I won't spend long on this part, probably best described in one word - carnage. So rather than getting bogged down in reporting % moves in markets etc. I'll try and discuss some of the bigger picture features and venture some opinions / guesses as to what might come next. I will however quote some figures for you in the Portfolio review section later on what was one of the worst quarters on record, just so you don't feel hard done by. If you are in a hurry then skip to the end where I've done a bullet point summary, but I'd encourage you to read the full post if you can possibly spare the time.
Market Timing Indicators
As for the UK Market Timing indicators which I have been producing / following for a while now these have obviously all gone heavily negative and indeed the most negative since I started compiling them back in 2014. They are all between 19% (FTSE) and 22.6% (Mid 250) below their trends at the end of March 2020, so we will need to see quite some recovery before these turn positive again. As such on their own they signal that you should be reducing risk / be out of the market.
Regular readers or those with good memories may recall that I have also been tracking these along with economic indicators which might signal a recession ahead. As the original research that prompted me to start producing these suggested this was the best way to improve the signal and avoid whipsaws from dips below the trend which get reversed. As of the end of March these economic indicators had not triggered. These will though as of Friday 3rd of April when some horrendous Non Farm Payroll numbers are expected to be announced and the US Unemployment rate will blast upwards. In addition Manufacturing PMI's have come down below 50 in March and are expected to fall further in April too.
Thus with recession signals triggering the model would suggest this is the time to go defensive, sell everything and switch into treasury bills or cash. This was shown to improve on buy & hold returns and market timing based on the trend without the economic triggers by avoiding the whipsaws. You can see my original post about this here & the authors original post - In Search of the Perfect Recession Indicator.
The slightly unfortunate thing in this case is that this has been such an unprecedented event that the market has already crashed in record time and was already down by around 30% or more before the recent rally left the FTSE All Share with a negative total return of -25.13% for the quarter. Given the last two proper bear markets accompanied by recessions led to 50% or so declines I guess this one could only be half way down, so maybe it is not such a daft idea if you have a small portfolio and can be nimble enough to sell up and get back in.
Outlook For Dividends
What we do know is that the shut down of many economies around the world is unprecedented and many forecasters / economists (for what they are worth) are speculating that the economic downturn / recession will be worse than that endured during the Global Financial (GFC) in 2008/9 and some are suggesting that unemployment could spike up to levels last seen in the Great Depression. The knock on effect of that and Companies inability to forecast in the short term is that dividend cuts and suspensions / deferrals have come through much more quickly and to a greater extent than seen back then.
Indeed on the subject of dividends looking at the Link Asset Service Dividend Monitor this showed that dividends in the UK only fell by around 13% in 2009 to £54bn in total before stabilising in 2010. Since then they had doubled to £110bn, although Link did think they would have fallen back to about £103bn. This time around apparently dividend forward contracts in the derivative markets are indicating cuts of at least 30% and up to 50% in Europe. While there was a good piece from John Kingham looking at a long history of this in the US which suggested that the combined dividend of the 500 largest US companies has decline, multiple times, by more than 20% to more than 50% over the last century. The 50% falls came after wars and around the great depression.
So since current unprecedented conditions have been likened to a war and raise the outside possibility of a deflationary depression, as he says income investors should prepare for the worst and assume that dividend income form the markets might get cut in half this year. Which if it comes to pass would take overall UK dividend back to where they started in 2009.
One would however expect that they would then stabilise and potentially bounce back quite strongly thereafter next year as hopefully normal service is gradually resumed in the second half of this year. Of course individual experiences will differ depending on the make up of your portfolio and may be better or worse than this.
Compound Income Portfolio (CIP)
Which brings me nicely onto this and what has happened to it this quarter and what my plans for it are going forward from here. As this is also the fifth anniversary of the Portfolio being launched I had hoped that this would have been a good time to highlight the longer term performance but sadly I guess no one will be that bothered now, but more on that later.
After the first two months this year the portfolio was holding up well having been up slightly in January when the market was down and was over 6% ahead of the index by being down less in February too. That trend came to an end in March as many Mid Cap and Smaller Companies, which the portfolio has a greater exposure to than the broader index, played catch up and fell heavily. In addition one or two position which were more sensitive to shut downs of activity in the short term also fell more heavily. Thus the portfolio recorded its worst ever monthly fall of -22.16% compared to the -15.07% from the FTSE All Share. Year to date this leave the CIP with a -26.83% total return and therefore -1.7% behind the return from the FTSE All Share (which I use as a benchmark) quoted earlier.
