"Life is a roller coaster just got to ride it" Ronan Keeting
Well that would have been good advice if only we had been able to live our lives last year, but as we all know we were stopped from doing that in the main by Covid-19. In terms of Stock Market investments it was certainly a roller coaster ride as a record breaking bull market, in terms of duration, finally came to an end. This was then followed by a seemingly record short bear market (certainly in the US) or does that mean it was just a correction? While in the UK we have continued to struggle on back below 7,000 on FTSE as our old economy type stocks and sectors and lack of technology champions in the main took their toll on the index.
Meanwhile we finally managed to leave the EU and agree some sort of on going trading relationship at the last minute as is always the EU way, but as ever time will tell as to how good or bad that might turn out to be. Unbelievably I see that people are already calling for us to re-join even though we have only just left and finally agreed some sort of trade deal.
So early signs of a neverendum mentality taking hold already until remainers / EU get the answer they want I guess. Any way I'm sure you are all familiar with and fairly fed up with all these issues - so I'll move on.
Compound Income Portfolio - Performance
If anyone is interested in this, it managed to outperform the FTSE All Share (which I use as a benchmark) again this year making it 5 years out of 6 now since inception in April 2015 or 4 out of 5 years if you count just full years. As this was set up to try and demonstrate if the Scores had any merit in picking outperforming stocks, I think an 80% or so success rate might be some evidence that they do, but as they say the past is not necessarily a guide to the future.
Having said that though the numbers this year are to be honest a little underwhelming in absolute terms as the CI Portfolio produced a total return of -1.26% versus the -9.8% from the FTSE All Share, although that is still a decent 8.55% out performance. This came as the portfolio produced a 6.01% return in December versus the 3.86% from the FTSE All Share, thereby clawing back just over 2% or around 1/3 of the under performance it saw last month in the vaccine inspired rally.
Since inception the CI Portfolio has just about doubled with a 99.84% total return or 12.8% per annum which compares to the 22.79% or 3.64% total return from the FTSE All Share. See also the graph on the website under the portfolio menu or at the end of this piece for comparisons with the Mid 250 and Small Cap Indices as well as the All Share. I put these on there as the portfolio has tended to have an above average exposure to these out performing part of the market, which will have accounted for some of the performance differential. For example at the end of the year the portfolio was split roughly 50/50 between FTSE 100 stocks and Mid 250 + Small Cap stocks (including AIM).
At the year end I also like to check how the CI Portfolio has done versus widely available pooled funds to see if I'd be better off putting more of my money into those type of vehicles. This year while the returns were not that great they still compared favourably with the UK Equity Income sector where its returns would have put it 5th out of 85 funds and 5th out of 26 in the UK Income Investment Trust sector. While over 3 and five years it has substantially outpaced all of the funds in both of these sectors. So even though the returns were a bit underwhelming in this unusual year I'm satisfied that the Scores are still doing a good job compared to pooled fund / index alternatives.
So I shall continue to use them in helping me to identify and select suitable Companies to help me achieve my investment objectives. The Scores will also continue to be available to subscribers' for a modest fee if they should like to use them to help them with their investing too. A table showing the total returns from the CI Portfolio and the FTSE All Share over the last 1,3 & 5 years is presented below and you can see the full table of returns via the Portfolio menu on the site.
Out of interest I took a quick look at how the Portfolio would have performed if I had left it untouched from it's positions at the end of March & April and it appears that the returns were around 5 to 8% better as a result of the trades that I did subsequently. So not bad for a monthly screening process, although this year was one in which it probably paid to be even more aggressive with your portfolio as evidenced by some of the exceptional returns I've seen reported. Rightly or wrongly I tended to focus on those businesses that could survive and manage their way through all this as it seemed that vaccines might have taken a long time to arrive. As it happens they managed to come up with those in double quick time so recovery plays then came to the fore even more.
