Compound Income Scores Portfolio Performance
So the brief spell of Summer like weather gave way to a more soggy end to the month and so it proved in the Stock market too. The FTSE All share after a strong start in line with the weather sold off mid month before recovering somewhat toward the end and returned -1% for the month as a result. This relapse in the market came as there were some concerns about a Chinese property developer going bust and that being a Lehman type moment for the Chinese economy. The authorities there seem to have that under control though, but on going inflation worries and supply constraints in certain areas also weighed on sentiment more generally.
Meanwhile the long run of outperformance by the Compound Income Scores Portfolio since last November finally came to an end in a very disappointing fashion as it returned – 5.9% on the month. The Portfolio has outperformed by over 10% in the year to date with a total return of 24.4% and it has compounded at just over 15% per annum since inception just over 6 years ago.
It is therefore perhaps not too surprising, given the strong run it had prior to this, that some underperformance at some point was probably inevitable. In addition the FTSE 100 held up better than the Mid and Small cap parts of the market where the portfolio has been and remains overweight. That’s just the nature of this investing game and you have to take the rough with the smooth as I always say and not get carried away when things are going well and equally not get panicky or depressed when you have a bad run. As long as you have confidence in your process and are prepared to accept some volatility in your capital in the short term for potential gains in the longer term, which is after all what investing is all about.
There were quite a few contributors to the poor performance this month with 6 stocks underperforming by more than 10% on either fundamental news flow or profit taking in the main. The two worst examples were CMC Markets (CMCX) which fell by around 30% on the back of a poor trading update / profits warning as markets became calmer over the summer and they saw some relapse from the extra trading they had seen in the previous quarters and last year when the pandemic was in full swing.
The other big faller to a similar extent was Luceco (LUCE) which succumbed to a heavy bout of profit taking as their excellent results didn’t lead to any further upgrading of forecasts. This profit taking was probably also prompted by their honesty in admitting that they had seen an extra boost from Covid trading and highlighting cost pressures, although they have been able to deal with those thus far. Their Score fell back to the lower end of the top quartile as they did see a few small downgrades on the month but it stays in the portfolio on that basis and it now also looks better value on a mid teens PE with a well covered 2.5% or so yield.
On the positive side of things there were not too many, but S & U (SUS) put in a good performance after their trading update which led to upgrades which I covered in the mid month update post. While City Of London Investment Group (CLIG) responded well to their full year results reported in mid month which led to some upgrades. While the 10% increase in the dividend for the year was also presumably well received given the dividend background surrounding the pandemic.
British American Tobacco (BATS), EMIS, Strix Group (KETL) & Paypoint (PAY) all featured as holdings with scores in the second quartile this month & as part of the process I therefore consider whether they should remain in the portfolio or if there might be better cheaper alternatives available. Of these I decide to give BATS and EMIS the benefit of the doubt as their scores were not that far into the second quartile. BATS remains cheap as they continue to manage the decline of tobacco products and invest in new vaping products.
While EMIS continues to trade well as reported in the results recently and they are confident of hitting their full year targets. So I’ll continue to run that one as a quality compounder for now although the rating has got a bit richer. I also decided to keep Paypoint again as they enter their close period ahead of the H1 results in November. A further director purchase by the General Council and Head of Compliance just before that helped to sway my decision, while the coming energy price hikes should help to boost their declining bills paying business.
I did however decide to let Strix Group (KETL) go as a bit like Luceco, even though they did report good results they also struck a note of caution on current market conditions and saw a few small downgrades. In addition the rating was not that cheap on still over 21x PE and with a Score of less than 50. Nevertheless it does appear to be a good quality business with a well protected dominant market position, so I wouldn’t put you off holding it for the long term. That’s just the way the Scores process works and it also felt like the time to rotate into some better value given the inflation / interest rate outlook. With the proceeds from this sale and some cash which had accumulated from dividends over the summer I was able to add a couple of better value situations.
One was a housebuilder, despite my own personal reservations about the timing of this, but as several had appeared towards the top of the list I decided to follow the Scores even if they may be a bit rear view mirror in this case. Housebuilders will probably never be highly rated given their cyclicity, but they currently look fairly cheap within their usual 7 to 10x PE rating ranges. This probably reflects concerns about over heating post the ending of the stamp duty holiday, affordability, plus labour costs and materials pricing and availability. Against that interest rates remaining low (for now) and the on going supply demand dynamics continue to offer support. So again I’d leave you to decide if this is a sector you want to participate in. There was also a good Podcast from Money Week which featured an interview with Gary Cannon of Phoenix Asset Management, who had some interesting comments on the builders and remains a bull of the sector.
The other value stock I added, was even cheaper than the housebuilders and subscribers will have seen the details of this in their Scores sheet. In addition to this I also decided to sell CMC Markets (CMCX) on the back of their profits warning (even though it did not score outside the top quartile) and switch into the similar IG Group (IGG) where I prefer the business model and it scores more highly than CMC having had a positive update last month in contrast to CMC.
