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Best UK shares for trading a Covid vaccine-led reopening story in 2021
D’ya like dags? Or indeed goats. The market rally in November was led by the dogs of the markets: energy, financials and Value were among the best shares to buy. Here are a few big-name stocks to watch in December and into 2021 on a ‘back to normal’ trade.
- Vaccines to support a return to near-normal by year-end 2021
- Economic recovery will not be instantaneous but steady improvements are expected
- Earnings per share should increase as corporates benefit from pro-cyclical growth
- Inflation to rise as output gap closes and enormous savings glut is spent
Effective vaccines will be rolled out in 2021 in the developed world, supporting a return to normal economic and social activity by the year end. Whilst there are risks associated with the delivery of vaccination programmes globally, overall, it looks like countries will be able to support a ‘return to near-normal’ by the end of next year.
Return to normal ought to support European and UK equity markets with their strong weighting towards more cyclical stocks and sectors vs the US which has led the way with big tech and growth. A powerful value rotational trade was the dominant market trend in November 2020, leaving financials, energy and travel stocks among the top shares to buy, and while it will not move in a straight line upward, this pivot ought to continue through the earlier part of 2021 as markets adjust to economic and social activity returning to normal. December has begun very much like November was.
Britain has been hobbled by Brexit uncertainty for 4 years and UK equities have underperformed peers. Even allowing for the November recovery which was the best month for the FTSE 100 in 31 years, UK stocks have not had a good time of it in recent years. However, with Brexit risks likely to disappear and the UK in possession of the means to deliver a comprehensive vaccination programme, the outlook for the economy – and UK equities – may be about to improve. The FTSE 100 has an expected 2021 dividend yield of 4%, making it the most attractive among developed market stock indices. Is the dog of all dogs to finally ready to bark?
Two major caveats to this thesis – a Brexit deal and effective vaccination rollout are both essential, and not a slam dunk certainty.
GOAT: Get Out And Travel picks
IAG (LON: IAG) – Return of lucrative transatlantic routes will be big fillip for IAG shares. In the 11 months to December the stock was down by around 60%, making it the worst performer on the FTSE 100. Nevertheless, the stock rallied over 80% in the month of November as vaccine optimism drove the rotation trade. Whilst this may effectively have priced reopening in 2021, there could be further upside driven by on-the-ground improvements to travel. In addition to the roll-out of vaccines, efforts by airlines like BA and airports like Heathrow to find creative solutions to ending quarantine requirements for travellers such as digital health passes will progress and make it easier for travel to take place. Shares are not expected to get back to pre-pandemic levels next year – passenger travel levels are not seen returning to 2019 numbers for some years. But a steady reopening of the economy and pent-up demand among holidaymakers to get out and travel ought to support earnings recovery in 2021.
Cineworld (LON: CINE) – A GOAT favourite but huge debts are a factor. Shares have been very volatile, with the price collapsing when the company announced closure of UK and US screens due to pandemic and then surging on news of Pfizer’s vaccine in November. YTD, the stock was the worst performer on the FTSE 350 to the end of November. Cineworld was bloated before the pandemic – net debt is over $8bn thanks mainly to two large leveraged acquisitions in recent years. The fear is that there have been permanent behavioural shifts in consumers that will mean the market is forever smaller, however the stock is probably already reflective of these risks. It is hard to gauge right now what permanent damage is done to cinemas, but the advance of over-the-top streaming services, especially Netflix with its vast Hollywood budgets and ability to make feature films, has dealt another big blow.
Cineworld shares have recovered a further portion of the losses after the company secured a new debt facility of $450m and issued equity warrants representing over 11% of share capital. It also managed to get banks to waive debt covenants until June 2022 and further reduced costs. This new facility should act as a bridge to get to a point where it can reopen screens in the UK and US and get the cash flow moving in the right direction again. However, the company is working on the assumption that can reopen in May. Under this base case scenario, Cineworld has sufficient headroom for 2021 and beyond. But in the event of a further delay to cinema reopening, whilst it has sufficient liquidity ‘for a number of additional months’, it ‘may require lender support in order to deploy that liquidity’, management said today. Bums on seats by May is dependent entirely on a vaccine – if there is a stock trading on this vaccine roll-out it’s Cineworld. Warner Bros decision to stream all new releases as soon as they they hit the big screen is a blow and sent shares lower by 14% on Dec 4th.
