Time to ease off on gas stocks? – FE Trust Network

Look at the relative performance of the FTSE 100 Index over the past 12 months and you would think the UK was the world’s economic leader. It is up almost 4% at the time of writing compared to the US S&P 500, which has fallen more than 10%.

Of course, these broad numbers hide a much more nuanced story – and perhaps some investment opportunities. too.

The FTSE 100 was “fueled” by the performance of the natural resource companies that dominate it. BP is up 31% over the past year; Shell up 46%; Glencore up 33%.

We believe that over the long term, strong growth tends to come from small and medium-sized companies. But their performance can be volatile, and large-cap and natural resource companies can act as stabilizers within a portfolio.

This philosophy has made a big difference to our performance this year, and I can’t remember a time when, as multi-cap managers, we had such exposure to these ‘stabilizing’ companies. But in recent weeks, we’ve been wondering if it’s time to get back to small and mid cap stocks that have been through such a tough time.

Too dark ?

The alternative investment market has fallen nearly 27% over the past year; the FTSE 250 is down 13%. Experience tells us that small businesses go through these periods of darkness, but tend to surge when they reach the other side – usually triggered by a change in sentiment.

The current market narrative is dominated by fate. Central banks raise their inflation expectations as well as interest rates; economists point to inverted yield curves as the IMF just said the outlook for the global economy has “darkened considerably”. A global recession seems imminent.

We cannot rule out further stock falls, but markets seem to have largely priced in these expectations. I cannot imagine a darker scenario than the one we saw at the start of the Covid crisis. The markets collapsed. This year, many stocks have experienced similar corrections.

Take sofa manufacturer DFS. In 2020, when the Covid crisis hit, its share price fell by almost 60%, from £2.82 at the start of the year to £1.16 three months later. By June last year, its shares had rallied sharply – to a high of £3. Today they are £1.57. The falls are similar for M&S – down 53% during Covid, followed by a recovery, then down 43% so far.

There is a broader perception in the market that price/earnings compression has occurred and that there could then be substantial downward earnings revisions.

But that doesn’t match the messages we hear in company meetings and calls. Reflecting on the performance of the stock price, management seems quite puzzled – and sometimes frustrated. So far, demand appears resilient, and we’re impressed with the number of companies that have price escalation clauses in their contracts.

Downgraded shares

One area that has downgraded considerably is building materials companies. Even if house prices were to drop, homebuilders would have to keep building houses, or their incomes would run out. So they will always need bricks and other materials.

One of our holdings in the Henderson Opportunities Trust is Sigmaroc, which produces heavy building materials for the UK and Europe. Its stock price is down more than 40% in the past year, but it’s a company with a history of smart acquisitions and organic growth. We await its final results, but the last five years have been impressive – EBITDA has grown from £6m to £49m and earnings per share have more than doubled.

Energy price hikes will hurt many people, but they will especially hurt those whose finances are already strained. There are many people whose savings have grown significantly during the lockdown and whose incomes have grown not far behind inflation. The UK savings rate is still higher than it was between 2017 and 2019.

Vertu Motors has seen its share price fall 21% so far this year. But it’s still trading satisfactorily, and the switch to electric vehicles is encouraging more people to buy new cars.

Vertu pays a good dividend – over 3%. Brick maker Ibstock, another company we like and whose share price is down about 13% in the past year, pays closer to 4.5% in dividends. Epwin Group, a UPVC window manufacturer, delivers over 5%.

We are told to sell cyclical stocks as we enter a recession. But markets appear to have priced in a significant amount of bad news, with the median share of the FTSE 350 down almost 20% this year. And maybe – just maybe – this time around, a recession might not be as painful for many of these companies as it has been in the past.

We’re not calling the bottom, but for us it made sense to pocket some of the gains we made in energy stocks and start to slowly move back into some of those cyclical areas for recovery. In the meantime, we’ll gladly take those dividends – we call it getting paid to wait for the rebound.

Laura Foll is co-manager of the Henderson Opportunities Trust and the Lowland Investment Company. The opinions expressed above should not be considered investment advice.

