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!
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!
February was another good month for equity markets generally with the US S&P 500 continuing its strong run and regaining levels above its 200 day moving average in the process. The UK market also continued to rally although in common with other markets it lost some momentum toward the end of the month. Nevertheless the FTSE All Share still produced a positive total return of 2.3% which leaves it up by 6.56% for the year. In terms of where this leave the market in relation to the timing indicators. Unlike the US the UK market has not yet recovered beyond its 200 day moving average. It therefore remains below its moving averages that I use for this purpose by around 1.3% for the main indices and 2.2% for the Small Cap, although during the month it did look as though these would turn positive.
The Compound Income Portfolio had actually had a negative month, which may be not that surprising after its massive out performance in January. Thus it sagged back by 0.5% and thereby under performed this month by 2.77% but this still leaves it up by 8.23% for the year which is still ahead of the FTSE All Share by 1,67% year to date and 45.31% since inception in April 2015. Most of the damage was done by a couple of Marmite type stocks which score well but that some, including me, would find unpalatable to buy. These together with some draw downs in some more cyclical stocks explained the set back and while risers were in the majority, they were not sufficient to offset the losses from the big losers.
This months screening has thrown up a couple of potential trades, both of which I could question because one is a classic quality compounder, although its rating reflects this like a lot of these situations. while the second one is lower quality and therefore more lowly rated, but does have results coming up this month and had the CEO buy some shares recently. Nevertheless I decide to push the button on these for the Compound Income Portfolio and replaced one of these with a stock that brings something different to the portfolio, subscribers to the Scores will be able to see the details of these transaction in the Scores sheet when it is updated on Monday.
In light of the timing indicators mentioned above I decided to keep the second unit of cash raised as a precaution in case the market should relapse and retest its lows. I am however disinclined to take the hedging any further than that at this stage as we are not due to get the latest US Unemployment data until Friday 8th March. Having read around and looking at the commentary and forecasts on Trading Economics for this, I see that it is generally perceived that the US government shut down may have distorted last months figure and this month the rate is expected to fall back again to 3.9% which would probably reverse the signal from this or make it neutral at least for now. The other reason for waiting is that I also came across a more detailed model using unemployment as a recession timing indicator and this one suggests taht we would need to see US unemployment rising to 4.1% before this is triggered on their model. Waiting will also give us a better idea if the market recovery is likely to be sustained or if we see it relapsing this month and heading for a retest of the recent lows.
Whatever happens it still feels as though we are in the latter stages of this bull market to me, although who knows how much longer it can go on? Maybe we are into the last hurrah topping out process, where you have a peak, then a recovery which fails to break the high - I think we have seen this pattern before (see graph at the start of this post). So it will be interesting to see how this one develops from here or whether the Fed's change of heart and the minting of the Powell put can keep things humming along for a bit longer yet?
Amazing to see at the after Oscars Party that even the Luvvies and pop stars are up with the trend too in the video below - perhaps? Or for Older readers maybe a bit of Elvis could call it from here too?
UK Markets & Compound Income Portfolio
First the good news, although it's not news by now that January proved to be a better start to the year / first quarter for investors than the dreadful fourth quarter of 2018. The FTSE All Share delivered a total return of 4.2%, which was slightly ahead of the 4% from Small caps. The stars of the show were the Mid Caps. which produced a 7.1% return on the month.
That may be encouraging as the old saying of, as goes January goes the year or something like that. I guess time, as ever, will tell on that, although it certainly worked last year after a poor January in the UK led to a poor year.
The Compound Income Portfolio also bounced back well in January, in fact it had its best ever month (see table above) with a total return of 8.8%, making up for all of last years loss in one month and beating the FTSE All Share by 4.6% in the process. This takes the total return since inception in April 2015 to 67.9% versus 19% for the FTSE All Share, which equates to 14.5% per annum versus 4.7% per annum respectively.
This just goes to show the perils of market timing and why, in the main, I have tended to adopt a fully invested approach most of the time on the basis that it is to better to try and benefit from time in the market & compounding rather than trying to time the market. This months strong bounce back seems to reinforce that view as I guess it would have been easy to have been spooked into raising large amounts of cash in the last quarter of last year, which I know some people did. That's fine if it helps you sleep at night, fits in with your risk tolerance and investment objectives, but what do you do now? Do you buy back in at higher levels potentially or are you able to stay patient and wait for a better opportunity to present itself. I'm sure there are many different views on this.
