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.
As you may know from some other posts in the past, I am generally a buy and hold kind of investor who does not generally try to time the market. This is because timing the market is incredibly hard to do and I also prefer to allow time in the market and the power of dividends and compounding to work their magic. See a good piece from a useful website called 7 Circles for more on this.
However, with equity markets around the world flirting with all time highs as I write and with the US Federal reserve about to raise interest rates for a third time, I cannot help but start to feel a little nervous. This is compounded by the fact that US equity valuations in particular are looking somewhat stretched and towards the top of their range. Now while this in itself is not that helpful as a timing indicator, it does suggest however that returns from US equities may not be that great from this point. There was a good post discussing this in more detail which can be accessed by clicking the image below.
Thus given where Sterling has fallen to against the US Dollar I certainly would not be chasing US equities up here especially as the old saying goes - "don't fight the Fed." Nevertheless UK equities still look less stretched, but would not be immune to a shake out on Wall Street if the current rising rate cycle should lead to problems down the line.
Interestingly Neil Woodford put out a note pointing out the attraction of dividend yields in the UK Market and the benefits of taking a longer term view which reduces the risks of suffering losses, although he does have a new fund to sell - so he would say that wouldn't he? Nevertheless the article in the link above and an earlier piece a colleague of his did called - Are UK Equities Overvalued? - are both worth a look. In particular the second one suggests that the UK could offer 8% real returns based on its current valuation, but does caution that this could be undershot as it has been in recent decades. Interestingly Research Affiliates 10 Year Expected Returns analysis shown above also seems to confirm this and suggests you should probably invest anywhere except the US.
If you are taken by his arguments and evidence of the benefits of investing for the long term, then his new fund, the CF Woodford Income Focus Fund, will be available for investment from 20th March 2017, with the launch period closing at midday on 12th April 2017. Alternatively if you want to go your own way and do it yourself to save the fees, then don't forget the Compound Income Scores are available to help you identify good value, quality growing dividend stocks for further research.
Summary & Conclusion
Another old saying is that the market climbs a wall of worry and it may be that I'm worrying prematurely about rising US interest rates plus the fact that while valuations can be a good indicator of future returns they are not very good as a timing indicator.
Talking of which the timing indicators that I follow like the trailing 10 month moving averages, US Unemployment and PMI data plus general economic news are all still generally supportive. Thus despite the high valuations in the US, given the current economic background and the reasonable valuations in the UK, I'm inclined to extend my time in the market further and carry on compounding my dividends.
Of course if the US does catch a cold then the rest of the world will probably get influenza and likely lead to some downside when and if that happens. However this would then likely throw up more opportunities and an even better entry point in terms of timing and valuations.