Look at the relative performance of the FTSE 100 Index over the past 12 months and you would think the UK was the world’s economic leader. It is up almost 4% at the time of writing compared to the US S&P 500, which has fallen more than 10%.

Of course, these broad numbers hide a much more nuanced story – and perhaps some investment opportunities. too.

The FTSE 100 was “fueled” by the performance of the natural resource companies that dominate it. BP is up 31% over the past year; Shell up 46%; Glencore up 33%.

We believe that over the long term, strong growth tends to come from small and medium-sized companies. But their performance can be volatile, and large-cap and natural resource companies can act as stabilizers within a portfolio.

This philosophy has made a big difference to our performance this year, and I can’t remember a time when, as multi-cap managers, we had such exposure to these ‘stabilizing’ companies. But in recent weeks, we’ve been wondering if it’s time to get back to small and mid cap stocks that have been through such a tough time.

Too dark ?

The alternative investment market has fallen nearly 27% over the past year; the FTSE 250 is down 13%. Experience tells us that small businesses go through these periods of darkness, but tend to surge when they reach the other side – usually triggered by a change in sentiment.

The current market narrative is dominated by fate. Central banks raise their inflation expectations as well as interest rates; economists point to inverted yield curves as the IMF just said the outlook for the global economy has “darkened considerably”. A global recession seems imminent.

We cannot rule out further stock falls, but markets seem to have largely priced in these expectations. I cannot imagine a darker scenario than the one we saw at the start of the Covid crisis. The markets collapsed. This year, many stocks have experienced similar corrections.

Take sofa manufacturer DFS. In 2020, when the Covid crisis hit, its share price fell by almost 60%, from £2.82 at the start of the year to £1.16 three months later. By June last year, its shares had rallied sharply – to a high of £3. Today they are £1.57. The falls are similar for M&S – down 53% during Covid, followed by a recovery, then down 43% so far.

There is a broader perception in the market that price/earnings compression has occurred and that there could then be substantial downward earnings revisions.

But that doesn’t match the messages we hear in company meetings and calls. Reflecting on the performance of the stock price, management seems quite puzzled – and sometimes frustrated. So far, demand appears resilient, and we’re impressed with the number of companies that have price escalation clauses in their contracts.

Downgraded shares

One area that has downgraded considerably is building materials companies. Even if house prices were to drop, homebuilders would have to keep building houses, or their incomes would run out. So they will always need bricks and other materials.

One of our holdings in the Henderson Opportunities Trust is Sigmaroc, which produces heavy building materials for the UK and Europe. Its stock price is down more than 40% in the past year, but it’s a company with a history of smart acquisitions and organic growth. We await its final results, but the last five years have been impressive – EBITDA has grown from £6m to £49m and earnings per share have more than doubled.

Energy price hikes will hurt many people, but they will especially hurt those whose finances are already strained. There are many people whose savings have grown significantly during the lockdown and whose incomes have grown not far behind inflation. The UK savings rate is still higher than it was between 2017 and 2019.

Vertu Motors has seen its share price fall 21% so far this year. But it’s still trading satisfactorily, and the switch to electric vehicles is encouraging more people to buy new cars.

Vertu pays a good dividend – over 3%. Brick maker Ibstock, another company we like and whose share price is down about 13% in the past year, pays closer to 4.5% in dividends. Epwin Group, a UPVC window manufacturer, delivers over 5%.

We are told to sell cyclical stocks as we enter a recession. But markets appear to have priced in a significant amount of bad news, with the median share of the FTSE 350 down almost 20% this year. And maybe – just maybe – this time around, a recession might not be as painful for many of these companies as it has been in the past.

We’re not calling the bottom, but for us it made sense to pocket some of the gains we made in energy stocks and start to slowly move back into some of those cyclical areas for recovery. In the meantime, we’ll gladly take those dividends – we call it getting paid to wait for the rebound.

Laura Foll is co-manager of the Henderson Opportunities Trust and the Lowland Investment Company. The opinions expressed above should not be considered investment advice.