Sorting the Wheat from the Chaff

US and UK investment bankers and corporate broking firms have enjoyed bumper times since Brexit with a very high level of takeover (M&A) activity and new stock market listings.  In the UK, the value of flotations is thought to have trebled so far in 2021 to over £50bn with the likes of Darktrace, Deliveroo, Trustpilot and Wise amongst many.

M&A activity is usually welcomed by shareholders as most bids are typically at a healthy premium to a company’s current share price and in some cases can lead to counter bids. However, when a stock de-lists, it can provide a headache for investors. Can you find a replacement investment of comparable quality?

Despite media headlines about investment banker bonuses, stock markets provide a vital function in raising fresh funds for companies. During the pandemic and lockdown many companies turned to shareholders to back fund raisings to provide working capital or to provide headroom to expand when conditions improved.

New issue activity has also picked up as companies have sought to list on the stock market to fund growth. While new issues can provide attractive new investment opportunities, investors need to be selective. Many new issues tend to see existing early backers such as private equity investors exit their shareholdings. It then comes down to assessing a fair price with vendors looking to maximise their exit proceeds and new investors trying to come aboard at a sensible price. Sometimes vendors and their advisers can be too greedy and set a very high valuation and new investors can avoid the floatation leading it to be pulled. In some cases, the new issue may attract a premium valuation if market conditions are favourable but if conditions change subsequent share price performance can suffer. For example, half of the companies that raised $1bn at initial offerings this year are currently trading below their listing price.

We spend a lot of our time screening potential new issues but tend to be quite selective about what we support. Sorting the ‘wheat from the chaff’ can pay dividends! What you avoid can be just as important as what you buy.

What have we been watching?

Omicron and inflation continued to create uncertainty. Like the Bank of England, the US Federal Reserve appears to be shifting its stance on transitory inflation with signs inflationary pressures might persist into the second half of 2022.

The Omicron variant continued to overshadow global markets. Moderna’s Chief Executive Stephane Bancel provided a reality check by saying that existing vaccines would be less effective against Omicron.’ There is no world, I think where the effectiveness is the same level we had with Delta and scientists I have spoken to expect a material drop due to the high number of mutations on the spike protein.’ He predicted vaccine manufacturers would need several months to mass produce a vaccine that would be effective against Omicron. Markets then steadied after BioNtech’s Chief Executive said that the vaccine it makes in partnership with Pfizer was likely to offer strong protection against Omicron.  Meanwhile, Glaxo announced a new anti-body treatment that it says works against Omicron received regulatory approval in the UK. It has been found to cut hospitalisation and death by 79% in those at risk.

US pandemic advisor Anthony Fauci said of Omicron ‘Though it is too early to make a definitive statement about it, thus far, it does not look like there is a great deal of severity to it. Thus far the signals are a bit encouraging.’   The WHO confirmed that Omicron has been identified in over 38 countries around the world although there have not as yet been any deaths. The wider impact of government measures on economies, businesses, households and healthcare systems remains to be seen.

Long-term ocean freight rates jumped by 16% in November reflecting strong demand, port capacity and supply chain issues.

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In the UK, the booster jab programme is being accelerated but whether this will save Christmas is too early to tell, although the hard hit hospitality sector is already reporting an increase in cancellations of Christmas office party bookings. More to ponder for the Bank of England on the transitory inflation debate. The UK services sector said costs were rising at the fastest pace in twenty years. Meanwhile, a separate survey by Lloyds Bank suggest that 50% of businesses are planning price increases while 25% are expecting wage growth of over 3%. UK November manufacturing PMI touched a 3-year high but conditions remain challenging with input price inflation at a survey record high. Bank of England (BoE) committee member Mike Saunders who had been calling for an interest rate hike said he will now assess the impact of Omicron on the UK economy before the next vote on interest rate policy. Sterling futures now suggest a less than 20% an interest rate hike in December. Sterling slipped to $1.32.

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Eurozone November manufacturing PMI stabilised after a 4-month slowdown but supply chain issues persist.

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US manufacturing PMI edged up slightly in November. The more significant news from the US was the change in stance on transitory inflation by the Federal Reserve (Fed).  Chair Jerome Powell reinforced the message that the US central bank would keep inflation in check and said that Fed officials should consider speeding up how quickly they withdraw policy support. One Fed member said they were very open to scaling back the Fed’s asset purchases at a faster pace so it can raise interest rates a couple of times next year if needed. ‘Making the taper faster is definitely buying insurance and optionality so that if inflation doesn’t move back down significantly next year we are in a position to hike rates if we have to.’ The arrival of the Omicron variant in the US will present another challenge for the Fed in 2022.

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Japan’s factory production edged up in October ending a three-month slide and adding to signs that the global supply chain crunch may have been easing before the emergence of the Omicron variant.

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China’s factory activity unexpectedly picked up in November growing for the first time in three months as the crippling surge in raw material prices and power rationing eased.

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Brent oil dipped to $71 on concerns about oil demand given the Omicron variant. Meanwhile, Iran is reported to be ramping up its enriched uranium capacity. OPEC+ decided to keep its oil production policy unchanged and will add another 400,000 barrels of oil a day to output from January 2022.

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Finally, sad news with the passing of Mr Goxx the hamster who traded in cryptocurrencies. He famously would warm up on his ‘intention wheel’ before trading by entering either a buy or sell tunnel. In his short career the tiny trader, who often outperformed human investors, had made a 20% return.

 

Read Last Week’s Alpha Bites – A Punch in the Face

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.