Energy has been a laggard but the likes of Shell (LON: RDSA) and BP (LON:BP) should stand to benefit from stronger average crude pricing in 2021. Both fell by around 40% in the 11 months to Dec YTD. Whilst the International Energy Agency (IEA) has been right to sound cautious over the demand pickup in the early part of 2021, oil markets will be trading largely on sentiment. There are clear near-term risks from rising inventories – a lockdown in the US would lead to demand destruction in Q1. Tertiary lockdowns in Europe cannot be ruled out in Q1 and even Q2 should the virus reappear in strength. OPEC and allies will continue to hold the fort, albeit not as comfortably as in the past. Towards the end of the year, oil markets may also benefit from an expected supply crunch. The spectacular collapse in oil markets due to the pandemic led to a massive wave of capex cuts – according to Rystad about $100bn cut – which threaten to flip the market from glut to crunch as vaccines start to take effect and boost the demand side. Risks remain for old world energy players though as ESG investing takes on added importance.
Reflation picks: Banks
Lloyds (LON: LLOY), Natwest Group (LON: NWG) both were among the largest decliners on the FTSE 350 YTD through to the end of November, down in the region of 30-40%. Both have a lot exposure to the UK economy, especially the housing market and consumer spending. Two factors could support gains. First, the reflationary environment in 2021 as vaccines encourage a return to normal ought to see a steepening yield curve and support net interest margins. Secondly, clarity over Brexit should be a positive for the UK economy. Other factors, like the remarkable resilience of the housing market and relative strength in consumer spending, are also supportive.
Share prices of both have fallen this year as 2020 has really been a story of UK plc risks – negative rates, deficits, pandemic-related GDP destruction and of course Brexit. 2021 should see a more encouraging outlook for the UK economy and the removal of tail risks like no deal Brexit. Near-term, rising unemployment will be a problem but ultimately a ‘return to normal’ in2021 will support financials. A resumption of dividend payments in February when results are announced would be a big help, too. In many ways banks have been unfairly swept up in the markets’ pandemic crossfire as investors followed the playbook of the last war: financials are in much better shape this time and well provisioned to weather the storm. As of the end of November, Lloyds traded at a price to book ratio of 0.55, whilst Natwest was at about 0.47.
Meanwhile Barclays (LON: BARC) price to book was a measly 0.36. Some may doubt the sustainability of handsome trading revenues from its investment bank, but the outlook is still overall positive. Third quarter results smashed expectations, with pre-tax profits of £1.2bn double what was expected. Loan loss provisions were 40% below expectations, albeit higher than last year.
Shell sold, Lloyds crumples, markets look to future post Covid
Shares in Shell slumped 7% as it cut its dividend and reported net income in the first quarter almost halved. Whilst BP chose to absorb a $6bn rise in net debt to $51bn and gearing above 36x in order to preserve its precious dividend, Shell seems to be taking a more prudent approach in cutting its dividend for the first time since the 1940s. Arguably BP is better placed to weather the storm, but Shell is taking the more sensible course of action. Shell’s gearing ratio is down to around 28x, a more comfortable level for Ben van Beurden than it is for Bernard Looney. This poses a simple question for investors – can BP keep it up?
Shares in Lloyds sank 4% after profits collapsed in the first quarter and it significantly raised impairment charges. Profits before tax fell by 95% to £74m, as it raised credit losses provisions to £1.4bn. More worryingly for Lloyds is the 11% fall in revenues – if the housing market remains sluggish it’s got a lot of exposure to worry about and doesn’t have the investment banking arm to fall back on that Barclays does. The read across hit RBS, which is similarly exposed to credit impairments in the UK, with shares almost 4% lower.
