Now that the dust has settled on the recent bout of volatility, just thought I'd put a few thought down and provide an update on the January screening of the Compound Income Scores Portfolio (CISP). So taking the market first as I suspect that will be of more interest, it has obviously come as a bit of a shock to many that share prices can go down as well as up! This is because we had been lulled into a false sense of security by the seemingly never ending story of Central Bank Quantitative Easing or QE as it is known. This led to an extraordinary period of smoothly rising asset prices, or a bull market in everything as one wag called it.
This period seems to be coming to a close as the US Federal Reserve had already started raising rates from the emergency levels which had endured for years and had quite clearly sign posted a route to the withdrawal or reversal of QE over the coming quarters a kind of Quantitative tightening or QT as it were. Stock markets had ignored these signals, even as bonds started to sell off, causing some famous bond investors to call the end of the long bond bull market. Equity investors were aided in this myopia by stronger economic statistics and the US government passing some hefty corporate tax cuts which further boosted animal spirits & hopes of stronger growth. These moves in bond yields were accelerated and brought into sharper focus after the US Non Farm Payrolls and Unemployment data last Friday came in with another strong reading and showed unemployment sticking at 4.1%. The fly in the ointment was however a pick up in wage growth, which in turn fed into fears of rising inflation and hence the knock onto bond yields and ultimately equity markets.
Now I'm not saying that this divergence originally was irrational as earnings, share buy backs and dividends tend to drive stock market returns along with expansion and contraction of the multiple that investors are prepared to pay for those earnings. Given the benign background on the back of QE and recent signs of accelerating growth investors chose to focus on that and bid up stock prices in an exponential fashion, rather than worrying about the build up of debt, rising bond yields and the probable prospect of at least three interest rate rises from the Fed this year. Last weeks events seem to have brought about a reassessment and a quick bought of profit taking which has then led to more volatility as some automated algorithms probably kicked in too. Thus equity investor may now reconsider how much they are prepared to pay.
Any way enough of the rationalizing already, what to make of it all? Personally I wouldn't be too concerned just yet, given the stronger economic background discussed above. Thus this is probably just one of those normal periodic corrections of up to 10 to 20% that you quite often get in stock markets. Quite frankly if you are not prepared for that, which is the price you pay for investing in volatile equities then you should probably not be investing in the stock market at all. In addition to that you also need to be prepared to see the value of your equity portfolio potentially cut in half, when a really bad bear market rolls around, usually on the back of a recession or more recently the financial crisis. Now that is relevant here as I don't see a risk of recession in the statistics that are coming our from the US and elsewhere at the moment and that's why I say this is probably just one of those normal periodic corrections. Going forward I will however continue to watch the US unemployment & ISM numbers as well as the shape of the yield curve which has proved to be one of the best advanced indicators of a coming recession.
So no great change to my strategy as I want to remain invested in real assets and to benefit from the power of Compounding, but I will look to reduce risk when and if a recession seems to be on the horizon. On which the only thing I can add is that in recent decades we usually seem to have had either events like recessions, the dot com crash in 1999 and the early 2000's and the financial crisis in 2007-9 starting or having their effect late in each decade with the effects extending into the early part of the next decade. Earlier back in time I'm thinking of the late 1970's peak and early eighties recession, the late eighties peak and early 1990's recession etc. As the old saying goes history doesn't repeat itself, but it rhymes so as we approach the end of this decade it seems we may well be overdue another recession or event but as ever I guess time will tell.
Update on the CIS Portfolio
So if you are still with me I'll finish up with a quick review of this months CISP Screening. There were three potential sale candidates that came up this month, Wynstay (WYN) which was a clear sell on the scores and two which were much more marginal - Bloomsbury Publishing (BMY) and Unilever (ULVR). On balance I decide to give the latter two the benefit of the doubt. In the case of Bloomsbury I was tempted as it was a the top of its trading range and looked as though it could be breaking out of what has been a fairly well defined trading range, plus there had not really been any news flow recently which is why the score had moved down on unchanged earnings. I must admit I was tempted to let it go though because of the trading range. Sadly I didn't, as when the volatility hit it promptly collapsed back toward the bottom of its range where it is now looking over sold, so maybe there's a buying opportunity there again now?
On Unilever they had just reported results and having come back from their highs it was starting to look better value and a tad oversold. Thus I thought I'd leave that for another month and see how the market digests the figures, although I note that the earnings have been downgraded since - knocking the Score further. So we shall probably have to bite the bullet and sell it at next months screening, but we will at least pick up the dividend this month.
