Further to my last post I thought I would do another quick update as the mayhem / madness in markets has continued and got much worse as the Corona Virus pandemic panic has spread around the World. After the lock down in Italy which has now just been extended beyond two weeks as I write, we are seeing similar things in Spain & France with likely the UK and maybe the US to follow.
Scary times indeed and it certainly seems to be trashing all economic forecasts and expectations in the short term & worse we don't know how long this may go on although China does provide an encouraging precedent that it may not be too long lasting if Western Countries can get it under control soon. Indeed it looks like after about 5 or 6 weeks Beijing is starting to slowly return to normal thus far, although Boris with his herd immunity strategy seemed to be talking about 12 weeks last night.
So maybe we might write off about 1.5 to 3 months of economic activity or 1/6 to 1/4 say. Which in itself might well be worse than the 2008/9 recession let alone any knock on effects that linger thereafter. So no wonder that the market has crashed I guess. Just wish I hadn't been so complacent about the effects of this virus, but I don't feel so bad about that as even Ray Dalio and Bridgewater Associates along with some other Hedge Funds go caught out by this too. Not sure why they didn't quarantine all the sick and elderly in empty hotels while letting the rest who are likely more mildly effected get on with and self quarantine as required without shutting whole economies down? But hey I'm not a virologist and any death is terrible so presumably they know what they are doing - hopefully.
it is probably too late to be panicking (in the stock market if not the Supermarket seemingly) although personally I did do some selling as things started to cut up rough but now wish I had done more given how far some of the stock I sold have fallen. But hey ho you have to take the rough with the smooth in this game and I have certainly enjoyed the ride up in the last eleven years. I did move more defensive and in addition to normal rainy day cash reserves I raised a fair bit of cash last year as we were moving home and needed some extra cash for that. Plus with the yield curve inversion I was worried about a recession ahead at some point. As we came into the year the market seemed to have forgotten these worries only for the Virus to finally cause the crash and bring on a recession.
Going forward it remains to be seen how this all works out with interest rates being slashed to record lows and central banks and governments flooding the markets with unfunded cash left right and centre. Its not clear how any of this get paid back, but I saw John Stepek of Money Week talking about this being the start of some kind of debt Jubilee with some or all of it maybe getting written off - e.g. Central banks just cancel the bonds they have been buying maybe? Guess it could all be deflationary in the short term followed by inflation thereafter due to all the money printing - quite frankly who know, your guess is as good as mine. As I said last time we are sailing or hunkering down as it were in uncharted waters.
As for the Compound income Portfolio, this normally does monthly screening. However it got its allocation of Ninety One Plc (N91) via the de-merger from Investec with great timing on the 16th March. This fell about 25p below the bottom of the price range 175p to 225p that was quoted, which didn't seem much versus the falls in the market & the hit taken by other asset managers. I noticed that the Employee Benefit Trust has been buying so I took the opportunity to slot my stock and that for the Compound Income Portfolio into this given it was a small holding and their profits and dividends may be pressured by all this. Plus the fact that other asset mangers have nearer halved during this period I think there could be more downside here in the short term. As for the balance of Investec that seems to have cratered like everything else & looks incredibly cheap, but again who knows how banks pan out from here. Their year end update today seemed OK but like everyone else they can't really say what the future holds.
With that in mind I would just caution subscribers to be careful with the Scores at the moment as they will reflect historic forecasts, which in the main do no reflect much if any of the likely hit to earnings other than for those who have already initially warned about the effects. In addition we are seeing lots of corporates suspending and even scrapping originally declared but not yet approved dividends so you probably can't rely on all the forecast yields being accurate, but again that comes with the equity territory. Having said that these are quite extreme circumstances which could mean that the dividend cuts this time around could be even worse than normal and those seen in the 2008/9 so watch out and be careful out there but don't you know....
March 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!
We have had full year results today from Lloyds Bank (LLOY) - which you can read the full 62 pages of if you so wish by clicking the link in the name. These seem like a decent set of numbers as you would expect with low unemployment and steady if unspectacular growth.
The shares trading this morning at around 60p are at a modest 13% premium to their tangible book value of 53p which seems justified by their 12% of so return on that equity. While the dividend was increased by 5% to 3.21p, this was slightly shy of forecasts of around 3.3p, but does leave them on a yield of 5.35% which is a lot better than you can get on money in a bank "savings" account!
They suggest in their commentary that they hope to get their return on equity up to between 14 to 15% this year which by my reckoning could justify a share price in the range of 64 to 80p, thereby offering potentially some modest upside on the current share price in addition to the 5% plus yield. Of course it will not be without its risks if we do end up in a post BREXIT / Global recession later this year or next, but for now it seems like a reasonable value, if slightly boring banking stock, but then you probably don't want a racy or exciting banking stock.
Meanwhile having had some success with holdings in Moneysupermarket (MONY), which had result recently, both personally and for the Compound income Scores Portfolio, I am tempted by price / value comparisons between this one and one of its competitors Go Compare (GOCO). On a cursory inspection this may be explained by differences in the balance sheets, cash v debt, assets v negative assets etc. and a better earnings revision trend at MONY perhaps.
Nevertheless GOCO does seem cheap on the face of it and it may be a good time to check it out further as there are some potential catalysts coming up. Firstly they have their own full year results due on the 28th February 2019 & we already know that MONY traded and continues to trade well. Plus after that they have a Capital Markets Day scheduled for the 20th March 2019 too, all of which I guess could help generate some renew interest in the shares perhaps, as they trade on less than 10x with a well covered 2.5% yield and are on a big discount to MONY. See the comparison below from Stockopedia between the two below, while I note they label them as Balance, Mid Cap, High Flyer versus an Adventurous, Small Cap, Contrarian - which seems to sum up the situation well.
A catalyst seems to be needed as GOCO shares, in contrast to MONY, are trading near their lows for the year, but they do seem to have formed a nice base from which they could stage a recovery if the results are OK and they can break out of their recent range between about 65p and 82p. As ever you pay your money and take your choice or not as the case may be - always do your own research and Go Compare and see what you think?
For what it's worth the Compound Income Scores suggest there is not a lot to choose between the comparison companies, but they are definitely scoring better than Lloyds Bank. So don't forget if you would like to see how these three compare on the Compound Income Scores and see daily updates to these and 500+ other UK stocks, then do check out the Scores page for more details of how you can do this & go compare if that is of any interest to you.
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.