"You're riding high in April, shot down in May
But I know I'm gonna change that tune
When I'm back on top, back on top in June. "
From That's Life by Frank Sinatra
So this is a delayed end of May update in the same was that Mrs May has delayed her departure as PM and leader of the Tory party. In my case the excuse is I've been busy on personal matters.
In brief as you know markets were poor in May and the Compound Income Portfolio (CISP) was also down, but by less than the overall market and therefore extended its out performance for this year and since inception. Please see the Portfolio tab for the full details of that and all the history since inception in the portfolio tab or at the high lighted links if that's of interest to you. You can also read more about the Scores from which the Portfolio is selected in the Scores tab & how to get access to them too.
Meanwhile in terms of the market timing indicators that I follow for the UK market, these remained in positive territory at the end of May and therefore suggest staying invested despite the wobble in May, as do the recent economic statistics from the US. Interestingly the Mid 250 was the least positive probably reflecting the more domestic orientation of its constituent and the on going sluggish growth / uncertainty brought about by the BREXIt impasse, but more on that later.
Since the end of May (the month) markets have cheered up as it seems that the US Federal Reserve has had a change of heart and decided to roll out a Powell put, so investors are now half expecting a rate cut by as early as next month with another to follow before the end of the year. That's quite a turnaround and thus we have had a decent recovery in June back toward the recent highs - so as in the words of Frank Sinatra we are nearly back on top in June.
Personally I'm not so sure it's off to the races again as the Fed may actually be acknowledging that they have over done the tightening and that a big slow down or even recession is on the way. Indeed the dreaded yield curve has inverted again in the US and this time more significantly by around 20 basis points or more as measured by the 3 month to 10 year curve - which suggests a recession probability of around 30% in the next 9 to 18 months or so, although PMI's in the US remain above 50 in the US but have dipped below that in a few places in Europe.
Thus it will be a case of remaining watchful to see how this pans out and whether the Fed are able to cut sufficiently quickly and far enough to keep growth going or if it is already too late to avoid a slide into recession. The other joker in the pack is of course Donald Trump and his trade policy (war) with China and how that turns out. I guess there's an outside chance he could be planning to reach an agreement to provide a boost to his 2020 re-election hopes - who knows how his mind works?
As for Mrs May can't say I'm sorry to see here going, but I do feel a bit sorry for her as delivering BREXIT seems to be a bit of a thankless task, even though her meaningless phrase BREXIT means BREXIT is not what she meant at all as I think she was a remainer at heart. Now we have the farce of the Troy leadership election to look forward(?) to. I'm not that confident that this will solve the BREXIT problem as even if a Johnson or Raab type candidate get in and are committed to leaving without a deal on 31st October if necessary, parliament and the Speaker seem determined to block it. Indeed Labour have said as much today, which makes it curious that people seem to think that the Tories would be obliterated if there was then an election. As assuming they had a BREXIT leader who tried to deliver BREXIT but was blocked by Labour wouldn't the 52% be furious with Labour & not the Tories? Personally I still doubt we'll ever leave and will probably be forced into another extension with the condition that we have another vote to get the "right" answer this time as far as the EU and UK politicians are concerned. Who knows maybe by then everyone will be so fed up with the whole business that they'll vote to stay just to get it over with four years down the line - what a waste of time and money.
So that's the end of the rant - That's Life I guess, so lets carry on regardless for now, but mind how you go out there and enjoy the rally while it lasts and may I wish you nothing but the best for your investments.
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Chuck Prince, Citigroup CEO - July 2007.
The non farm payrolls came out stronger than forecast last Friday & also confirmed that the US unemployment rate remained unchanged at 3.8%. This means that it remains below its moving average and therefore we can ignore the signal from the timing indicators for now and remain invested. In any event as discussed in my last post the headline indices have turned positive in this regard again after the strong first quarter from equity markets around the world.
This has come on the back of the US Federal reserve calling a halt to further rate rises and possible unwinding of QT for now. The recent IMF Q1 update to their outlook is quite useful in this regard as it suggests a slowdown this year in Global Growth to 3.3% followed by a recovery to 3.6% for 2020 and thereafter, although they do acknowledge the downside risks & policy priorities to avoid these. See here for full details and the graphic below.