Which is all very disappointing but not that surprising in the circumstances. So what about the longer term and the 5 year returns, which are quite frankly more relevant and a decent time frame over which to judge whether a portfolio based on and selected from the Compound Income Scores has any merit. Well the picture as shown in the graph at the very end of this piece is not too bad even if I say so myself. This is because the CIS has still returned 48.1% over that time frame or 8.2% per annum versus 1.9% or 0.4% per annum from the FTSE All Share, so I must be doing something right or I was very lucky or somewhere in between I guess. Out of academic interest I decided to check how this compared with other UK funds that had been available over the last 5 years both of an open ended and closed end or investment trust variety.
On checking I noted that the top UK Equity Income OEIC was Trojan Income with a total return of just 12.5%. While in the All Companies Sector out of 250 funds there were just 4 funds which bettered this return which were MFM Bowland +77.9%, Chelverton UK Equity Growth +75.9%, CFP SDL UK Buffetology +60.4% and Slater Recovery +48.7%, with figures taken from Trust net. So they might be worthy of further investigation if you want to go down the fund route or they might be about to blow up if the past is no guide to future as the marketing blurb says? I did notice a few names that the CIP has in common with these so they are probably fishing in similar waters to a certain extent and probably structuring their portfolios completely differently from the index rather than the closet indexing that still tends to go on in mainstream investment houses.
As far as Investment Trusts went I was somewhat surprised to find there were hardly any UK Trusts that had done better over the last 5 years. I say surprised as my perception is that Investment Trusts tend to do better thanks to their closed end nature and maybe lower charges, plus the benefits of gearing. Having said that I guess any gearing may well have been a hindrance rather than a help given the now low returns over the last 5 years unless they managed that very actively and well. In fact the only one that I could find that had done better on a NAV total return basis was a small cap fund - Standard Life Smaller Co.s - which returned 52.6% according to figures from JP Morgan Cazenove, although AIC figures are also available. The only other fund that came close was from the much trumpeted Nick Train and his Finsbury Growth & income which returned 42.1% and he certainly falls into the category of doing things differently too.
As to the income funds they were all surprisingly poor too, but the one that is probably closest to what I'm doing in terms of the make up of the portfolio is probably Gervais William's Diverse Income Trust which has returned 11.1%. Other than that Troy Income & Growth cropped up again with +17.7%. While a quick look at the Stockopedia guru screens showed only the Geraldine Weiss & Dividend Achievers delivering anything much with 16% & 12% respectively, which if you add in dividends might be around 36% and 32% so close to the CIS, but no cigar! So maybe the Compound Income Scores are a Guru screen you've never heard of! For the sake of completeness of all their Guru screens Jim Slater, Peter Lynch, Price Momentum & James O'Shaughnessy Tiny Titans did better so they may be worth investigating if you're a Stockopedia subscriber. If not you can get a two week free trial here.
So I am quite happy with all that but not getting too smug or carried away given we are going through an unprecedented event and nobody really knows what will transpire. Nevertheless once Companies feel able to forecast again and things start to get back to normal I'm reasonably confident that the Compound income Scores will continue to be a decent guide as to where to look for good quality companies which should be able to grow their dividends and thereby provide decent returns over time.
With that in mind and thinking about the Market Timing Indicators mentioned earlier I have come to the following decision. Since I am sceptical of market timing and I would like to see how the Scores perform during a downturn, I have decided to keep the Portfolio going and remain pretty fully invested. This will also enable subscribers to see which stocks I pick during this next phase rather than just stopping. Thereby I'll be aiming to benefit from time in the market rather than timing the market and not have to stress out about trying to time the bottom and when to re-enter. Against that I'll continue to produce the market timing indicators and the follow the economic signals to determine when it would have otherwise re-entered and see what the difference is in terms of the valuation at that time versus what it was at the end of March 2020. So I'll highlight this months valuation in the table, although I think March 2020 maybe seared on our memories any way.