The replacement for Wynstay was Portmeirion (PMP) - the exciting (OK I made that up) ceramic tableware, cookware, gift ware and tabletop accessories provider. Not that being dull is a bad thing in the stock market it can mean that an attractive business is overlooked. In this case that is what the Scores are saying as it had upgrades after its recent trading update and looks reasonable value if not an outright bargain on around 13x with a 3.75% yield for the coming year. My only doubt is that it has been flat lining for the last 18 months or so after a sell of in mid 2016 on a trading disappointment I seem to remember, although it had done pretty well in the years prior to that. Since then the market has been strong and maybe enough time has now elapsed since the trading problem which may mean it's not such a bad time to get into it - I guess time will tell?
Finally I've been updating the Scores daily this week for subscribers so they can keep up to date with the moves in Scores on the back of the price moves and search for good value over sold stock. So if you would like to be able to do that too do check out the Scores page for details.
Which is said to be an old Chinese curse, but this week could equally apply to the UK Prime Minister given the latest shenanigans in the BREXIT process and there is even talk now of an early election (click image above for more details).
Investors probably feel it has been applied to them too as in addition to the fall out from the BREXIT legal challenge we have the US election result to look forward to as well as the possibility of a rate rise in December from the US Federal Reserve. That is of course assuming that markets don't have another rapid downward lurch which scares them off from doing this again as it did last time they were thinking of doing this. We saw the Non Farm Payrolls data yesterday which were slightly light of consensus at 161,000 jobs created although this did bring the headline unemployment rate down to 4.9%. This puts that indicator just below its 12 month moving average which reverses the move above the average we saw last month hence negating the recession indicator in the short term, but this will need watching in the months ahead.
Meanwhile in the UK market we got hit harder this week by these concerns and thus the headline indices like the FTSE All Share and FTSE 100 fell by around 4% on the week while Mid and Small caps only fell by around 2%, although they may play catch up next week. In terms of the timing indicators at the end of October these were still showing bullish trends with most of the indices around 8% above their moving averages with the exception of the Mid 250 which was only around 4% above. Thus for now the bullish trends on these measures remain in tact, but we'll have to see where we end up by the end of November.
Personally I have been getting a bit more cautious about markets recently and the recent moves and news flow have done little to reverse that caution. However, it is probably still not worth taking too much avoiding action unless you have lots of speculative positions or are running with gearing. We may see more of a shake out in the short term but once the dust settles post the US election then seasonality might kick in with a year end rally perhaps. As discussed above, given my current caution on markets I wouldn't get carried away with any rally and would probably view it, if we see it, as an opportunity to take some risk off and get a bit more defensive. So mind how you go out there and watch out for fireworks today in the UK and next week in markets too, mind how you go.
July saw a further improvement in the UK Equity Market with Mid and Small Cap indices leading the recovery as investors got over the shock of the BREXIT result towards the end of June. This reflected the fact that some of the knee jerk heavy mark downs of domestic cyclical companies got reversed to a certain extent as investors presumably felt these had been over done and because early indications were that the world had not ended as suggested by project fear.
In terms of the Monthly Timing Indicators, (which regular readers will know I have been tracking since January 2014), given the positive returns this month, these have all turned bullish again including the small and Mid Cap indices which were still below or flat against their 10 month moving averages last month. The FTSE 100 continues to look stronger trading some 8% or so above its moving average which incredibly, is the largest bullish divergence we have seen since I started tracking these indicators (see chart above). The Mid 250 & Small Cap indices unsurprisingly look less bullish but nevertheless still trade some 3% and 6% or so above their moving averages respectively, although this is not as extended as they were back in May 2105 when they reached levels 11.2% and 7.7% above their 10 month moving averages.
With that in mind and although this may be a bull market Jim, but not as we know it, thanks to the Central Banks monetary policy support boldly going where no man or woman has gone before, I'm not sure I entirely trust this rally given the otherwise risky looking macro background. Then again the old sayings like "the market climbs a wall of worry" and "the market can remain irrational for longer than you can remain solvent" spring to mind. So I'll continue to ride the bull for now as the other indicator that I have started looking at (US Unemployment) to help avoid whipsaws in these indicators remains supportive, although it is getting closer to breaking up through its moving average which would be bearish in this case. (See Chart at the end).
