Its Not Harry

Comment and opinion for retail investors in the UK

Mark Potter

‘This is insanity!’

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I quote from a US venture capital specialist whose words I read this morning, commenting on the stampede of investment funds into new businesses, the vast majority of which are not making profits and in some cases not even making products!

His main reason for making the exclamation is that new ventures are able to secure new capital funding, on notionally higher equity valuations, as often as every 6 months. That used to be something that happened every 2 or 3 years. It is said that there is so much money available to invest that investors are actually queueing up.

That can hardly encourage the target companies to use the cash prudently – there are now anecdotes of fantasy order books and family members getting huge salaries to do nothing obviously useful.

A more sober fact came my way last week. Premier Miton presented data giving the CAPE (cyclically adjusted price earnings ratio) ranges for global markets as measured by the MCSI World index for various past time periods.

Naturally this ratio is highest when markets are expensive and has been highest of all ahead of major market setbacks, like in 1999/2000. The current data point is right at the extreme of the range, just where it usually is ahead of a sudden return to reality.

Some warning flags ought not to be ignored

Of course, no-one can say when a crash will happen and it usually happens so fast that one knows about it too late to protect ones profits.

As I have written consistently, timing markets is very difficult and the battle with human psychological biases is tricky. Crashes are always reversed over time anyway. So staying in the market is logical and in the long run gets rewarded.

However, I do think it might be wise to note the frequency of warnings from objective commentators that the runaway train might be about to come off the rails.

I am taking profits from my best performing holdings constantly now and only buying anything new that is great value, has not made much money for ages and comprises companies with cash flows generated by actually delivering goods and services at a steady profit.

And I am still retaining plenty of cash – I would much rather miss out on some of the ‘opportunities’ that are soaking up the tsunami of cash let loose by central banks.

As a lesson, I have excellent memories of people buying over-priced spec built houses in the early 1980s with 100% mortgages – the mass of repossessions that followed the collapse of the boom cycle was such that individuals who had cash on hand were able to buy multiple properties at knock down auction prices (at times 60% below the original purchase price) and they then set up property rental portfolios that made them millionaires in a decade or so.

As someone famous (probably Mr Buffett) said, the foremost mantra of investing successfully is ‘buy low, sell high’. I am attempting a bit of both. I still have a core portfolio in the markets, of course, but as I have said before, tinkering at the edges can be profitable. That means being active, taking profits often and if those profits are to be re-invested, buying with utmost care.

Monday mashup – Vanguard Lifestrategy update

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Some time ago, I noted in passing that the recent returns of the various equity/fixed income mix Vanguard Life Strategy funds had come together in an unusual way. Now we have seen a recovery in most global equity markets, especially in the US where all the funds have a heavy equity weighting, I thought it would be sensible to take another look.

I know that many of my subscribers own these funds and with good reasons – they are a cost effective and transparent way to test out the classic market theory of asset class diversification. But as I explain in more detail in the members only Muti-asset Academy section of the web site, they are not a panacea.

Here is a plot (click on the title to view) of the 80%/60%/40%/20% equity funds in order (the 80% fund is A and so on).

The reversal of the long term performance trend which duly shows the funds with the higher equity content making the most money is obvious in March this year at the peak of the pandemic driven sell off.

Vanguard-Lifestrategy-FundsDownload

In the period prior to the sell off, the fund at the top of the graph (turquoise line) is the 80% equity fund and at the bottom is the mauve 20% equity fund. This order is neatly and dramatically reversed as the additional volatility of the funds with more equities amplifies the impact of the market taking fright.

This is a textbook example of diversification working as a ‘shock absorber’. If you had invested at the beginning of 2020, you would likely have been a lot less worried in April if you owned the fund with 80% fixed income and probably felt quite smug right through until the Autumn.

But if you really understood that investment is a long term process and having recently invested you correctly decided to ignore completely short term returns, looking at your portfolio only occasionally, you would be happier of you had invested in the 80% equity fund.

My point is not to suggest that diversification is without merit. What I do believe is that although the classic (over 50 years old) theory of using fixed income stocks to diversify risk can be proven to lower volatility, that is only useful during a sell off and if you did not actively trade the asset mix (selling bonds to buy equities at the bottom of the sell off), you gain nothing over the medium to long term.

In truth, owning fixed income stocks in an ultra low interest rate climate adds long term risk and supresses overall returns. Only highly active tactical bond funds with macro themes and short duration make sense to me.

The almost set in stone structure of the Vanguard Life Strategy funds means that the fixed income exposure is not tactical and appears to have far more long dated bonds coming from the fixed income indices than I would be comfortable with. For that reason, I suggest that any reader holding funds with more fixed income than equity takes a careful look at what assets she or he actually owns. That means scrutinising the Morningstar X-Ray analysis and looking carefully at the style data and top 10 holdings.

If owning more equities makes you more money in the long run and owning fixed income stocks at this point in time is arguably riskier than it is allowed to be by historical theory, should you not look for other ways to diversify long term risks, not just look to benefit from a psychological shock absorber? I think that question is worth some of your time.

Monday mashup – the hokey-cokey

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The title reference is to the ‘in, out, in, out shake it all about’ line in that dance. I am prompted to write about the evergreen conundrum of market timing, mainly as a refresher, for two reasons.

A perpetual question

Firstly, when I am completing the first stage of my training plans with subscribers, they inevitably become nervous when the time comes to actually make purchases from cash reserves. Secondly, the current climate is one where all 3 of the major uncertainties overhanging financial markets for so long are becoming less unpredictable (US elections, Brexit and Covid-19). One might say, one sorted, one soon to be sorted in a way we can predict and the last looking a bit less disastrous.