Summary & Conclusion
After a disappointing end to the summer in the UK we also had a disappointing start to the Autumn in markets and also for the Compound Income Scores Portfolio. This relapse in the market came as there were some concerns about a Chinese property developer going bust and that being a Lehman type moment for the Chinese economy. On going inflation worries and supply constraints in certain areas also weighed on sentiment more generally.
There seem to be concerns that this will retard the on going economic recovery and some of these pressure like supply shortages, commodity price increases and shortages of labour seem likely to put pressure on corporate margins which may well cause the market to continue to struggle in the short term until this picture becomes clearer. Some suggest that this could presage another leg of outperformance for value stocks in the short term if rates rise (or bonds sell off) on the back of higher inflation as hinted at by the US Federal Reserve.
With that in mind I used this months Screening to add a couple of more value orientated shares to the portfolio after taking profits in the more quality growth situation, Strix Group – which had enjoyed a re-rating during its time in the portfolio. While in the UK more widely, the market, for once, seems better placed with its bigger exposure to energy and commodity sectors.
While the UK economy seems to be suffering badly from the after effects of the Pandemic, the resultant supply shortages and the squeeze on energy prices. As a result stagflation fears have stirred given the hit to incomes and coming benefit cuts and tax rises. As a result some fear we might face a Winter of discontent much like the 1970’s which saw three day weeks and power cuts which I remember from my childhood. Despite this politicians have insisted there are no fuel shortages, that Christmas will be fine and that we won’t see power cuts even though some industry representatives claim otherwise.
Given that and the inflation outlook, bonds remain a no go area for me and so personally I continue to rely on a mix of equities and other real & alternative assets to try and maintain and grow my capital and income in real terms. I would highly recommend reading the recent final results from Ruffer Investment Company in this regard and particularly the Investment Managers comments starting on page 19.
After a recent visit to Thatcher’s farm to see their Cider production facilities, it put me in mind of Mrs Thatcher’s comment from the last time we had stagflation & as Maggie May have said "There is no alternative" in terms of sticking with equities. They are simply the best way for me, although I saw that Tina Turner has decided to cash in her royalties which may be the best way for her at her at the age of 81, although I do have a few Hipgnosis Songs Fund (SONG) as part of my alternative assets exposure.
Any way that’s all for now as I must get off down to the shops and get some candles, a frozen turkey before they sell out or go up in price. I’ll leave you with some music appropriate to the above comments.
Today we have seen a small negative print for the latest CPI figures in the UK, although I seem to recall the RPI went negative in 2008/9 so it is not the first time we have seen this in recent years. However, personally I am not getting too worried about that becoming entrenched as you have to go back to the 1920's to 1930's to see the last real period of sustained deflation in the UK.
I would say that we could have faced a similar depression type scenario and deflation in the last few years if the authorities had not learned from history and cranked up the printing presses this time around with the various Quantitative easing measures etc. However, it does mean we are now in uncharted waters, with huge amounts of debt still outstanding and economies generally being sustained by cash being pumped out by central banks and competitive beggar thy neighbour currency depreciation.
Of course it could be that the Central Banks have just delayed the day of reckoning and the word economy and markets could eventually come crashing down under the weight of all this debt as deflation takes hold. In my view though inflation is more likely to be their chosen route to get rid of the debt over time, which they did quite successfully for a few years in the UK after the 2008/9 recession. So it remains to see if the current deflationary episode turns out to be temporary as Governor Carney suggests (although the Banks forecasting record is pretty poor) or if a deflationary debt spiral is taking hold.
No point worrying about these things too much in the short term, so I'm going to continue to invest in the least bad asset class as far as I'm concerned - equities. I believe that will be the best way to protect my capital and income from the ravages of inflation over time, although you have to be prepared to accept some volatility in your capital and income. In the long run we're all dead, but in the meantime I think a decent income producing equity portfolio should do the job for me.
If however you believed that deflation was more likely then high quality fixed income and even cash may serve you better as your purchasing power would increase against the falling prices, which might be bad for corporate profits and earnings - witness the food retailing sector recently.
Talking of corporate earnings I see we have had final results from one of the UK's major companies and dividend payer - Vodafone (VOD). They themselves continue to struggle with falling prices and the need to invest in their networks and other technologies for the future. Nevertheless they have delivered a 2% increase in the dividend this year taking it to 11.22 pence to give a yield of 4.9% at the price of 229 pence at pixel time. Within the statement they say they are also planning to increase the payment annually as a sign of their confidence in future cash flow generation, although they don't say by how much, although I see forecasts suggest another 2% or so which beats inflation at the moment. In addition this does at least compare favourably with the other major UK stocks like RD Shell and GlaxoSmithKline who have indicated flat dividends in the next few years, but then they offer yields of around 6% and 5.5% respectively.
So while Vodafone does not score well on the Compound Income Scores with a score of just 2 - I think this is probably distorted to a certain extent by some of the figures being depressed by all the restructuring and corporate changes like the Verizon demerger for example. Therefore in this case, given their position in the European mobile and fixed line markets, I would do a human over ride and suggest that it would be OK as part of a more broadly based income portfolio, but as I always say you pay your money and take your choice and you should do your own research. Or stick to a cash ISA paying 1 or 2% and see how you get on.