This threw up three potential sale candidates this month, based on how they score in the Compound Income Scores. Of these I decided to hang onto Sage (SGE), a fairly recent addition to the portfolio, which has taken a bit of a hit as they are having to invest to stand still as it were as they transition to a software as a service model. Given it is a high return business you'd want them to reinvest if they can, but the wrinkle here is that they are having to invest to update / keep up with the competition. Nevertheless I felt that they still looked reasonable value on an EBIT/EV Yield basis & offer a well covered 3% Dividend yield, even if the PE doesn't look particularly cheap at around 24x.
Another high quality business that looked more of a sell on valuation grounds was Auto Trader (AUTO) which as well as a high rating has seen some substantial downgrades and the car market in the short term still seems to be quite challenged. Thus I let it be sold as per the process but personally feel a bit mixed about it as the valuation certainly feels expensive but it is a high return moat type of business that one would probably want to hold for the longer term. Having said that though I felt the same back in October last year when the process had me sell Avon Rubber at £43.40 due to a poor score based on high valuation and poor earnings trend too. So it will be interesting to see if Auto Trader crashes too on any future disappointment given the valuation. As this post is already getting quite long and taking longer than I thought it would, I'll move on. Subscribers though can see the full details of this and the other sale plus the two new stocks that replaced them on their files as normal.
Brief Economic / Market Outlook.
After such an exceptional year the consensus seems to be that we are through the worst and that some kind of economic recovery is at hand despite the fact that we seem to be entering another National lock down in effect in the short term. The roll out of the vaccines thus far is encouraging investors to look through that and anticipate a V-shaped recovery as all the pent up demand and cash that may have built up in some peoples bank accounts is released as and when we get back to some kind of normality.
While the initial recovery might well be quite perky on the basis of pent up demand and the sod it factor as we hopefully eventually emerge from the grip of the virus, I do worry a bit about the medium / longer term. That's mostly due to the level of debt to GDP around the world, which while it may be manageable if central banks and governments engage in yield curve / financial repression, the conventional wisdom is that debt at these levels is likely to prove to be a drag on growth in the medium term (like Japan as I mentioned last month).
I guess governments might continue to print and spend to offset those effects but it is above my pay grade to forecast where that might all end, although quite a few are expecting a pick up in inflation as a result this time around, which might offer governments a way out from their debt traps, perhaps.
In terms of dividends, as previously discussed and as I'm sure some readers are painfully aware of, these have been cut substantially this year with the UK dividend base expected to be down by around 40 to 50%. Having analysed the dividend flows on the Compound Income Portfolio is seems that the total income received this year was down by 30% year on year suggesting that some of the existing holdings and the changes that were made along the way have helped to lessen the effects of the cuts. So some evidence that they help one to select dividend paying stocks that might be more robust than the average.
That represents a yield of about 2.3% on the average portfolio value for the year which is somewhat lower than that of previous years but not that surprising in the circumstances and also as I have relaxed my value constraints somewhat this year and ran winners on higher valuation more. Based on forecasts the portfolio is expected to generate a yield of 4.2% with some strong dividend growth forecast. While in PE terms it is on 13.7x with an EBIT/EV Yield of 8%, so it looks to be offering decent value and growth on the basis of current forecasts. Again subscribers can see the full details of the portfolio in their Scores file.
In terms of the UK market when Link asset service last provided an update in Q3 they suggested that they thought dividends in the UK could recover by between 6% and 15%. While the FTSE ended the year at 6460.2 and offered a yield of 3.65% to give a dividend base of 235.79 index points. So I thought I would update my FTSE Dividend ready reckoner and see what it looks like if we assume those dividends could remain unchanged or grow by up to 15%. For the bulls I have also added a 3% yield column to see how far we could go if investors really get carried away and bid the market up and consequently down to a historically toppy level of a 3% dividend yield.
Outside of that I suspect that a 3.5% to 4% range is more likely to pertain this year suggesting a trading range for the FTSE of potentially between about 5900 - 7747 or say 6,000 to 7,500 if you wanted to tighten that up a little by looking at the chart from the beginning of this post and where likely support and resistance might come in. Indeed on that basis, while I wouldn't be surprised to see FTSE hitting or exceeding 7,000 again at some point this year, although technically it looks like there is a lot of over head resistance in the 7000 to 7700 range. It seems therefore that we might have to wait another year for the FTSE to surpass its 1999 high. At least it means if it should make it up into that range then we might be able to look forward to 10 to 15% returns this year to make up for last years disappointing returns from the UK market as a whole.