At least it will be a useful real time test of the efficacy of using the timing indicators in this way in these circumstances and the Scores during a downturn. Personally I suspect things could still get worse in the economy and markets from here as markets have usually had their worst losses in bear markets when they are accompanied by a recession, which seems likely on the back of this. Indeed some commentators who I hold in high regard suggest that fundamental value and therefore better long term returns may not be reached until the S&P 500 get down into the 1700 to 2000 range versus recent levels of around 2500 after the sell off and rebound. In the UK I suspect we could end up with FTSE trading somewhere in the 4000 to 5000 range before we see the low, but don't take that as gospel just my gut feeling based on past downturns. Against that there has been a massive response from Governments and Central Banks as expected and this might well help to offset the worst of the hit from the Corona shut down. Nevertheless I'd be surprised if we didn't see at least a re-test of the recent lows just under 5,000. It is however worth remembering that it is a market of stocks and all this volatility will likely throw up some decent opportunities along the way in individual stocks. Indeed I have made a couple of successful acquiistions of stock myself through the recent sell off.
With that in mind I made a few changes to the Portfolio this month with three stocks that had seen falling Scores and which i think will be vulnerable to the current and future conditions exiting the portfolio. These were replaced with four new stocks, all of which are still running their operations. Three have cash rich balance sheets and could potentially benefit from the turmoil. Subscribers can see the details of these trades and brief rationale for them on the Transactions section of the Scores sheet. I'll also reserve the right to perhaps make some intra-month changes rather than the usual monthly screening given the market conditions.
Firstly thank you if you have got this far as these are extraordinary / unprecedented times & I sincerely hope you and yours are keeping safe and well through all this even if your portfolio may not be.
I have to say I wasn't and i don't think anyone else was expecting this, although clearly there had been some on going concerns about valuations in the US prior to this. So maybe the virus was just the pin that the market had been waiting for? Of course how economies and markets come through this remains to be seen, will we see a V shaped recovery or will it be a more protracted affair given the economic damage done by all the shut downs?
All we do know is that dividends have fallen in the short term in an unprecedented fashion, although I'm hopeful that they will stabilise and bounce back at some point later in the year.
Markets will discount this and bottom out at some point and given all the support offered by governments and Central Banks this may come sooner rather than later, but as is often said: “Bear markets have three stages —sharp down, reflexive rebound and a drawn-out fundamental downtrend.” As it looks like we have entered a bear market I would therefore at least expect a re-test of the recent lows.
Indeed a good US commentator that I follow thinks 2300 on S&P 500 may be fair value based on median PE's, but we often see an overshoot so 1700 to 2000 is his suggested Zone for getting more positive and reinvesting etc. This would tie in with my thoughts in the UK that the 5000 low or thereabouts may well get re-tested and better opportunities may present themselves in the 4000-5000 range.
As ever though it is a market of stocks and rather than focus on headline indices time is probably better spent focusing on individual stock threats and opportunities as we go forwards from here. We may well be in f or a bad and possibly even a deflationary recession in the short term. Beyond that with all the money printing etc. one would probably expect inflation to become more of a problem this time around down the line. This would still suggest that Equities & real assets will be the place to be for the long term.
It sometimes feels like I'm the only person in the Country who has not had their daily routine disrupted by all this as I've been "working" from home and self isolating for 11 years before this any way! So absolutely no change to my daily routine with the markets still being open and all, apart from not being able to go out for shopping, dining, leisure and entertainment when I want. Routine is important if you are new to this, perhaps I'll try and do a blog about that.
As for my portfolio and what I'm doing personally. Well to coin the old phrase I'm keeping calm and carrying on investing. Yes my portfolio and net worth has taken a big hit, but then they went up a lot prior to this so I'm OK with that as I always say you have to take the rough with the smooth.
At times like these it is more important to avoid losers and losing too much. While it may be a bit late for that now it is always worth re-assessing and adapting as events unfold as far as you can, Indeed I'm glad I did a bit of that last month as the crisis started to hit and sold a few stocks which seemed more vulnerable to all this. In reality though I was never going to be willing or able to sell everything and I wouldn't want to. Who know maybe I'll come to regret those words when this is all over with?