I must admit that I have some sympathy for those who have raised cash, particularly given the current economic and market circumstances. Indeed as I have grown older and my net worth has multiplied, maybe I might become a bit more cautious myself given that actuarially speaking I probably only have about 20 to 30 years to go, although I'm hoping to live to 100. So that still means I probably have a long enough time horizon (hopefully) to be able to ride out another downturn, but despite my reservations about market timing, I can see also that in an ideal world, it would be great to step aside from a bear market to a certain extent and therefore preserve more of ones wealth in the shorter term, although if you are younger and newer to investing you should probably view setbacks as opportunities rather than threats as you will have time on your side and will presumably be investing new money each month or year regardless. Any way having said all that this brings us nicely onto the next topic.
UK Market Timing Indicators update.
Now for the bad news, which is despite this months recovery this did not change the signal from these as they all remain below their respective moving averages, albeit to a lesser extent now than they were, with all of them being around 4% below at the month end when they are calculated.
The US unemployment rate has by coincidence ticked up to 4% this month, which is pretty low historically and means that after matching its 12 month moving average last month, it has now moved above the moving average. So what you might be thinking? Well this is the key indicator I have been using to either turn off / ignore the signal from the market timing indicators or turn them on / pay attention to them.
This move therefore suggests that we should now be paying attention to the timing indicators. As they remain negative, this suggests we should be reducing risk / hedging as the market is in a negative trend and a US recession may lie ahead. So more on that a bit later, but in terms of what it means, the table below shows the history of what has happened in the past when US unemployment has turned higher. While the middle chart shows this matching up with recessions and the second graph brings that chart up to date and shows the recent uptick in unemployment - if you have good eyesight.
As you can see it has been a surprisingly timely warning of impending recession in the US with anything from 0 months to 8 months lead time and an average of 3.45 months which is why it was chosen as an indicator to focus on in this regard. The market setback and near bear market in Q4 last year may also have been an early warning sign, although the US Federal reserve at their recent meeting seemed to do a U-turn on their tightening plan in light of the market sell off and seemed to imply that they could even be done on tightening.
While this has helped to further the rally that we have seen since Christmas and means that the S & P is now starting to challenge resistance levels and may seem like a reason to expect a resumption of the bullish trend. I note in this weeks update from Steve Blumenthal at CMG that the S&P typically peaks after the Fed is done tightening. So equally the Fed's halt to raising rates could also mean they see bad things coming out of the statistics that they watch perhaps?
So while it seem like everything might still be OK, especially as ISM indices are still generally above 50, and the yield curve has not yet inverted, there does seem to be plenty to be concerned about what with Trump's trade war with China and the resultant slow down there plus slowdowns / recessionary conditions in Germany, Italy and of course Britain with all it's BREXIT fiasco.
My only caveat is that perhaps the unemployment statistics might have been distorted by the recent US government shutdown perhaps? With that in mind I'll wait for one more months data to see if the unemployment rate remains above its average and to see if the stock markets remain below their moving averages next month too before implementing any hedging arrangements for the Compound income Portfolio based on these combined market timing indicators. At the time of writing the All Sahre for example is just 1% below its average now based on last nights closing value.
In light of that I've decided to skip doing any trades for the portfolio this month, as a couple were quite marginal and a bit suspect given lack of recent news, while the one clear sell is a pretty stodgy, cheap defensive any way. Thus as there may be a lot of turnover required in the next month or two if I do implement some risk reduction moves I thought I would save on trading cost this month ahead of that.
In addition addition to Steve Blumenthal's piece above the other thing I would recommend is The Investors Podcast which featured Jonathan Tepper this week topically discussing bear markets and how they can differ depending on the circumstances in which they take place. His comments about the early 2000's one and the ability to shelter in old economy value stocks certainly resonated with me as I remember doing the same back then myself. The 2007-8 one was much more painful and widespread as far as I recall, unless you were smart and brave enough like Mr Tepper to be shorting US sub prime etc. or of course to have spotted the trouble in time and gone to cash in a big way early on. The other point he made which resonated with me was that in addition to sheltering in value you can also ride them out in quality stocks and obviously avoid the financially challenged etc. which is the type of stocks that the Compound Income Scores seek to identify.