Thus investors heaved a sigh of relief and piled back in after the Q4 wobble. Whether this is maintained and markets push onto new highs or fail at or below the previous peak will be data dependant form here. If we see some recovery in the economic data and perhaps a resolution to the China trade issue then In that event, may be this could just be the mid cycle slow down that was mentioned in the Cycles research I highlighted recently, which could then lead onto a record breaking economic expansion into the 2020's perhaps?
I suspect markets, perhaps after an interim swoon (sell in May type thing), could then resume their upward progress as defensively positioned investors and those sitting in cash might them feel compelled to pile back in for fear of missing out or FOMO as it is called. I saw some good stuff about these type of short term market dynamics etc here: https://fat-pitch.blogspot.com/2019/03/weekly-market-summary.html
While on the other hand if weak economic data continues or get worse then I suspect we may see the market have a setback to retest the Q4 lows in that instance. If we then slide into recession then we will be into a bear market, although so far most of the data does not suggest that's likely in the short term at least. It does however remain a risk for the medium term into 2020 I suspect. Unless of course the Central Banks can keep economies and markets going by cutting rates, keeping QE in place and making the correct policy responses if they see weakness as the IMF suggests.
For now it seems that we need to stay on the dance floor as market technical and the economic background remain constructive. You do however need to be aware of the risks you are running given high valuations in the US, although as I mentioned before maybe we are less exposed in the UK given valuations here? That may of course be a triumph of hope over experience and the apparent cheapness may just reflect the damage done to the UK by our incompetent handling of the BREXIT process?
Any way if you have the time it is worth reading the following post from John Hussman for some longer term context on the current situation we find ourselves in. Even though he is often seen as a perma bear, he too is dancing along while the music plays and the market set up remain "constructive" as he calls it. https://seekingalpha.com/article/4253224
If not then enjoy the appropriate titled song from dear old Steve Miller, because if you keep on Dancing you never grow old and you never stop Compounding either!
March turned out to be another positive month for UK equities with a total return of just under 2% from the All Share Index. This rounded off a positive quarter as global equity markets recovered in a v shaped fashion from the big sell off at the end of last year as the US Federal reserve blinked and stopped raising interest rates. Thus for the quarter the All Share returned 8.67% and this has helped to turn the monthly timing indicators that I produce for the UK market positive again for the main indices such as FTSE 100 & the FTSE All Share. The Mid & Small Cap indices remain below their averages, probably reflecting their greater exposure to the domestic economy and the fears about the effects of BREXIT on the UK economy, but more on that later.
Meanwhile the Compound Income Scores (CIS) Portfolio had a stronger month in March with a total return of 4.4%, thereby recouping most of the under-performance seen in February. This leaves it up by 13% in the quarter & year to date some 4.34% ahead of the All Share. Since inception it is now up by 74.43% or 14.95% per annum over the four years it has been running. This compares to 24.16% & 5.57% over the same time frame and annualised for the All Share index which I use as a comparison. See the Portfolio link above or at the top of the site to see the full table of returns over that time frame and a graph of the performance against various UK indices. As it is an anniversary of sorts, I am hoping to do an update post on lessons from investing full time for a living over the last 10 years for me personally and for the CIS over the last four years. So do check back for that later in the month.
In light of the return to a positive reading from the timing indicators I have reinvested the cash that was retained last month and added two new positions funded by this cash and the proceeds from one stock that flagged up as a sell due to the fall in its score. I was happy to see that one exit. There were two other stocks whose scores had fallen into the potential sell zone, but as they are both decent dividend growth stocks suitable for long term compounding given their long history of dividend increases I decided to give them the benefit of the doubt for now. Subscribers to the Scores will be able to work out which stocks I'm talking about from the Portfolio and they will see the stock sold and the two new positions in the transaction and reflected in the Portfolio when the Scores are updated today. If you'd like to learn more about the Scores and how you can access them, details of the portfolio and transactions then please click here or on the Scores navigation tab at the top of the site or in the three bars if you are on a mobile or tablet type device.