The US economy shrank more than expected in the first quarter, declining by 4.8% and signalling the slowdown in Q2 could be well beyond estimates. Spain’s economy declined by 5.2% in the first quarter, marking the steepest contraction since records began in 1995. It was also worse than the ~4% decline expected.
But the extent of economic destruction matters less to the market than the speed at which recovery will happen, so news from Gilead that its remdesivir drug can probably treat Covid-19 sent stocks into a strong rally. White House health advisor Dr Anthony Fauci gave it a cautious thumbs up, too. Global stock markets are looking to a world post-Covid-19, although the wider macro trade is less optimistic.
The S&P 500 rallied over 2.6%, closing 5 points above the important 61.8% retracement found at 2934, after the Gilead news. The Dow also rallied and is on pace for its best month since 1987. The broader S&P 500 is tracking its best month since Oct 1974. These are strange times for markets, but you have to look at the way in which tech is driving gains and how large caps can lean on central bank support.
European markets jumped yesterday and are skirting around the flat line after almost an hour of trading as traders try to figure out whether there is any more left in this rally. I don’t think markets are going to want to retest the highs any time soon and profit-taking and renewed risk-aversion will likely see a pullback before long.
Last night the Federal Reserve warned of medium-term risks to the economy and signalled there is not going to be a V-shape recovery. Jay Powell did nothing to upset markets and suggested it was likely the Fed would need to do more. The European Central Bank will need to communicate a similar message of support today.
Microsoft and Facebook earnings were very strong, beating estimates, but this does nothing but underline the relative safety to be found in high quality technology companies with strong balance sheets and resilience to lockdown measures. Facebook jumped 10% in after-hours trading as it said April showed some stability in ad revenues, echoing the statement from Alphabet.
Oil continues to notch gains as the risk rally reflects hopes of the global economy opening up sooner, and after a smaller-than-feared build in US crude inventories. Front-month WTI rose above $17 in early European trade. US crude oil inventories rose by 9m barrels from the previous week less than the 11-12m expected and giving some flicker of hope to beleaguered oil traders. Domestic US production slipped, but not by a lot, falling to 12.1m bpd from 12.2m bpd a week before.
Russia’s energy minister Novak said the country’s producers would cut output by 20% from February levels in May, while Norway is playing ball with the OPEC+ arrangement by reducing production by 13%. But demand falls still seem to exceed the capacity of the market to reduce supply. The International Energy Agency said Thursday that global energy demand will fall by 6% in 2020, and will be down 9% in the US and 11% in the EU.
Lloyds: PPI still bites as Q1 profits miss expectations
Compensation for customers mis-sold PPI continues to gnaw away at Lloyds profits, whilst it missed on top line revenues in what’s probably not the best quarter for the bank. Net interest income remains ok but we wonder if there is enough in here to continue the rally in shares YTD.
Lloyds took an additional charge of £100 million for PPI in the first quarter, bringing its total provision to very close to £20bn since the scandal first came to light.
Net income increased by 2% to £4.4 billion, which was a little below the consensus forecast. Profits were flat at £1.6bn, which again was below expectations. Doubts on credit risks are not going away, with asset quality ratio up again to 25bps. Return on tangible equity improved to 12.5%, above its cost of equity. CET1 dropped to 14.2% pre dividend.
Its net interest margin looks solid enough, holding at 2.91%, which compares favourably with peers. Cost cutting is helping the bottom line even if revenue growth is not really there – cost to income improved to 44.7% with positive jaws of 6%.
The company backed its full year outlook – NIM remaining around 290 basis points, operating costs below £8 billion and a net asset quality ratio below 30 basis points. Lloyds still expects a return on tangible equity of 14-15% in 2019.
As previously stated, the problem with Lloyds is from its very high exposure to the UK market, both unsecured and mortgage lending. It’s really tethered to the UK economy – rising and falling in tandem with consumer spending and the mortgage market, and doesn’t seem to be driving revenue growth unless the economy is growing.
Shares skidded 2% lower after the results underwhelmed. After the PRA boosted the stock by cutting its capital requirements, it’s as you were.
Lloyds shares have outperformed chief peers Barclays and RBS in the last year.