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Global Market and Share Commentary – Nov 2017

04 December 2017

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by Peter Little

Global stocks ended November higher, thanks in large part to US stock markets, as investors appear hopeful that lower US corporate tax rates in the foreseeable future will boost earnings for US companies.

The S&P 500 Index recorded its thirteenth consecutive positive month for the first time since its inception in 1927. It’s also only the fifth time ever that the S&P 500 Index has had 11 positive calendar months in the same calendar year. With a month to go the potential is there for this to be the first-ever calendar year with every month showing a positive return. Other global stock markets were generally weak, Europe had its weakest month of the year, but the soft dollar and the strong US stock market were enough to keep the MSCI World Index positive for the month – also its thirteenth monthly advance in a row. The MSCI World’s previous record sequence of positive monthly performances, since its inception in the 1970s, was 12 consecutive months ending in February 1986. The MSCI Emerging Market Index was dragged into marginally positive territory, thanks largely to a rampant month from Chinese IT companies. The rest of the BRICs countries equity markets’ all ended the month down. Japan was the only other major global stock market to experience a positive MoM performance in November, as Prime Minister Shinzō Abe’s structural reforms seem to be driving the economy and corporate earnings in the right direction.

The S&P 500 IT sector has been responsible for roughly half of the index returns year to date through the end of October, but barely contributed to November returns. Excluding materials companies (where weak industrial metal prices weighed on stock prices), the S&P 500 IT sector was the worst performer for November. The S&P 500 Index was largely driven by consumer stocks in November, as some retailers delivered strong doubledigit returns, off depressed valuations. Retailers including L Brands, Foot Locker, Macy’s and Michael Kors, who have mostly been on the wrong end of a switch to online shopping, showed initial signs that they’re having some success fighting back against structural shifts in the retail industry.

Global bond yields were largely unchanged for the month, but credit spreads had a volatile month. US junk bonds sold off as their credit spreads widened about 0.4% at the beginning of November before rallying to end the month largely unchanged. The credit sell-off was initially ignited by an offer from Broadcom to buy its semi-conductor rival Qualcomm – the combined entity would end up with a sizeable debt load. Oil also kept grinding higher – Brent Crude oil is up 40% since its June lows, when it ended a sequence of six consecutive monthly declines.

Blue Buffalo Pet Products(+6.1% MoM)

We took profits on Blue Buffalo Pet Products this past month following significant capital gains since we acquired the stock in April at c. $23/share. As a reminder, the investment thesis for this company hinged on the business gaining market share in a fast-growing category of the pet food industry in the US (“wholesome natural”), gross- and operating-margin leverage as a consequence of growing scale (we believe it can ultimately achieve a 30% operating margin) and sustained excellent returns on capital employed (>30% for the foreseeable future). The 3Q17 results suggest the company remains on track, with sales rising 18% YoY and adjusted net income +20% YoY. GP margins rose by 90bps, and operating profit climbed by 26% YoY on an adjusted basis, with a higher effective tax rate an offsetting factor to bottom-line profit growth. Our decision to exit the holding has been driven by a rapid rise in the share price to our fair value in a relatively short space of time. The stock currently trades at ~$30, equating to a 12-month forward 28x P/E multiple. We like the fundamental positioning of this company and will continue to follow it with interest.

Facebook (-1.6% MoM)

Facebook reported its 3Q17 results at the beginning of November, which exhibited continued strong momentum in user numbers and advertising revenue. Monthly active users (MAUs) continued to grow at an annualised rate of almost 14% from 2Q17, while average revenue per user (ARPU) grew by 26% YoY. It is clear from the commentary on the results call that management have been focussed on optimising advert mix on the platform such that higher revenue adverts take priority, rather than additional volumes driving this revenue growth. This is expected to continue. The bottom-line result itself was a significant beat vs consensus expectations, but what held back the stock from what would otherwise likely have been an enthusiastic share price response was guidance that the Group will invest heavily in headcount to improve content safety / counter terrorism on the platform, which is likely to see operating margin deleverage into FY18. The company has guided to operating expenses growing by 45%-60% YoY (although we note that its initial FY17 guidance has proved too aggressive or conservative on the cost line), which should prove to be above turnover growth. At the same time, capex was guided to being roughly double FY17 levels in FY18 at $14bn, meaning a dip in free cash flow generation into FY18. Nevertheless, we believe the structural growth drivers for Facebook remain very attractive and we expect adjusted earnings growth of more than 20% YoY in FY18. On our estimates, Facebook trades at a forward P/E of 22x and we believe it has scope for further gains.

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