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  • QE threat to unsettle Man Group? 0 comments
    Nov 6, 2010 2:20 PM | about stocks: GLG, MCRO, QAI, SPGH, DXJ, CPI
    It has been billed by many as the most important week of the year and the chart of the FTSE 100 below highlights the markets strong reaction to the Federal Reserve’s (Fed) highly anticipated statement on quantitative easing (QE).


     

    On Wednesday evening the Fed launched a fresh effort to support the US economic recovery, committing to buy $600 billion in government bonds, which lifted riskier assets around the world, despite concerns it could do more harm than good. The Fed gave itself further flexibility by saying it would regularly review the overall size of the asset purchase programme.

    Encouraging economic data from other parts of the globe offered further ammunition to the bulls, with the purchasing managers index (PMI) from China, the US and the UK reporting surprisingly robust manufacturing activity in the fourth quarter.

    Furthermore, the Reserve Bank of Australia and India’s central bank also unexpectedly raised interest rates, sending the Australian dollar through parity with the US dollar. The hike sent commodity prices to multi year highs, bolstering the heavyweight FTSE 100 index.

    In the background, there has been no respite for the peripheral eurozone debt problems, with the spread between Irish and German ten-year yields widening to another record amid growing concerns that the country would struggle to reduce its budget deficits, while Portuguese and Greek spreads also widened.

    Technical analysis highlights the break out above recent highs to levels last since in mid 2006, suggesting the medium term uptrend remains intact. Despite the underlying index moving significantly higher the oscillators remain well below their recent peak, indicating the momentum behind the rally is fading and a sharp retracement may occur with short notice.

    In summary, quantitative easing is going to give investors a short term shot in the arm as people are seeing that central banks are going to do whatever it takes to support the economy. After rising for weeks in anticipation of the stimulus I was surprised with the continued strength after the announcement.

    The general summer slowdown in the global economy seems to have abated, with recent US data showing the risk of a “double dip” is slowly receding, therefore I am somewhat surprised by the QE announcement as I expected it to be method of last resort.

    US equity prices are currently more than twice the average level long term cyclically adjusted price to earnings ratios should be. With high corporate profit margins and the effect of austerity measures ahead that must be funded via private sector cash flows, I believe this premium is unsustainable.

    Hedge fund manager Man Group (Epic: EMG) has been the biggest riser in the FTSE 100 this week, gaining over 11.5% after a well received trading update on Thursday.

     

    As can be seen from the above chart of Man Group the shares have gained almost 40% in the past six weeks, breaking out to ten months highs. Despite the fresh high the RSI remains below its recent peak indicating the momentum behind the rally is declining.

    The world’s largest listed hedge fund manager, which completed its acquisition of US based GLG partners last month, said that investment performance has improved and assets of the combined company increased to $67 billion from $63 billion at the announcement of the merger in May.

    After digging deeper into the numbers I am less convinced that the strong share price reaction is warranted. Before the merger was announced, assets at both Man and GLG had shrunk significantly from the 2008 levels. Man’s funds under management had fallen to $39 billion in March from $79.5 billion before the financial crisis.

    Excluding the GLG business, Man recorded a $109 million profit for the six months which ended September 30th, down 56% from a year earlier. This was a sharper drop than previously indicated due to a decline in fees from its AHL fund amid poor performance earlier this year.

    Man’s flagship AHL fund, comprising 55% of total funds managed, is up around 15% this year after posting losses of 16% last year and GLG’s hedge funds are up about 10% year to date on average.

    However, this week’s announcement of more quantitative easing could mean the improvement in performance may be short lived. QE distorts asset price trends, which is bad news for funds such as AHL that rely on exploiting trading ranges. Man previously blamed last year’s abysmal performance on QE, so I am wary that the same may occur.

    The shares currently trade on a comparatively expensive 19 times forecast earnings, considerably more than sector average at around 14 times. The dividend has also been rebased down to 5%, but with no earnings cover and net cash depleting from $1.7 billion to around £400 million it looks vulnerable.

    At the time of writing the share price is 290.8p and I believe it looks vulnerable given the stretched valuation and threat that QE poses. Near term targets are seen at 276.5p, 270.25p and 255p, with a stop loss at 302.5p.


    Disclosure: no position
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