Despite my reservation about the outlook for global growth etc. and the potential for a recession at some point in the next year or two it does seem that all the BREXIT shenanigans have left the UK market looking pretty good value and this could protect it from some of the downside if the worst should happen on the economic front down the line. In this regard I would refer you to a recent interesting set of slides from Research Affiliates which showed that the average retiree in the UK should be OK going forward as a 60/40% portfolio in the UK is forecast to offer fairly attractive real returns if their projections turn out to be any where near right. They also suggest UK equities are priced to provide very decent future returns, albeit with potentially high / normal volatility of close to 20%. You should note that these are unhedged US$ returns, so I guess they could also be factoring some recovery in Sterling into that too perhaps?
So despite all the BREXIT concerns in the short term the above suggests that the outlook may not be as bad or as bleak as the main stream media make out or maybe it has created an opportunity? As you know I tend to agree with that view that it is time in the market that counts, but nevertheless I'm still keeping an eye out for trouble on the economic horizon, but in the short term that too seems to have cleared up a bit as Central Banks seek to keep the show on the road.
Meanwhile on BREXIT I suspect it will be resolved one way or another fairly soon. There is an outside chance that we could crash out without a deal on 12th April. I would however attach a small probability to that as the majority of MP's don't want no deal and they have stupidly ruled it out any way. In addition the EU don't want us to leave either and since a no deal would be worse for them then they are almost certain to grant another more lengthy extension I would have thought. I then believe this will lead to a much softer or BREXIT in name only, if at all. Alternatively as I have suspected from day one we may be forced to vote again and get the "right" answer as far as the political elite / EU are concerned. Indeed they have already suggested that the second referendum should be a choice between whatever "deal" on a soft BREXIT in name only they eventually come up with or on remaining, with leave not even being on offer on the ballot paper, which I guess would ensure the result they want! See this interesting piece on the likely way forward called UK Independence Day Cancelled which appeared recently on the Market Oracle web site & included a link to his very prescient piece from about two years ago about the Game Theory Strategy the UK should have followed to win, which then predicted the shambles we find ourselves in now.
Thus given the UK market looks cheap, the pound is probably undervalued, institutional investors are largely underweight and BREXIT ain't happening I think the UK could actually do relatively well. So you probably should keep calm and carry on compounding for now, although as I said earlier I remain on alert for signs of deterioration in the economic outlook which might signal more difficult times ahead. I think this is especially important given how mature the current economic and stock market cycles are at this point and the levels of debt in the world which have been encouraged by Central Banks super easy monetary policies over the last decade. Plus the fact that it is not clear if we are out of the woods yet as markets remain below their recent highs, so this could still be a bear market rally for all we know.
With that in mind if you have read this far, as a reward I'll leave you with this link to the Q4 letter from one of the Top Performing Macro Hedge Funds last year, who benefited from their bearish stance and who still see us as being in a market which is vulnerable given their Macro Model has topped out, valuations, debt levels etc. Enjoy and don't get carried away out there with this Q1 rally, as if we end up with a Corbyn led government then heaven help us and all bets are off!
As I flagged last week we had these out yesterday and as forecasters had predicted the headline rate of unemployment came back down this month. In the event this was by more than expected with the headline number coming in at 3.8% rather than the 3.9% forecast by the consensus. This is good news in so far as it take the rate back below its moving average and means that for now we can ignore the signal from the market timing indicators again.
The headline jobs numbers themselves and signs of faster rising wages did seem to spook investors a little, although I note the three month average job creation still looks fine. As with the headline rate it may well be that the actual job numbers have been distorted in the last couple of months by the US Government shut down too.
Thus as it stands it still looks as though the US economy is going along reasonably well in the short term given the above and the ISM indices still being well above 50 suggests that no US recession is imminent - famous last words! I also wonder whether we could still see the economy moving ahead for a lot longer yet, given what happened in the last cycle. Indeed the 2000/2002 downturn doesn't even show up in these annual US GDP numbers (shown below), although it was generally categorised as a recession as far as I remember, probably due to the at least two consecutive quarters of negative growth definition.