Summary, Outlook, Conclusion & Personal Note.
So very much a year to forget in terms of what happened to our lives and how the stock market performed in the UK at least. Obviously within that and globally there were many threats and opportunities thrown up so congratulations if you manged to navigate that and make decent returns & hats off to you. Equally if you lost some money, don't get too down about it but put it down to experience and try and learn from it I guess.
In terms of economies and markets the consensus seems to be expecting economic recoveries on the back of the vaccine roll out, but that may be tempered by the on going 2nd or 3rd waves and associated lock down restrictions, but hopefully we might be out the other side of all that by the summer, perhaps. Heaven forbid that the new variant of the virus should turn out to be resistant to the vaccines or that they should turn out to have more serious side effects than expected. If either of those came to pass I suspect all bets would be off.
On the market side of things the US market is generally perceived to be expensive (hasn't that been the case for a few years now?) but seems to carry on regardless so far. The flip side of that is that some other developed markets like Japan and the UK in particular look cheap, while emerging markets are widely tipped to do well along with commodities.
Whatever or however you decide to approach things this year may I wish you good fortune in the markets and good health for you and your families and loved ones and my deepest sympathies if you or someone close to you have been hit by Covid in the last year.
Talking of Covid I'm pretty sure that both my wife and I had it back in March before the lock down started and before it was widely known about. Fortunately being fairly fit and healthy (touch wood) 50 somethings we managed to come through it pretty quickly after a few days
of feeling unwell and fortunately did not need any medical intervention. Our planned trip to Berlin at Easter got cancelled and we didn't get to go away at all last year - what a drag.
On the portfolio front across the piece with our overall more broadly diversified asset mix we did at least manage to increase our net worth by 1.5% so thereby just about maintaining the real value of our assets. I should probably say more about longer term compounding and rates of returns but that is probably the subject for a post in itself as this one is already rather long.
For the income side of things my boring diversified stock investing approach together with the use of investment trusts helped to protect us from the worst of the dividend cuts this year. It was also helped by redeploying most of the cash buffer that we'd built up in 2019 during October and November after NS&I cut rates to zero and the market was having a second leg down before the vaccine news broke.
As a result our income was "only" down by about 9% year on year so not great, but not too bad in the circumstances and we can easily live with that. So while we didn't manage to increase or maintain that in real terms this year it does still leave it well up in absolute and real terms since we started full time investing for a living in 2009. So despite this somewhat trying year we have still managed to achieved my objective of growing our capital and income in real terms over that time frame. I still think that accessing quality companies with with good yields and the prospect of dividend growth is still a good way to try and achieve that, although of course others will have their own ideas.
So we literally live to fight another year having survived Covid and the roller coaster ride in the market last year. Here's to hoping that 2021 might be a better year all round, but so far it has not started that well with another national lock down, but perhaps we might get back to some sort of life by Easter or the Summer at the latest and maybe we might even get to travel somewhere too thereafter if we're lucky. Thanks for reading, you deserve a medal if you got this far and sorry for being so boring, take care & good luck for the year ahead.
Having mentioned the dividend flows in the market and for the Compound Income Scores Portfolio in the September / Q3 update, I thought I'd provide an update having read the latest Link Asset Service Dividend monitor recently.
For the portfolio it looks like things are looking up on the dividend front this month with 9 holdings having gone or are due to go Ex Dividend, which is two times more than last year and the totals received are also over double. So as I said in the last update the large fall in year to date income, whilst no doubt reflecting the trends in the market, also reflects some stock and timing differences this year too.
As for the Link Asset Services I'll not try and regurgitate too much of the detail here but offer a few key takeaways and observations plus a link to the full document if you missed it and should wish to download a copy and read it for yourself. Below is their Executive summary with my thoughts thereafter.
