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The planned rise in VAT will push prices of DIY and gardening products up further, with the sector already under cost inflationary pressures. Demand for DIY products is heavily reliant on the housing market and recent economic data from the US suggests this could be starting to slow.

A glance at the chart below of the FTSE 100 shows the early strength gave way to renewed profit taking later in the week. Optimism that greeted China’s decision at the weekend to allow greater flexibility in its currency faded, as concerns about the US housing market and the eurozone banking sector returned to haunt investors.

China’s surprise decision to end the Renminbi’s two year peg against the US dollar has been a long time coming and should encourage exports into the thriving economy, giving a boost to global equity markets in the near term.

However, housing market concerns resurfaced in the US, after data showed that existing home sales had unexpectedly fallen 2.2% in May and the sales of new US homes slumped by a record 32.7% last month to the lowest level since records began in 1963. Many analysts say the falls are due to the expiration of the home buyer’s credit, but the size of the drop was alarming.

The Federal Reserve also acknowledged the faltering pace of recovery, as it left interest rates on hold and warned that Europe’s debt problems posed a real threat to the US economic recovery.

Chancellor, George Osborne’s emergency budget passed without incident, as much of the detail was omitted and it was not as bad as initially feared. Even the “banking tax” was more benign than many of the best case scenarios analysts had been expecting and the impact on profits is expected to be minimal.

European equities have recovered well recently, with the Eurofirst 300 closing at seven month highs earlier in the week. There was some encouraging news on the German economy, as the Ifo business climate index reached a two year high this month, confirming the German recovery remains intact.

However, fears still linger and investors remain unsettled by the recent negative news flow on the European banks. BNP Paribas, France’s second largest bank, suffered a ratings downgrade by Fitch and Credit Agricole warned of a €400 million writedown on its stake in Emporiki Bank in Greece.

Technical analysis confirms the recent upward trend of higher highs and higher lows. However, the oscillators appear to be rolling over and look vulnerable to further weakness, despite the past two month’s upward trend. Near term targets are seen at 5300 and 5400, with support coming from the recent low and psychologically important 5000 level.

In summary, investors remain nervous over the global recovery and this week’s uncertainty cast fresh doubts over the possibility of a double dip recession. Volumes are starting to decline as we head into the summer and trading is likely to be choppy. I believe that support at 5000 should contain the recent weakness and the next milestone is seen at 5400.

The much hyped emergency budget naturally stole the headlines this week and our Chancellor rightfully summarised it as “tough but fair and aimed to re-establish creditability in Britain’s public finances”.

One main change George Osborne announced was a hefty hike in VAT by 2.5% to 20% in January next year. When the Labour Government previously cut the VAT rate to 15% in 2008, it cost retailers an estimated £90 million to implement the change. It will also add to inflationary pressures as most retailers will be forced to pass this onto customers.

Minutes this week from June’s monetary policy meeting already showed one member voting for a hike in rates in order to combat inflation, so further inflationary pressure will put additional pressure on an increase in interest rates.

The planned rise in VAT will push prices of DIY and gardening products up further, with the sector already under inflationary cost pressures. Demand for DIY products is heavily reliant on the housing market and recent economic data from the US suggests this could be starting to slow.

My least preferred stock in the DIY sector is Kingfisher (Epic: KGF), the owners of B&Q and Screwfix in the UK and Europe’s biggest home improvement store by sales.

The group issued a trading update on the 3rd June, which showed a 14% rise in retail profit to £146 million for the 13 weeks to 1st May, although same-store sales fell 2.8% in the UK, as cost cutting offset declining sales hit by poor weather conditions.

Kingfisher currently trades on a forward multiple of 12.1x, which is a premium to FTSE 100 rival Home Retail, owners of Homebase and Argos, which trades on 10.2x next years earnings. Forecast growth at Kingfisher is also lower, with only 15.9% growth expected into 2012, versus Home Retail’s 25.9%, which puts them on a less attractive PEG ratio of 0.76 compared to Home’s 0.39.

Home Retail also yields over double the dividend of Kingfisher at 6.3% per annum, versus 3.1%, which makes them considerably more attractive on valuation grounds.

 
As can be seen from the above chart of Kingfisher the shares have doubled from its lows in March 2009. The oscillators are becoming overbought, with the MACD histogram stepping gradually lower and the stochastic appearing to be rolling over.

The shares are trading only 10% off the annual high and in light of the recent housing market data and impending VAT hike I am inclined to suggest the shares are overvalued.

At the time of writing the share price is 224.9p and I believe the shares will decline in the short term. Near term targets are seen at 213p, 206.5p and 197.75p, with a stop loss at 238.5p.

This report was written by Mark Allen – Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Kingfisher, but client accounts may. The material in this report has come from Simply Charts and Kingfisher’s corporate website.