Well November turned out to be quite a month to say the least. The fantastic news that a vaccine for the Corona virus had been very effective in tests prompted a record monthly rise in the UK stock market with most of the main indices providing total returns of around 12.6 to 12.7%. While Small caps again led the way following on from them moving above their moving average last month and thereby turning bullish. Thus this month they managed a +15.1% total return.
These moves also prompted a sharp rotation from previous quality / growth / defensive winning names towards low quality / challenged / recovery under performing names in the main, as investors anticipate a quicker return to normal and a more rapid recovery than hoped for in those sectors most afflicted by the virus. Now I'm sure you are familiar with all that by now so I'll move on.
Market Timing Indicators.
Unsurprisingly, after such a large move up in the market in the month, these have all moved above their longer term moving averages. As a result they are giving a positive signal that one should be more positive on and invested in the market. This is backed up by the US Unemployment rate which is used as a back up economic signal to judge whether to pay attention to the signal or not. This has also, somewhat surprisingly, moved down below its moving average, which is bullish, although it remains to be seen if the second wave or the vaccine disrupt or reinforce that trend.
Within that the main indices are now about 6-7% above their trend which is towards the upper end of where they have got to in the past. While the stronger performing Mid and Smaller Cap indices are 12.3% and 17.6% above their moving averages which is a record amount in the six years or so since I've been compiling these indicators. So that might suggest that the run up in Mid and Small cap names has perhaps gone a bit too far in the short term perhaps? Or maybe they just take a bit of a breather while the larger stocks play catch up, although you would have thought in these circumstances the moves might have been the other way around. In addition in the short term, after such a strong move, it might not be unusual to see some mean reversion on the back of profit taking perhaps.
The swing factor in whether this comes to pass might be the binary BREXIT deal or no deal outcome. Press reports seem to suggest that a deal was possible this week, although it is looking as though that could even extend into next week before a key EU summit on 10th December. My best guess is that a deal will be done at the last possible minute as that is the way the EU seem to operate in negotiations with 11th hours agreements often coming at the last moment.
Also it is noteworthy that the Portfolio since the March low to the end of November has returned 27.3% while the market has provided a total return of 16%. So on this occasion the Market Timing indicators have failed to add any value and indeed if one had traded out and were now looking to get back in you'd have also have incurred significant fees and spreads too in addition to missing out on the subsequent recovery. Thus this tends to confirm my suspicion that market timing is a bit of a mugs game and that it is generally better to remain invested and benefit from time in the market. Provided of course you can stomach the downs as well as the up and not panic out at the bottom.
To be fair these type of timing indicators did work well in the 2008/9 GFC as Central Banks were a bit more tardy in responding that time around. On this occasion they were very quick to respond and pump in liquidity which facilitated the turnaround in double quick time. It does of course leave the US market in particular looking particularly extended in terms of its valuation at this early stage of the recovery unless that can surprise dramatically to the upside in terms of its effect on Company profits and earnings.
On the back of that I'll probably stop writing the timing indicators up on here on a regular basis. I may however keep the data going and mention them if it seems significant in the future in terms of the signal. As a result of that I'll be keeping the Compound Income Portfolio still mostly fully invested going forward from here
Compound Income Portfolio.
It was also a positive month for the portfolio, although sadly not to anywhere near the same extent as the +12.7% total return from the FTSE All Share which I use as a benchmark. Indeed in that context the +6.8%, while great in absolute sense was perhaps, a little disappointing and not even a record, as the Portfolio has done better than that on a monthly basis on a few occasions over the years.
Nevertheless it is worth seeing that in context as the Portfolio had outperformed the index since the March low by producing +18.6% versus +3.2% for the FTSE All Share to the end of October. Thus the portfolio in November gave back around a bit over a third of its out performance since the low. As a result the Compound Income Portfolio has year to date produced -6.86% versus the -13.17% for the FTSE All Share. Since inception the portfolio has returned +88.51% or 11.84% per annum which compares to +18.22% or 3% per annum from the FTSE All Share.
Quantitative Factors & the Growth/ Quality versus v Value debate.
This doesn't come as a surprise to me as the process is designed to identify and target quality growing shares with robust finances and ideally supported by improving prospects in terms of estimate revisions. Whereas the winners as a result of the vaccine news were the precise opposite of that i.e low quality, loss making in some cases and with poor balance sheets that had been heavily downgraded. Though if users of the Scores were so minded to make that switch they could have identified suitable candidates by just looking in the lower quintile of the Scores rather than the top quintile as usual!
