NGPs), i.e. e-cigarettes and heat-notburn cigarette alternatives, could start to arrest the cigarette volume declines that investors have become accustomed to – and this should have a materially positive impact on the company’s valuation.



Oct '18
Strat Doc 4Q18 – Southwest Airlines


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Southwest Airlines – A leading low-cost carrier


Oct '18
Investment Thesis – JP Morgan



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