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.
Compound Income Scores Portfolio
Well I say year end, but I should point out that the performance numbers I am about to talk about are based on closing prices up to 28th December 2018 as I was visiting family and in laws over the New Year period and therefore not around to collect the figures after the last half day of trading on 31st December. As I'm sure you are all aware December was another pretty tricky month for investors and Santa singularly failed to arrive with his rally.
As a result the FTSE All Share provided a total return of -3.74% in the month to the 28th & -9.47% for the year to the same date. By comparison the Compound Income Scores Portfolio (CISP) produced -5.12% in December which meant it produced or rather lost 8.52% for the year to the 28th December. So another year of outperformance, this time by 1% or so, but you can't live off of relative performance, although the portfolio will have produced between 3 & 4% in income which could be used to live off of. Still overall OK but not a lot to write home about as I know some who are prepared to run with much more concentrated portfolios and who have may be made use of stop losses etc. may have produced positive results even in this negative market background.
Now these type of losses may have come as a shock to more recent investors who have become accustomed to steadily rising equity markets on the back of low interest rates and Quantitative Easing by central banks. It is however quite a regular occurrence to see occasional bad years and in a proper recession induced bear market you can get falls of up to or in excess of 50% which you need to be able to stomach or take action to avoid or mitigate losses if you can't.
The CISP is designed to be a demonstration of whether the Scores they are based on are any good at selecting quality, growing dividend stocks and as such is generally run on a fully invested basis to allow it to do this. So far in the relatively short three and three quarter years or so it has been running, it has done a reasonable job by producing Compound returns of +54.4% in total or +12.3% per annum over that period. This compares with +14.3% or 3.6% per annum from the FTSE All Share. Again I'm sure people with more concentrated and actively traded portfolio may well have done better, but for a relatively relaxed monthly approach I don't think it's a bad result for limited effort. It certainly compares pretty well with what one could have got from investing in the index or an actively managed main stream fund for that matter, although here the CISP is probably benefiting form being more concentrated and active than most main stream funds.
Market Timing Indicators & other matters.
Regular readers will know that I have been producing these for the UK market since January 2014 despite my own reservations about trying to time the market. This was after reading some useful research which helped to eliminate the whip sawing that you can get by following these moving average / trend based indicators by adding economic indicators to them to keep you in the market for longer.
Given the falls in markets in December and during 2018 it will come as no surprise that these ind actors, based on moving averages, continue to be negative. Indeed after December they have mostly moved to the most extreme negative position that I have seen since I started producing them in 2014. FTSE 100 is the only one that has seen a more negative reading back in September 2015, so may be it has been helped more this time around by the overseas exposure it brings and the benefits or weak Sterling perhaps?
So these are all very negative and the markets are looking quite oversold, so I guess it is possible we could see a counter trend rally in the short term which could take us back up by 5 to 10% perhaps. I say this because the economic indicators that I track along side these are all still painting a more positive picture, although clearly there have been some signs or economies coming off the boil & some other more local difficulties with BREXIT and trade / growth in China more generally.
It is also worth noting that the US yield Curve (2 Year minus 10 Year) has not yet inverted, which is something that has been a precursor to previous recessions and something that everyone has suddenly become an expert on this year. I guess that's the power of the internet and information being more widely available. If however you don't know what I'm going on about, or even if you do, I would highly recommend this piece from dear old John Mauldin, whose writing I have followed for years and which acts as a great teach in on the subject with lots of useful links on the subject too.
One of the other things I have been following along side the timing indicators, as in the past it was shown to be a good coincident indicator of a turn in the economy, is the trend in US Unemployment. Now this has been firmly trending down and shows no signs of turning up just yet. So again that would also suggest that it too soon to panic or take evasive action.
One thing that did give me pause for thought on this though was a very good video below, which looks at the confluence of the current economic and debt cycles and issues coming out of the demographic situation in the US with baby boomers coming up to retirement. This had some interesting observations on possible trends in employment and other things coming out of that and is well worth a watch in my view. It did therefore call in to question whether the unemployment trend will be such a useful coincident indicator this time.
Monthly Screening for the CISP
This was also carried out just before the end of the year given my travel schedule. It resulted in two sales, the proceeds of which were reinvested into two new positions and a top up to an existing holding which had been halved after it had doubled on risk control grounds, but which had now come back to earth and was therefore now a smaller holding despite still scoring very well. I am not going to be detailing these changes here on the Blog anymore as I am giving a Free New Year upgrade to existing Scores subscribers who will now be able to view the full Compound Income Scores Portfolio together with details of the transactions each month alongside their weekly Scores updates. If you are not a subscriber or are not familiar with the Scores and if that is something that interests you then you can find out more about them and how to sign up here.
Summary & Conclusion
So after the first difficult year for a while for investors one can't help feeling nervous as we come into 2019. That being said I wouldn't be surprised if we saw some kind of rally in the first quarter although no guarantees of course, as the FTSE chart looks a bit like a top and seems to be in a pretty bearish trend in the short term. If anything I'd personally be more tempted to view any such rally as a selling opportunity as we may have entered into a more major bear market as the stock market anticipates the next recession, but as ever time will tell on that.
As for the CISP it will remain fully invested and continue to focus on the top quartile of Compound Income Scores stocks until such time as the economic indicators flash negative too, when I'll then think about what action I want to take for the portfolio on the back of that.