As I mentioned in the previous update I came into this fairly well placed having moved more defensive and reduced cyclicals. On top of this I had built up substantial cash reserves. So even if some of my day to day income portfolio stocks end up cutting their dividends I'm sure I'll survive even with no bailout, government loan or furlough payments (can I get those for my Butler and House maid I wonder - no only joking). Any way I guess that's the point of / beauty of financial independence. Meanwhile I'm still investing our ISA's for the long term but sitting on a bit of cash in those too pending forthcoming opportunities and about to top them up with this years allowance next week too.
Any way at the end of the day its only money, as ever health, family, friends and your local community should be more important. Here's to hoping we all pull through and as the song says....
Towards the end of November last year I flagged up Residential Secure Income (RESI) in a post that you can see here if you missed it or can't remember it. It is basically a play on social housing and you get to buy in at a discount to NAV & it offers a decent yield of over 5% which looks reasonably well underpinned which is no bad thing is these days of dividend cuts and suspensions left right and centre.
Any way they put out a COVID-19 update today where they gave an update on the portfolio, financial position and dividend. All seems fine, so check that announcement out if this interests you.
I added to my holding in the 70's during the recent sell off after they announced they had been awarded Investment Partner status by Homes England. Investment Partner status with Homes England extends ReSI Housing's ability to access grant funding to include schemes outside of London and bring forward much needed additional Affordable Housing at national level. So sounds promising in terms of their ability to deliver more homes, given they probably can't issue shares at a discount. i also noted that 4 directors were buying shares around this time too which gave me some reassurance.
It has done a decent job for me as a boring defensive play (see chart below) outperforming by about 20% and looks like it should continue to deliver the dividend too, so two ticks there. I guess there could potentially be some falls in house prices, but given the nature of their properties and the discount I'm not too worried about that.
Finally below the chart see a decent presentation that they did last year which might give you a better understanding of the business if it is of interest to you.
Further to my last post I thought I would do another quick update as the mayhem / madness in markets has continued and got much worse as the Corona Virus pandemic panic has spread around the World. After the lock down in Italy which has now just been extended beyond two weeks as I write, we are seeing similar things in Spain & France with likely the UK and maybe the US to follow.
Scary times indeed and it certainly seems to be trashing all economic forecasts and expectations in the short term & worse we don't know how long this may go on although China does provide an encouraging precedent that it may not be too long lasting if Western Countries can get it under control soon. Indeed it looks like after about 5 or 6 weeks Beijing is starting to slowly return to normal thus far, although Boris with his herd immunity strategy seemed to be talking about 12 weeks last night.
So maybe we might write off about 1.5 to 3 months of economic activity or 1/6 to 1/4 say. Which in itself might well be worse than the 2008/9 recession let alone any knock on effects that linger thereafter. So no wonder that the market has crashed I guess. Just wish I hadn't been so complacent about the effects of this virus, but I don't feel so bad about that as even Ray Dalio and Bridgewater Associates along with some other Hedge Funds go caught out by this too. Not sure why they didn't quarantine all the sick and elderly in empty hotels while letting the rest who are likely more mildly effected get on with and self quarantine as required without shutting whole economies down? But hey I'm not a virologist and any death is terrible so presumably they know what they are doing - hopefully.
it is probably too late to be panicking (in the stock market if not the Supermarket seemingly) although personally I did do some selling as things started to cut up rough but now wish I had done more given how far some of the stock I sold have fallen. But hey ho you have to take the rough with the smooth in this game and I have certainly enjoyed the ride up in the last eleven years. I did move more defensive and in addition to normal rainy day cash reserves I raised a fair bit of cash last year as we were moving home and needed some extra cash for that. Plus with the yield curve inversion I was worried about a recession ahead at some point. As we came into the year the market seemed to have forgotten these worries only for the Virus to finally cause the crash and bring on a recession.
Going forward it remains to be seen how this all works out with interest rates being slashed to record lows and central banks and governments flooding the markets with unfunded cash left right and centre. Its not clear how any of this get paid back, but I saw John Stepek of Money Week talking about this being the start of some kind of debt Jubilee with some or all of it maybe getting written off - e.g. Central banks just cancel the bonds they have been buying maybe? Guess it could all be deflationary in the short term followed by inflation thereafter due to all the money printing - quite frankly who know, your guess is as good as mine. As I said last time we are sailing or hunkering down as it were in uncharted waters.