In conclusion the UK Equity market seems back into bull market territory despite the BREXIT vote and fears of a looming recession in the UK and possibly elsewhere and we have some more US employment data to watch out for soon. As it is however August and the silly season and as I said earlier I'm not sure I would chase this FOMO (fear of missing out) rally given how extended FTSE now looks and with the often tricky autumn period still to come not to mention the heavy overhead resistance around the 7000 level. So enjoy the rest of the summer whatever you are up to and don't forget to keep calm and carry on compounding!
...go back into the market, FTSE 6200 starts acting as resistance and technical analysts are suggesting "A few ballsy traders will go short at 6,230 with an extremely tight stop. It’s a potential 600 point trade with very little risk." In addition to that we had a worrying story from the Investment Association on Thursday. This report on it from Reuters suggested that British retail investors poured more than 2 billion pounds into equity funds in July 2015, the highest since wait for it April 2000.
So what you might think? Historically when the small investor has gone charging into equities in a big way, the timing has often been well - poor to say the least. This comes after a six year bull market when the market has been showing signs of topping out before its correction in August. While the April 2000 record came just after the dot com peak at the end of 1999 and early in the year 2000 when FTSE last hit 7000 - a level it has only just surpassed briefly earlier this year some 15 years later!
So that was the holiday month of August that was and if you have been away you may have come back to see the markets dramatically down and talk of a China crisis or some such. Which put me in mind of the album above and given the weather has been a bit patchy in the UK this summer - the cover could be a postcard from the UK if you had a staycation?
Any way getting back to the financial markets it was certainly a poor one for the UK headline indices such as the FTSE 100 and other mainstream large cap indices as these have heavy weighting in mining and oil shares which were hit particularly hard this month by the slide in commodities and the on going worries about China's growth rate.
Monthly Timing Indicators
Thus on the monthly timing indicators that I follow for UK markets the main indices FTSE 100, 350 and All Share have all slipped below their 10 month simple moving averages by 4 to 5% as a result of this months sell off. Thus this indicator is suggesting you should now be cautious of large cap stocks, although these indicators have done this 4 times in the last 12 months yet the indices remain above where they were a year ago as each time a rally has followed.
So a sign of caution perhaps, but if this proves to be just another one of those short term wobbles then I suspect these indicators will turn positive again if the market rallies further from here again. But with the normally volatile months of September and October still to come I guess it would be sensible to proceed with caution for now.
Having said that though it is noticeable that the Mid Cap and Small Cap indices remain above their 10 month moving averages by around 1.5% and as such would still suggest that they continue in a bull market and that you should remain invested. Again this probably reflects more the fact that there is less concentration / exposure in these areas to mining and oil and more exposure to the domestic economy which still seems to be doing fine. But of course it could be that institutions have just raised cash in the biggest most liquid names and haven't got around to selling mid and small caps yet. So if this does degenerate into a more generalised sell off / mark down then obviously Mid and Small caps would not be immune to that.
Compound Income Scores Portfolio
Which brings me onto a monthly performance update for this. As regular readers may remember this is a mechanical portfolio I set up back in April this year based on picking top scoring stocks from the Compound Income Scores. On the one hand this was to see how a portfolio based on top scoring stocks would fare and also to see how it compared with my own portfolio on the basis that models often outperform humans.
It is pretty heavily over weight in Mid Cap and AIM stocks and as such again benefited from the trends discussed above. Thus in August it saw a total return of -3.08% which compares to the -5.32% total return from the FTSE All Share. This brings a fifth consecutive month of out performance and leaves the portfolio with a total return of 6.34% since inception. This compares to -5.46% from the All Share on the same basis over the same time frame, so not bad but still early days.
Being a mechanical process I'm next due to review it and make changes at the next quarterly review at the end of September when I'm thinking of making a small tweak to the selection criteria which I think should enhance returns.
But in the meantime this months events in markets have brought home to me the attractions of a mechanical screening based selection process which is carried out on an infrequent basis as this forces you to take a detached view, not worry too much about market swings along the way and then deal in a dispassionate way when the time comes to re-screen.
So doing things this way has a lot to recommend it as you can then get on with your life and enjoying yourself and not get too hung up on the day to day minutiae. For me this is becoming apparent at this early stage as the Scores portfolio has also outperformed my own portfolio over this initial period, so food for thought there for me about how I might do things going forward if that trend continues. Cheers - have a great long bank holiday weekend, if you are in England and Wales and if you liked the music at the top of this post - then look out for a Bank Holiday Music Special I am planning as a bit of light relief from markets.