Fed sticks to its guns, Apple and Facebook earnings blowout

Morning Note

The Federal Reserve remains resolutely firm. Jay Powell reiterated that the central bank is not even close to talking about tapering bond purchases, a move that would begin to unwind some of the extraordinary accommodation delivered in the wake of the pandemic. The Fed chair said the US economy is still a long way from achieving the progress required to dial back stimulus – over 8m jobs are still lost and that means we need several blowout jobs reports to get there. Powell also stressed that policymakers are not worried about inflation and think any price pressures will prove temporary.  The Fed is doubling down here and sticking to its guns. Advance GDP numbers due to today should show the US economy roaring back. 

 

All this should be a green light for stocks, but the markets are wary right now as they tread record highs and all this stimulus is priced in and the macro outlook well understood. The US 10-year bond yield moved to test the 1.65% level. US stock markets closed marginally lower, though the small cap Russell 2000 managed to eke out a small gain. Futures point to solid gains for Wall Street later today when the cash equities open. European stock markets are largely higher in early trade today, with the FTSE 100 popping its head above 7,000 again on a raft of largely positive corporate updates.

 

Apple reported another stunning quarter, with sales soaring from last year and a fresh round of buybacks. The company raised the dividend by 7% to $0.22 per share and announced $90 billion in share buybacks. Apple revenues grew more than 50% year-on-year, with total sales of $89.58bn vs around $77bn expected. EPS came in at $1.40 vs $1.00 expected. At all levels, we can see Apple outperforming even the most bullish expectations. The core iPhone business saw sales up 65% to $47.94 billion vs. $41.43 billion estimated. This was stunning – the iPhone remains the golden goose and way in which consumers become part of the Apple ecosystem. Services – a higher margin business that includes things like the Cloud, App Store, Apple Music – grew revenues by 26.7%. Revenues in China rose 87% – albeit this was in comparison to a quarter last year in which China was most affected by the pandemic. Shares rose 2% in the after-hours market. A really exceptional quarter – it’s not a surprise that it exceeded quite a low bar, but noteworthy just by how much.

 

Facebook shares advanced 6% in after-hours trading as the company reported posted forecast-beating revenues and earnings. However, the company warned investors that growth could slow as new Apple privacy policies would make it harder to targe ads on social media. I’m fairly used to Facebook using earnings calls to warn that rates of growth could slow in future, and I think investors are too. Earnings per share came in at $3.30 vs $2.37 expected on revenues of $26.17bn, which were about $3bn more than expected and up 48% on a year before. Net income rose 94% to $9.5bn. Average revenues per user came in at $9.27 vs. $8.40 expected. 

 

BT confirmed it is looking to sell its TV business.  This has been a long time coming – the vast sums BT paid to secure football rights was always at odds with the core business. In a statement responding to press speculation, the company says “early discussions are being held with a number of select strategic partners, to explore ways to generate investment, strengthen our sports business, and help take it to the next stage in its growth”. Whilst clearly the pandemic has badly hit sport, BT has never set too well in the content space; there are many with deeper pockets who do content. Ballooning costs left BT paying a hefty bill for sports that wasn’t being covered. It’s further evidence of chief executive Philip Jansen ripping up the Gavin Patterson era playbook to focus squarely on the Openreach rollout and modernise BT. 

 

Shell raised its dividend after beating expectations thanks to higher oil prices and improved margins in its chemicals business. Adjusted net income rose 13% from a year before. Net debt fell $4bn. Meanwhile French firm Total said profits are back to pre-pandemic levels as adjusted net income hit $3bn, higher than the pre-crisis first quarter of 2019. 

 

Unilever shares rose over 2% as the company announced it will commence a €3bn share buyback scheme next month after a 5.7% jump in sales in the first quarter. Most (4.7%) came from higher volume, with just 1% from stronger pricing. For 2021 Unilever stuck to its target of underlying sales growth to be within 3-5%, with the first half at around the top of this range. Management also pointed to additional supply chain costs, with rising commodity and freight prices a factor as margins are seen declining a touch in the first half before picking up later in the year. Ongoing covid restrictions in some areas of the world continued to support in-home sales, whilst the slackening of restrictions in some geographies boosted out of home sales. Mayonnaise and ice cream were strong sellers. India and China both posted strong double-digit growth against a backdrop of strict lockdown measures which impacted the prior year. 

 

NatWest reported Q1 2021 operating profit before tax of £946 million and an attributable profit of £620 million. This was boosted by the reversal of provisions for bad loans as government support schemes reduced the amount of loan delinquency banks had anticipated. NatWest booked at net impairment credit of £102m. But shares fell as the total income was a slight miss, coming in at £2.66bn vs £2.7bn expected. Net interest margin fell 2bps to 1.64%. Shares declined more than 3% in early trade. Standard Chartered continued the run of positive news from the large banks as it recorded underlying pre-tax profit rising 18% to $1.4bn as lower impairment charges and strong cyclical recovery in the global economy offsetting lower interest margins. Return on tangible equity rose 220bps to 10.8% and management reaffirmed their view that income will start growing again in the second half of the year and for impairment charges to reduce significantly.

 

Smith & Nephew shares rose 6% to the top of the FTSE 100 after reporting Q1 revenue up 6.2% on an underlying basis (11.5% reported) to $1.264bn. This included 3.4% from foreign exchange and 1.9% from acquisitions, whilst the quarter also included two more trading days than the equivalent 2020 period. 

Best UK shares for trading a Covid vaccine-led reopening story in 2021

Equities
Investments
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.

Macro highlights

  • 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.

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