Thoughts and Observations
Personally I find it somewhat surprising that Mid and Small Caps have cut more both in number and in quantum as these indices have gone onto outperform the FTSE. Then again perhaps I shouldn't be as Mid and Smaller Companies may be more vulnerable to effects of the virus / shut downs etc. and dividends are not really driving returns this year or any other year for that matter.
In terms of the outlook they seem to think we are through the worst of the battle on the dividend front as we have seen some Companies starting to reinstate or make up for missed dividends in some cases. As a result they see the underlying dividends falling by around 39% for the year and by about 45% if one includes specials. So this is not far off the 30 to 50% falls that were talked about earlier in the year.
While for next year they are expecting some modest bounce back in dividends and tentatively suggest growth of 6% to 15% on a worst case to best case scenario. On this basis they see the current prospective yield being between 3.3% and 3.6% which they suggest leaves UK Equities looking fair value.
Thinking about that and the Ready Reckoner I presented back in the Spring that would be at the bottom end of the yield range of roughly 3.5% to 4.5% that we have seen for FTSE in recent years. With dividend having been cut back to more sustainable(?) levels then may be it makes sense for the market to trade towards the bottom of the range on a yield basis, perhaps. This is especially so given the fall in interest rates, bond yields, property rents and talk of negative rates by the Bank of England.
For what it is worth I present an updated version of the FTSE Ready Reckoner with two new rows reflecting Links latest thinking versus my original 33% to 50% cuts estimates and the original 3.5% to 4.5% range. Thus far the market seems to have operated on the basis of a 30 to 40% cut priced off of 3.5% or 5800 - 6400 roughly speaking.
Summary & Conclusion
So hopefully the worst is over on the dividend front for the UK market with a fall of 40 to 45% or thereabouts in dividends still foreseen, although this may have been discounted if investors are prepared to price those dividends off of a 3.5% yield. If not or if dividends were to fall a bit more then a re-test of the March 5200-5,000 lows on FTSE still can't be ruled out.
Indeed that leaves it looking pretty bedraggled and war torn with the chart trending down below its moving averages. Not great, as we head towards BREXIT but hopefully some resolution or last minute deal there and better news on the Virus front if a Vaccine should become available in the not too distant future might help sentiment. Failing that it seems we are in for a long hard winter as greater lock downs seem to be creeping around the Country and spreading South and Eastwards from the North and Wales!
Having said that it is a market of Stocks and there are always opportunities out there for individual stock pickers as demonstrated by some who have still managed to show decent positive returns despite all the problems. in addition UK Equities look pretty unloved and a bit cheap in a global context. So I wouldn't get too bearish and in the long run quality dividend paying equities still seem like a decent way to find a growing yield with potential for capital gains in a low yield environment. If you need help finding these don't forget that's exactly the type of stocks the Compound Income Scores try to identify.
Failing that if you would rather go down the pooled fund route & go active then I'd still recommend Investment Trusts which benefit from their closed end structure, independent boards and the ability to gear which can help to enhance or detract from returns depending on market conditions. They also tend to have revenue reserves and the ability to pay dividends from Capital which can make their dividends more reliable.
Given the bombed out nature of UK Equities it might be worth investigating a few UK Funds like Law Debenture (LWDB) which has solid reserves and benefits from an operating subsidiary which helps fund a fair chunk of its dividend and trades at a 4 to 5% discount with an experienced management team from Janus Henderson and offers a 5% yield.
Or there are a couple on wider discounts of around 10% which are either under new management in the case of Edinburgh Investment Trust (EDIN) or about to be in the case of Temple Bar (TMPL). Of these Edinburgh has increased it dividend and has decent reserves while Temple Bar has had to cut and will use reserves to pay its suggested dividend. But both might be interesting as a source of decent income from diversified portfolios, although you'd have to satisfy yourself that you are happy with the portfolio strategy of their new mangers.
Any way I'll leave it there as this note has already taken me longer than I thought and ended up longer too. So I'll leave you with a picture of the dividend history and outlook to sum up as I continue play some of my old favourites in the Stock market and on Spotify too.