As for the Compound income Portfolio, this normally does monthly screening. However it got its allocation of Ninety One Plc (N91) via the de-merger from Investec with great timing on the 16th March. This fell about 25p below the bottom of the price range 175p to 225p that was quoted, which didn't seem much versus the falls in the market & the hit taken by other asset managers. I noticed that the Employee Benefit Trust has been buying so I took the opportunity to slot my stock and that for the Compound Income Portfolio into this given it was a small holding and their profits and dividends may be pressured by all this. Plus the fact that other asset mangers have nearer halved during this period I think there could be more downside here in the short term. As for the balance of Investec that seems to have cratered like everything else & looks incredibly cheap, but again who knows how banks pan out from here. Their year end update today seemed OK but like everyone else they can't really say what the future holds.
With that in mind I would just caution subscribers to be careful with the Scores at the moment as they will reflect historic forecasts, which in the main do no reflect much if any of the likely hit to earnings other than for those who have already initially warned about the effects. In addition we are seeing lots of corporates suspending and even scrapping originally declared but not yet approved dividends so you probably can't rely on all the forecast yields being accurate, but again that comes with the equity territory. Having said that these are quite extreme circumstances which could mean that the dividend cuts this time around could be even worse than normal and those seen in the 2008/9 so watch out and be careful out there but don't you know....
March so far has certainly been a challenge for investors as the markets finally seemed to have panicked as the number of Corona virus cases continued to ramp up around the world and Italy went into lock down.
Against this background Central Banks including the US and UK have undertaken emergency cuts in interest rates as they seek to protect their economies from the negative effects from the virus in the short term. In addition to this governments are also likely to be coming forward with various measure on the spending and fiscal side to provide support and bolster economies too.
So given that and the fall in the markets so far, which is getting on for a fairly normal 20% correction it may not pay to get too bearish down here. That is unless this all leads to a larger and longer lasting recession rather than a v shaped affair if the virus effects and counter measures work out satisfactorily. As ever time will tell on that one, but as of now the other economic indicators I follow are not yet signalling a recession, although there does seem to be a increased risk of one in the short term. If that does come to pass then you would need to be prepared as Warren Buffet says for your holdings to be cut in half in the short term. If you are not prepared for that then obviously you would need to make other plans.
Meanwhile the Compound income Portfolio has been hit along with the rest of the market, but given it has no direct exposure to the oil sector, I think it should have fared reasonably well again in a relative sense at least. Indeed looking at the various metrics on the CI Portfolio as at last nights close it seems to be on 13x forecast PE with a 4% expected net yield on the back of forecast 1 year dividend growth of 18%. We should however take those forecasts with a pinch of salt as they could be vulnerable to downgrades if a recession does really take hold rather than a short sharp shock from the virus.
Meanwhile it is budget day today and this is widely expected to include quite a number of spending commitments on infrastructure type things with road, rail, telecoms and flood defences already being mentioned as recipients I think. On that basis I think it should be quite good for a stock called Renew Holdings (RNWH) which recently entered the CI Portfolio based on its good Scores and decent value metrics.
This one jumped on the Conservative Election victory but has drifted off a bit with the market recently, although it has out performed by falling less. It seems to tick many of the boxes of areas which are likely to be seeing extra government spending as follows:
What's not to like? Apart from the fact that it is construction related, which is often bad news when you are talking about contractors (see Costain today). The saving grace here may be that most of their stuff is more related to on going maintenance and upgrades etc. which should make their revenues & margins more predictable. I also seem to remember Paul Scott mentioning working capital financing by clients seeming hefty & negative assets etc. See here if you are a Stockopedia Subscriber. If not and you'd like to check it out here and if you sign up I might get a referral credit off my subscription.
The only other thing that slightly concerns me about the limited assets on the balance sheet, from reviewing past accounts, this seems to result from a few asset write downs in subsidiaries over the years which I don't quite know what to make of. It could mean that past profits were overstated and they have taken the losses through the balance sheet to hide this. They did however have a stated aim of raising margins over the last few years so maybe they were just tidying up an old structure by closing down lower margin operations to focus on the higher margin maintenance type work. Any way I'll give them the benefit of the doubt for now and don't forget to do your own research and make sure you are comfortable with these aspects if it is one that attracts you too. Happy Budget Day - hopefully barring any nasty surprises on the tax front!
