Confidence seems to have risen more
quickly, on less evidence, than in
previous ‘recovery’ rallies
􀀗 Fundamental valuations appealing on a
rapid recovery assumption; still too
early for many late cyclical business
services stocks
􀀗We raise Premier Farnell to OW as a
cyclical play, but cut Wolseley back to UW
from Neutral, and Sthree to Neutral from
OW (all ratings with volatility flags)
Is this the one true rally?
Some broader sentiment indexes are showing reduced yoy
declines. We believe indicators are demonstrating a pattern of
volatility that is normal as we approach the highest levels of
yoy decline – although this volatility does not guarantee that
we have now seen the highest rates of decline. Most of our
‘hard’ leading indicators are not yet showing this ‘bottoming’.
The market has accepted, and is effectively now discounting,
both a bottoming-out in rates of decline and a rapid return to
mid-cycle multiples on 2011e consensus estimates. Investors
in business services cyclicals are riding the ‘white swan’ of
bottoming-out and the bounce-back to normality.
Attempting to measure optimism
We have measured the rate of return implied by consensus
calendarised (CY) 2011e EPS estimates, assuming that the market
moves to mid-cycle PE multiples over 12 months. These
multiples imply considerably more comfort with that outcome
than in the 2001 beta rally, which was triggered by a similar (but
as yet broader) slowing in rates of yoy decline at the time. Current
stock prices imply that the market is now as confident about an
imminent recovery as it was in Q2 2003, when most business
services leading indicators had returned to yoy growth. We urge
investors to remember that smaller yoy rates of decline are not a
definitive indication that we have hit bottom and certainly do not
identify to us the rate of recovery to growth.
Although we see a few cyclicals that still have upside, more of
them have, we believe, run too far too fast.