Stockwatch: This huge prop should reassure

Does a recent spate of profit warnings imply an already high trend is worsening? The overall third-quarter number for UK listed companies has yet to be clarified; meanwhile, Moody's credit rating agency cites global corporate bond defaults running at the highest level since 2009, and the trend is worsening.

Stockmarkets remain buoyant while central banks maintain stimulus, helping explain steep falls among shares that get chased up - only then to issue warnings.

Overall, however, the US has fared well regarding third-quarter results, e.g. better-than-expected figures from banks and warnings mainly from established culprit sectors such as mining and construction equipment; Caterpillar has cut its 2016 profit target for a third time and indicated 2017 as likely a fifth year of no sales growth.

The apologist boss says: "Economic weakness throughout much of the world persists and, as a result, most of our end markets remain challenged" - rather showing why central banks are reluctant to ease off stimulus.

It's still hard not to feel the business cycle and stockmarket values look matureCrucially, there isn't much evidence of slowdown in consumer spending, and fiscal policy (i.e. government spending) is becoming fashionable, which should mitigate recessionary risks.

It's still hard not to feel the business cycle and stockmarket values look mature, e.g. some cyclicals are rated like growth stocks and price/earnings (PE) ratios for pricey online retailing stocks, rated purely on revenue, are being dismissed.

UK profit warnings are spreading by sector

The second quarter of 2016 had already seen the highest number of second-quarter profit warnings since the 2008 crisis, according to consultancy EY, with 66 companies warning - up a massive nine times, like-for-like. EY has yet to declare the situation for thid-quarter, but it will be interesting to watch out for this, mindful that the EU referendum may have meant some distortion.

Capita's much higher gearing looks a chief reason why its stock festersThe obvious medium-term effect is sterling's fall raising import costs and empowering exporters, but the transition from an import-and-distribution economy to better export sales will mean some disruption.

With one in six UK listed companies already issuing some kind of warning during the first half of 2016, it's vital to tune in, as they can amount to a slowdown.

Outsourcers remain a prime source, at an inflection point where these firms have over-expanded and now face government cuts. There is also an air of decisions being delayed, and Brexit uncertainties not helping here.

Such are broad reasons why Capita Group has seen its FTSE 100 shares fall 38% from 950p since an end-September warning as the stock de-rates from growth to income status.

The "unexpectedly rapid slowdown" in some areas of Capita's business is paralleled at Mid 250-listed Mitie Group, which fell from about 270p to 180p in response to a mid-September warning but which has recovered progressively to 206p.

Cyclical businesses float after strong profits growth, at a price better for vendors than new investorsCapita's much higher gearing looks a chief reason why its stock festers, so bear this in mind if trying to bottom-fish after warnings.

Cobham further shows acquisitions raising the risk profile and impacting shareholder value if revenues then soften.

The group supplies radar and other electronic products to defence and aviation industries; its Mid 250 shares fell this year from 240p as low as 127p, currently 146p, after a couple of profit warnings, the latest blamed on the acquisition of a US maker of wireless components - which ironically was bought to help offset defence cuts on the wider group.

While the warning does signal industry weakness, it's a perennial dilemma with acquirers.

Consumer demand issues also lurking

A recent warning from Motorpoint Group, a small-cap second-hand car retailer, dials more directly into consumer demand. Having listed at 200p only last May, its advisers appear desperate to avoid the indignity of issuing a profit warning, instead saying that revenue/margin have proven lower than expected: 11% revenue growth in the six months to end-September, with prices cut to stem a decline around the referendum.

There's not much headroom, with the flotation prospectus showing an operating margin around 2% - hence the stock plunged to 135p. This company had seen pre-tax profit more than double to near £17 million over its end-March years of 2014-16, reflecting a classic feature of the economy and stockmarket maturing.

Motorpoint's founders/directors continue to own over 40% of the groupAt this stage, cyclical businesses float after strong profits growth, at a price that soon proves more advantageous for vendors than new investors. Some £100 million was raised for the selling corporate shareholder, owned by Motorpoint's co-founder and other members of the management team.

In fairness, Motorpoint's founders/directors continue to own over 40% of the group and have just lately increased their exposure buying nearly £1.8 million worth of shares at 138p, with a non-executive director buying £49,000 worth at 140p.

But the net effect remains a transfer of risk to new investors at a much higher price. As prices for imported new cars rise, this could benefit the second-hand market, but all such discretionary buying is quite easy to defer in uncertain times.

UK "Red Flags" Report, comparatively more positive

Meanwhile, the Begbies Traynor "Red Flags Report" shows corporate financial distress down 6% in the third quarter, with construction and professional services seeing the biggest reduction e.g. as the government promotes more building and lawyers enjoy a boost from Brexit uncertainty.

This is no insight as to inward investment or how successful the economy's rebalancing will prove"Overall, the UK economy appears to be in a stronger position than expected following the EU referendum result."

Such a quarterly view is a snapshot, however. It acknowledges that Brexit terms will be significant for the longer term and "the stronger the UK economy becomes pre-Brexit, the better it will be able to withstand any post-Brexit shocks."

Fair enough, but this is no insight as to inward investment - which the UK has enjoyed significantly due to EU membership - or how successful the economy's rebalancing to exports will prove.

There's also the potential 2017/18 scenario of lower growth coinciding with inflation.

Highest portfolio cash levels in 15 years

But fear not, unless you are exposed to problem sectors. According to Blackrock, which manages over $5 trillion (£4.1 trillion), investors worldwide hold more than $50 trillion equivalent in cash, with up to 60% of clients' holdings in cash - amounting to three times US annual GDP and twice as much as the balance sheets of all the biggest central banks combined.

Medium-termers must heed profits warnings, but long-termers can be reassured by this cash propIt's manifestly a huge buffer, explaining why stocks don't drop meaningfully despite some problematic examples. Similarly, a Bank of America Merrill Lynch survey shows fund managers having built the highest cash levels since November 2001.

This isn't their occupational preference, it's an opportunity cost unless profit warnings multiply, yet a worse-case scenario is exactly what this huge extent of capital waits for, to pounce.

Medium-term investors, therefore, need to pay attention to warnings arising, while true long-termers can gain reassurance from this cash-prop.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.