The second factor suggest it might be a good time to invest but unusually the pricing of large parts of the market suggest there are only 2 games in town: booming new tech growth stocks and dull low value businesses doing old fashioned things. This makes decisions on purchasing far from straightforward without some discipline and methodology.

Resources

I have written on this subject from various viewpoints before. Here are some reference points (several will be subscriber only):

How to time investment sales

Blog post -June 2018

How to pick a fund for the future or how to be a contrarian

A fable for investors

The last article is quite long and I enjoyed writing it, but it may be tricky to follow for some readers. It serves to show that decisions to take money out of markets and re-invest later can be rewarded handsomely but in most cases, the source of the extra profit is luck.

This article can be understood well enough if you skip past my ‘in’ jokes about the financial system in the back story and start reading from the ‘3 decisions’ paragraph.

Some basic common sense

There is good sense in buying obviously cheap markets after a crash and not piling all your free cash into a market that has been booming for years. But aside from those common sense observations, I would suggest the best approach is to think about the long term and have a simple risk minimisation strategy.

Some years ago the then famous fund manager Anthony Bolton (a contrarian manager by style) used to often say that ‘time IN the markets is better than TIMING the markets’. If you look at very long term graphs of stock markets you will see that he is absolutely correct. The line goes steadily up and unless you have a gigantic screen or very large piece of paper, the compression of short term movements means you will not be able to even see the large drop of say October 1987.

Some text book rubrics

Don’t focus on the wrong data – investment is long term

Two things need to always be born in mind:

Every investor, however skilled or experienced buys the right investment at the wrong price when judged over a week or a month, but that might look like a stunning piece of judgement over 5 years or 10 years. In fact, I personally often buy investments I expect to do well a little early and lose money until the market catches up with my analysis. I don’t mind an initial 15% loss if my investment is up 25% in a year’s time – I might have made a lot less if I had waited and the price had already gone up 20% from the low point.

So rule number one it to not get all bitter and regretful about a fall in price in the early weeks or months of a well thought through fund selection.

The second idea to always remember is that when you invest sensibly (ie in diversified and intelligently chosen blocks of shares), you are just jumping on the capitalist machine. It’s function is to make money for investors and over time IT ALWAYS DOES.

Some of us (me included) find the way in which that happens at times rather inconsistent with our personal ethics, but that is really rather irrelevant – the machine exists as a part of the world and without it, the world would not function – even the Chinese communists seem to accept that.

So even if the machine grinds to a halt due to a malfunction from time to time and some people lose faith in it, it gets fixed pretty quickly. One only loses money from a diversified portfolio of collective funds (irrespective of when you bought an investment), if one withdraws money at the wrong time.

So the thing to worry about is managing your cash flow, not when to invest.

If I could ever claim to have been a good IFA, I would like to think it is because I got people to think about objectives first and short term investment returns second. If you have 3 young kids and can only afford one family car, you don’t start your selection process with 0-60 times and top speeds.

We all keep learning

To improve returns, it may arguably make sense to phase investments of larger sums – I accept that. Refer to the various articles listed above for other angles, but don’t expect a neat ‘this is the trick’ answer – it does not exist!

But we can try different techniques and become a little more skilled. We will make mistakes on the way – the world can mess up the most rational decisions. In investment portfolio construction and purchase, the only perfect science is hindsight

Nikol-ess?

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The strange title of this post is a cross reference to my post/rant entitled ‘Emporer’s New Clothes’ in June 2020.

This is about Nikola, the start up electic vehicle business into which GM invested a calculated 2 BILLION dollars, according to media reports.

By September 10th a major documented report (67 pages of it) was published by a researcher and market shorter called Hindenburg – look at hindenburgresearch.com – claiming Nikola’s founder Tevor Milton and associates were lying in their teeth. The founder had already built a track record of dubious dealing and misrepresentation and his brother, the named director of hydrogen technology, is reported to be well qualified in pouring concrete and maybe projecting fantasies but not as a hydrogen fuel scientist.

The up and running hydrogen powered trucks for which so many orders were claimed to have been placed (the same orders more than once) were of course fakes. This much had already been suggested by Bloomberg. Nikola’s first effort (in 2016) at a hydrogen truck was actually powered by gas, but CNG, not hydrogen. Natural gas powered buses are of course already in widespread use.

In the chaos that resulted GM appointed a new chairman (the guy who did the investment deal). They are still involved, but with probably not much money or even time really spent and they may have acquired a potential research facility. They probably got good publicity from the coverage of the ‘investment’ and there has not been much general publicity about the Hindeburg report and its consequences.

The quoted 2 billion investment was based on the supposed valuation of the Nikola business, not an actual amount of money spent.

The fuller story presented by Hindenburg is an entertaining story by itself if you are interested in the not uncommon blatant corporate deceit that pops up in the US in particular but also in the UK; those of you with Hampshire connections may recall a major IT con being perpetrated on the Wessex Regional Health Authority by a newly formed business.

The nugget of human behaviour that I collected from this tale was the willingness of people who should know better to take as fact presentations that are quite plainly suspicious or even obvious lies. They do this because they are ‘primed’ to do so and to act sceptical would risk opprobrium from their fellow humans.

Much as the Andersen tale warns. Good sense has always been around if you looked for it. Companies that never make profits and maybe not even any products are NOT worth a cent in reality. But plenty of money may get made trading their shares on fantasy valuations before the small child (or market shorting specialist) blurts out the truth.