The only thing I would add to that, from my own personal experience, is to also be wary of momentum in a downturn as when I worked at JP Morgan we had momentum as part of a quantitative investment process along with value, growth and quality factors, and suffered big draw downs and gave back a lot of prior out performance as momentum stopped working and crashed during downturns and through the trough until it then started working again. So any followers of Stockopedia stock ranks might want to take note of that and beware if we have or do eventually enter a bear market. However, I would stress that in the long term momentum seems to be a powerful factor but worth being aware of the downside in a downturn.
Summary & Conclusion
We have seen a decent recovery in markets and the Compound income Portfolio since Christmas and this has been spurred on recently by the U-turn from the Federal reserve in terms of halting rates rise and varying hopes that there may be a resolution to the US/ China or Trump trade war. Whether this proves to have been a short lived correction without a recession occurring remains to be seen and it was certainly of the right kind of percentage and duration to have been a correction in an on going bull market.
This conundrum may be answered in the next few weeks and months ahead if markets can continue to climb and break back into positive trends and challenge the previous highs. This view would be supported by the fact that ISM indices still remain above 50 which generally suggests on going growth is likely and valuations, especially in the unloved UK market, are not as expensive as generally perceived and therefore also supportive of gains in the longer term.
The alternative view would be that the market and Fed's move may be the harbinger of something worse or a recession ahead perhaps as the market and economic cycles remain extended and possibly overdue or perhaps may have even started on a path to correct excesses via a recession. The indicator that I have been following to indicate this (US Unemployment) has now triggered and suggests that the US could, if the past is any guide, be in recession this year. I have been following this and using it as a trigger for taking avoiding action in a mechanistic way.
So if it remains like that next month, I'll be looking to put some hedging in place for the Compound Income portfolio to protect against possible downside from a potentially serious bear market that would result from a US recession occurring. This does however go against my natural inclination to stay fully invested and benefit from time in the market, but does dovetail quite well with the fact that the Compound Income portfolio is designed to be a mostly rules based / mechanical system based on picking shares from the top quartile of the Compound Income Scores to demonstrate their efficacy at picking decent growing dividend stocks. Thus by doing this too may also help to demonstrate whether the timing indicators in conjunction with US Unemployment has any merit or not. If you are interested in the back ground to this then check out this incredibly detailed post from Philosophical Economics where I got the model from originally. If I do implement it I plan to put 50% into cash and or hedging type instruments & retain 50% in CIS type stocks to see how these two elements fare if we do end up in a bear market or to see how much it costs the portfolio if it turns out to be a false alarm.
Thus my head says everything may be fine and one should stay fully invested versus my gut which tends to suggest that this cycle is quite extended and that we are overdue a correction as there are quite a few straws in the wind being kicked up by the bulls. While as ever for most people it will come down to greed versus fear as to which way they want to jump or not as the case may be. Whatever happens it will be fascinating to see how this all develops in the months ahead and where interest rates end up if we do enter a downturn.
Thanks for reading if you got this far, well done and don't forget if you want to shelter in quality growing and financially secure stocks then the Compound Income Scores can help you identify potential candidates, as I believe this is a good pond in which to fish. This is as per the final graphic that I shared on twitter recently and which I'll leave you with today.
This is why I focus on dividend growth & other factors as well as yield. Picture shows: Average Annual Returns and Volatility by Dividend Policy in S&P 500 (1/31/72–12/31/17).
A quick update & reminder for Scores Subscribers after last weeks Red December update. Just in case you missed it in that post or didn't read to the end. As a subscriber to the Scores you will now have access to the Portfolio and transaction details along with the Scores. For this there is no extra charge so effectively a free upgrade. In addition in case you have not noticed the Scores are also now being updated on a daily basis too.
We hope to maintain this service level with the exception of quiet holiday times or when I am away myself, although this should in all be no more than about 4 weeks in a year in total accounting for Bank Holidays and public holidays too. Thus with around 48 weeks worth of Scores or 240 a year it works out at a bargain price of just 20 pence a day.
If you are not currently a subscriber but would like to gain access to the Scores, the Portfolio and transaction details and a free e-book explaining the research behind and background to the Scores then head over to the Scores page where you can learn more about them and sign up to receive automatic updates via either Dropbox, Google Drive, Microsoft One Drive.