So may be we could see something similar this time with a mid cycle slowdown causing a valuation driven correction followed by more Fed easing and a resumption of the bullish trend, perhaps? The reason I say this is based on some work on cycles that I read a while back in Money Week which I made a point of keeping as it tied into the property cycle work I have covered in the past in the book by Fred Harrison and how this drives the economy too.
I reproduce the Money Week article below at the end of this piece, so take a look and see what you think, as given when it was written, the calls it made have been remarkably accurate up to now. The next stage it foresaw was a mid cycle slowdown / recession around 2019/20 followed by the rest of the bullish cycle up to 2025/2026 and with the FTSE up to 12,000 by then, happy days.
Finally, as a largely UK investor (yes I m prone to home investor bias) I think we are slightly better placed in terms of valuations, although that may just reflect the heavy weighting we have in mature slow growth / low return industries such as Banking, Mining & Oil.
Aside from this though there are always stock picking opportunities out there which you should probably focus on rather than indices, unless your an index investor. So if you are looking for more stock ideas or inspiration for that then don't forget you can find hundreds of good quality growing dividend stock ideas in the Compound Income Scores.
February was another good month for equity markets generally with the US S&P 500 continuing its strong run and regaining levels above its 200 day moving average in the process. The UK market also continued to rally although in common with other markets it lost some momentum toward the end of the month. Nevertheless the FTSE All Share still produced a positive total return of 2.3% which leaves it up by 6.56% for the year. In terms of where this leave the market in relation to the timing indicators. Unlike the US the UK market has not yet recovered beyond its 200 day moving average. It therefore remains below its moving averages that I use for this purpose by around 1.3% for the main indices and 2.2% for the Small Cap, although during the month it did look as though these would turn positive.
The Compound Income Portfolio had actually had a negative month, which may be not that surprising after its massive out performance in January. Thus it sagged back by 0.5% and thereby under performed this month by 2.77% but this still leaves it up by 8.23% for the year which is still ahead of the FTSE All Share by 1,67% year to date and 45.31% since inception in April 2015. Most of the damage was done by a couple of Marmite type stocks which score well but that some, including me, would find unpalatable to buy. These together with some draw downs in some more cyclical stocks explained the set back and while risers were in the majority, they were not sufficient to offset the losses from the big losers.
This months screening has thrown up a couple of potential trades, both of which I could question because one is a classic quality compounder, although its rating reflects this like a lot of these situations. while the second one is lower quality and therefore more lowly rated, but does have results coming up this month and had the CEO buy some shares recently. Nevertheless I decide to push the button on these for the Compound Income Portfolio and replaced one of these with a stock that brings something different to the portfolio, subscribers to the Scores will be able to see the details of these transaction in the Scores sheet when it is updated on Monday.
In light of the timing indicators mentioned above I decided to keep the second unit of cash raised as a precaution in case the market should relapse and retest its lows. I am however disinclined to take the hedging any further than that at this stage as we are not due to get the latest US Unemployment data until Friday 8th March. Having read around and looking at the commentary and forecasts on Trading Economics for this, I see that it is generally perceived that the US government shut down may have distorted last months figure and this month the rate is expected to fall back again to 3.9% which would probably reverse the signal from this or make it neutral at least for now. The other reason for waiting is that I also came across a more detailed model using unemployment as a recession timing indicator and this one suggests taht we would need to see US unemployment rising to 4.1% before this is triggered on their model. Waiting will also give us a better idea if the market recovery is likely to be sustained or if we see it relapsing this month and heading for a retest of the recent lows.
Whatever happens it still feels as though we are in the latter stages of this bull market to me, although who knows how much longer it can go on? Maybe we are into the last hurrah topping out process, where you have a peak, then a recovery which fails to break the high - I think we have seen this pattern before (see graph at the start of this post). So it will be interesting to see how this one develops from here or whether the Fed's change of heart and the minting of the Powell put can keep things humming along for a bit longer yet?
Amazing to see at the after Oscars Party that even the Luvvies and pop stars are up with the trend too in the video below - perhaps? Or for Older readers maybe a bit of Elvis could call it from here too?