A more difficult month, to say the least, after the mixed start to the year that we saw in markets in January. So equity markets in the UK and around the world saw further negative returns, with the FTSE All Share, which I use as a benchmark for the Compound income Portfolio, providing a negative total return of 8.9% which leaves it negative by 11.9% YTD too. This came as markets suddenly seemed to get spooked about the potential negative effects from the spread of Corona virus having been fairly relaxed prior to that.
Compound Income Portfolio
Against this on going negative sentiment in the market it was unsurprising that the CI Portfolio saw negative returns too, albeit that the -6.7% was less than the -8.9% from FTSE All Share in February. This leaves the portfolio down by 6% YTD (having been up in January) versus the 11.9% negative return from the broader market. So at least some decent out performance in the bank should things get more difficult as the year progresses, not that you can spend relative performance! If you would like to see the full performance history please click here to view.
With this months screening there were a couple of stocks which came up as natural sales based on their deteriorating Scores & I did decide to top slice Avon Rubber (AVON) this month as the position size approached 10% as it held up well in the market carnage & I wanted to lock in some of that out performance having enjoyed a brilliant run in the stock from under £10 when the portfolio first bought in. This was also driven by the valuation with the PE of around 27x and a dividend yield of well under 2%.
In terms of reinvesting the proceeds from these sales a couple of names returned to the portfolio as their Scores, valuations and prospects looked satisfactory enough to justify a purchase, although one of them could be vulnerable to the virus causing public event shut downs, but one never quite knows how the potential spread of the Corona virus may hit any stock in reality. Aside from those I added to the portfolio's holding in Investec (INVP) as it has fallen further with the market and they have announced the pricing range for the Asset management arm which seems to be roughly as expected. This also helped to reinvest some of the proceeds of one of the sales which was also in the financial sector. If you'd like to find out more about the Scores that help to drive the stock selection and subsequent performance of the Compound Income Portfolio then please see the Scores & Portfolio menus or click here to learn more about the Scores and how you could gain access to them.
Market Timing Indicators
Given the fall in UK equity markets this month these all fell below trend into negative territory and therefore signalling a potential negative stance on the market. However as longer term readers may remember I don't follow these signals unless they are backed up by other economic indicators signalling a likely recession in the US to avoid being whip sawed. As of now these economic indicators are not suggesting that with the latest US PMI figure remaining just above 50 this month for example.
Nevertheless there is a risk that the Corona virus could dramatically cut global growth if it turns into a serious global pandemic, with the OECD for example suggesting a near halving of global growth if it does rather than a 0.5% hit for a contained outbreak. The more extreme outcome, or domino effect as they call it, would equate to a global recession. So no wonder markets have suddenly woken up to the potential threat of the virus, but we will need to see how it pans out from here and what response governments and central banks come up with in terms of fiscal stimulus and monetary policy easing to counter it. Indeed markets are already looking for the US Federal Reserve to cut rates by 0.5% fairly soon. Plus if the spread is contained, then I suspect in those circumstances this could turn out to be a run of the mill 20% or so correction and we could get a v shaped recovery.
Summary & Conclusion
A tricky month and an outlook which is difficult to call given the uncertainties surrounding the spread of the Corona virus. That and the negative signal from the market timing indicators suggests it is probably right to remain cautious for now, but not panic at this stage as we see how the virus and economies develop in the months ahead.
The main concern is that this all comes at a time when economies and markets are vulnerable after such a long rising streak which doesn't leave much protection to the downside in terms of valuation support or monetary & fiscal flexibility. As ever we seem to be continuing to sail in uncharted waters, although previous crises do offer some guides and it has usually paid to take advantage of crises and invest for the long term by being greedy when others are fearful as Warren Buffet says. Indeed the Sage of Omaha, said the other day, if you are likely to be investing for at least ten years then you probably should not worry too much about the effects of the current news in the short term, but you do need to be prepared to live with the volatility & the potential for your stocks to halve that it brings along the way (usually in a recession), which unfortunately we could be facing if we end up with a serious pandemic on our hands. So mind how you go and Keep Calm and Wash your Hands!