Stockwatch: Where's the true anchor for equity values?

Where's the true anchor for equity values? Screening UK company announcements daily I am attuned to the overall balance of revenue and profit growth. Expectations are broadly in line, with the few disappointments tending to be company or sector specific. Yet it's worth bearing in mind how the numbers are propped up to some extent - e.g. low interest rates boosting the housing market and consumer spending, at the expense of the savings rate and a stubborn current account deficit.

QE has raised asset prices and prompted riskier investing, albeit with downside issues such as pricing swathes of younger people out of home ownership, especially in London. At some point the downside factors will limit expansion if not conspire for cyclical downturn.

A Labour-SNP tie up is the biggest near-term risk

On 20 April there was a stark contrast to the flow of positive company updates, in the latest red flag alert from Begbies Traynor for Q1 2015. This corporate recovery practice says: "businesses across the UK have battened down the hatches since the start of the year, holding back investment for growth and initiating recruitment and pay freezes as they await the outcome of May's general election, resulting in a state of stagnation across all areas of the economy."

The fear is logical if a hung parliament leads to months of wrangling and a UK-destabilising, Labour-SNP tie-up. Otherwise it's easy for political sympathies to distract voters from how the two main parties both seek to steadily reduce UK deficits and support the National Health Service.

Snags exist with either majority government: Labour seeking to tax the rich more, leading to a loss of talent abroad; the Conservatives promising a referendum on Europe which is already unsettling industry/the City. Business should thrive whichever main party is in power or in alliance with the Lib Dems; the potential spoiler is Scottish Nationalist influence making the UK very hard to govern.

Bellwether cyclical firms are in good health

It's encouraging how various companies, serving a range of geographies, currently express confidence. Perhaps the most far-reaching is WPP as a global marketing services group - a business that dials directly into corporate confidence. Its Q1 2015 results

show revenue "reasonably above budget" with like-for-like constant currency revenue up 5.2% - which is very good for a near £21 billion company, also considering worldwide GDP growth slowed in H2 2014 and Q1 2015. Profits and margins haven't been quantified but are "well ahead of budget".

Industrial fasteners are a good test of industry and Trifast, about 50% oriented to the UK, 30% Asia and 20% mainland Europe, says its results for the latest year to end-March will be "as a minimum, at the upper end of current market expectations."

Not only does this represent margin enhancement through operational improvements, but management is upbeat on revenue also - "we remain encouraged by the many opportunities we have, both across our key sectors and with new and existing customer partnerships."

Yet the recruitment sector provides the most startling examples of vigour; the likes of Hays, Michael Page and Robert Walters all citing strong demand at home and abroad - a direct contrast with Begbies' dismal view.

One possible way to rationalise this is time horizons in the recruitment industry being notoriously short, however Begbies was specific about "the start of the year," which doesn't chime with what listed recruiters are saying. Hays, for example, stated in its update for the quarter to end-March 2015 that "good broad-based growth in the UK and Ireland" had slowed "modestly" as the quarter progressed.

Furthermore, strong operating profit growth is expected for Hays' financial year to end-June, with the second half ahead of the first (to end-December 2014). Robert Walters has seen the strongest momentum of all in the UK, with net fee income up 22% in the first quarter, noting a "broad-based upturn in permanent recruitment activity across both London and the regions" and confidence that 2015 profit will be ahead of market expectations (as at 8 April). Besides implying wider corporate confidence to invest, the significance of bullish recruiters is a virtuous economic circle where new jobs boost individuals’ esteem and pay, leading to higher consumption.

Mind how strains persist below the surface

Specific examples perhaps, but reflecting strained consumer finances: it appears new auditors at multi-utility Telecom Plus are responsible for uncovering seven years of bad debts, and retailer Shoe Zone has cautioned about a difficult trading environment meaning its results for the year to 4 October will be below market expectations with the dividend adjusted accordingly.

Significantly, this firm was one in a stream of flotations by private equity (PE) owners last year. To a sceptical eye it looked like PE was cashing in while stockmarket sentiment ran high and underlying trading was good enough to promote the story; yet PE was well aware of the risks. While near-term upside was sacrificed as the stock rose from about 170p to 270p over nine months, it has slumped back to 185p after the profit warning - implying the market had rose-tinted specs on.

At least price/earnings multiples are not stretched in the UK like in the US. The S&P 500 index is looking tired after years of QE-driven exuberance, and is trading flat overall for 2015. Q1 reporting looks generally good albeit with some revenue/profit disparity: at this stage 73% of S&P 500 firms have so far beaten profit expectations but only 42.2% for revenue, which begs a question whether US firms are broadly at peak margins.

It also shows markets can indeed look to the longer term, with investors also wary how a strengthening dollar (up 9% this year) will take its toll on US multinationals. The dollar is unlikely to ease back now US interest rate expectations favour a rise as higher wages signal inflationary pressures building. Mind that Wall Street still strongly influences global financial sentiment.

Oil price volatility shows just how tricky guessing cycles can be

The consensus anticipates a slow but sure global recovery, backed by cheap energy and low interest rates. Yet only recently the most respected oil industry analysts spoke of oil prices hitting $40 and lower; and here they are back up to $63 a barrel. Admittedly, the Saudi/Yemen tensions are a new factor, but the rise - as evident in UK petrol pump prices - quite changes the assumption consumers will have significant additional spending power.

So the chief dilemma is whether the business cycle is strong enough to support financial growth - hence dividends - to accommodate all the refugees from ultra-low interest rates, now holding stocks. Is it strengthening like the recruiters imply, or looking tired according to US firms and their stock valuations? There's an anchor, but it sometimes feels like it's dragging on the ocean bed.