As someone who has managed quantitative driven portfolios both professionally and personally, this move comes as no surprise to me. Indeed at turning points in the market like this quantitative factors tend to stop working for a short period while the buy crap / recovery stocks is going on before the factors that the model taps into reassert themselves in the longer term.
The monthly screening process does also not lend itself to that and I felt disinclined to throw out the process and charge into recovery plays or skate to where the puck is going to be as one big fan of crap stocks likes to say on Twittter! Sure if you are more of a trader and looking to make rapid short term gains then you will have needed to be buying crap and all those bombed out recovery plays hit by the virus. So congratulation to you if you have managed to do that. Personally as I'm looking to grow and compound my assets and income I still believe that buying and holdings quality stocks for the long run is probably a better way to go in my view, but each to their own.
Now I know that buying quality has become quite a trendy view in recent years after the success of Terry Smith and Nick Train with strategies based on that view. Indeed there has been a bit of a debate before the recent vaccine news about growth versus value and some even declaring the death of value investing as a major value investor threw in the towel and closed their fund in an echo of Tony Dye being sacked PDFM at the height of the dot com bubble. So the vaccine news or V-day was the catalyst for a switch back towards bombed out value stocks as the valuation differentials which had been stretched to the extreme snapped back the other way & previous momentum stocks cratered and previous losers soared.
How long this goes on for remains to be seen as we work through the second wave and await wider distribution of the vaccines. In the short term, given such a sharp move in the space of a month, as I said earlier, it would not be a total surprise to see mean reversion kicking in to reverse some of this move subject to the BREXIT binary outcome. Ultimately though the recovery in value trend might have a bit further to run for now.
While the Compound Income Portfolio and those type of stock that I target didn't fully participate at least I bought some Temple Bar (TMPL) (which I mentioned on here a few weeks back) for my own more widely diversified portfolio and incredibly have seen it rise by nearly 50%. Which is some small consolation and does help to demonstrate how extreme some to the moves have been in such a short space of time.
So I guess readers will have to make up their own mind about how they want to play things from here but for what it is worth I share below an interesting video from Terry Smith where he debates quality versus value. Now obviously he is talking his own book but he makes some good points even if he has probably suffered a bit of under performance in the short term since this was filmed as a result of the V for Vaccine rally in value stocks.
Summary & Concluding Thoughts.
So great news for the World that a vaccine has, somewhat surprisingly, been found to be effective in record time compared to the usual 5 to 10 years or never that had been speculated about. This has led onto a record month in stock markets around the World as investors celebrated this and the stocks beaten down as a result of the virus have had a relief recovery as investors moved to discount an economic recovery and an improvement in their prospects.
In the short term this picture is a little complicated by the current second wave restrictions, but in the medium terms is seems reasonable to assume that some sort of normality might be restored by next Spring / Summer & a sharp year on year increase in economic activity should ensue. Obviously the tricky bit will be how quickly this happens and to what extent the economy gets back to some kind of normality or will behaviour be permanently changed?
The UK market seems quite well placed within this current phase as it is heavy in many of the value sectors like Banks, Miners & Oils which are currently recovering strongly. Beyond that it remains to be seen how long that trend continues and at what point the financial and economic effects of the Pandemic start to bear on the market & the economy. Generally it is suggested that when economies get up to 100% debt to GDP which is where we are headed, then economic growth tends to be harder to come by. Think about Japan and what has happened there since their bubble peaked and how they have since struggled to grow despite low interest rates and lots of fiscal stimulus and their equity index remains below where it was in 1989.
I guess you could say the same about the UK as we have gone 20 years already since the dot com bubble peak in 1999 with the FTSE still below where it was then. So I'd say enjoy the rally while it lasts and hopefully it might have a bit further to go as we are into a traditionally seasonally stronger period. You never know one day this decade maybe FTSE will make it convincingly through 7000!
However as a wise old Stock Broker often said to me "things are never as bad or as good as they seem." So in the same way as I said towards the end of October that you shouldn't get too bearish when FTSE was around 5700. Equally now about 6 weeks on with the market now around 6500 I wouldn't get too carried away. Nevertheless rightly or wrongly I stand by the comment that "in the long run quality dividend paying equities still seem like a decent way to find a growing yield with potential for capital gains in a low yield environment."
So there you go obviously good luck to with your investing and however you choose to go about it and of course it may be possible to get higher returns by trading aggressively and jumping into low quality recovery plays but that's not something I'll be doing for the Compound Income Portfolio.
All that leaves is for me to wish any readers of this a very Merry Christmas if that proves to be possible at the end of this terrible year and here's to hoping that 2021 is a better one all round.