Just a quick update post my recent webinar and post about the Crash & Timing Indicators etc. In that post, given that I was ignoring the timing indicator sell signal I said: "I'll also reserve the right to perhaps make some intra-month changes rather than the usual monthly screening given the market conditions. "
With that in mind I have made one sale today of a stock at the smaller end of the market cap scale which is not currently in business and has had a decent rally off of its lows, although still sadly down a long way from its highs. Subscribers will be able to see the details of this when the sheet is updated after the close tonight so I can't give any more details here.
I will keep the proceeds in cash for now which will take the portfolio up towards a 4% cash balance. The reason for this is I feel that the rally has now possibly extended as far as it is likely to in the short term, although as ever I could be wrong on that. What did give me more confidence in this call is not only the history which I covered in the webinar but this excellent recent post from a guy called Sven Henrich called Just one chart. This is well worth a read in my opinion and you can follow him on Twitter. I'll leave you with just one chart from his post.
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!
Lots of people are worrying about "the market" being expensive these days, which in the US may be true to a certain extent. In the UK however, this may not be so true as we struggle with BREXIT & a generally downbeat economic outlook post the budget. This may not be such a bad thing though as there has been research in the past showing that equities in countries with low GDP growth tended to outperform those in countries that high GDP growth rates.
Any way lets look at the evidence of the valuations attached to UK Equities. According to Stockopedia the FTSE 100 index for example has a Median trailing PE of 17.8x with a forecast PE of 15.3x, which is not far off the long term average. This is and based on forecast earnings growth of just under 10%. Looking at the yield side of the valuation on the FTSE 100 Index this shows a trailing yield of 2.9% and 3.3% forecast, which must therefore be factoring in similar or slightly higher rates of growth to the earning growth forecasts. That headline yield of around 3% does compare favourably with what you can get on Gilts and on cash in the bank. Given the forecast growth it should also protect your income from the current 3% inflation too in the short run and in the long run too I would argue.
It is worth remembering not so long ago before Central Banks really got going with manipulating interest rates, there was something called the reverse yield gap. That was the gap between equity yields and government bonds where equities yielded less (yes less that's not a typo) but these days as the old chines curse says - we live in interesting times.
Now the other interesting fact when looking at the FTSE and looking at the highest yielders is that there are 25 or a quarter of the index yielding more than 5%. Thus it should be possible to put together a diversified portfolio of say 20 FTSE stocks with an average yield of 6% if you equally weighted them. You could take your pick form the list below although the growth on offer is lower than the headline figure suggested above and the cover is quite low in a number of cases, so dividend cuts could be possible in a number of these.
Despite this though some such as Centrica (CNA) and Glaxo SmithKline (GSK) have indicated that they are prepared to run with low levels of cover and maintain their payouts. Indeed GSK is currently toward the bottom of its 5 year range (see graph at the end) and therefore may be offering an attractive entry point. Whether these yields prove to be sustainable in the long run though remains to be seen, especially if GSK should finally decide to split the business up. Meanwhile in a similar fashion on SSE, I suspect their proposed merger of their distribution business may well lead to a lower total distribution from the split business, if it does go ahead down the line. Like GSK though they are also trading toward the bottom of their 5 year range too (see graph at the end). I'll leave you to decide if you think that's a good entry point or not.
Any way just goes to show you can get quite a lot of value in the market at the moment, although I wouldn't necessarily suggest rushing out and buying all the names below as they are a bit of a mixed bag in terms of their scores on the Compound Income Scores, but as part of a diversified income portfolio some of them could do a good job for you.
As ever you should always do your own research and pay your money and take your choice or not as the case may be. Good luck with your investing and don't forget you can get this kind of information and more to help you identify good value, growing, quality yield stocks if you sign up for the Compound Income Scores. These are now available via Dropbox, Microsoft One Drive as well as Google drive / docs. Alternatively if you would prefer to receive them via e-mail in a spreadsheet of pdf form then please do get in touch & I'm sure we might be able to arrange that too.