Its Not Harry

Comment and opinion for retail investors in the UK

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Midweek Musings – ‘The Times They are A-changing’

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As one Nobel Prize winning poet once wrote.

A quick look at the lyrics of the famous Bob Dylan song is interesting – they are highly relevant for investors. As a ‘writer… who prophesize with (my) pen‘, I agree that the ‘the loser now will be later to win‘ is a valid concept for investing – what I call being a contrarian.

You can sing along with this week’s post and play air guitar (or even get out your Taylor or Martin)

If I asked you to name an American electric car maker whose share price has risen 43% year to date, would you think immediately of Tesla.

In fact Tesla’s share price is down 9% or so year to date (in US dollars).

The car company whose share price is up that much (again in US dollars) is one increasing its electric car production and putting its prestigious Mustang brand behind the ‘halo’ model’, which looks to be an impressive car. It is, of course, the oldest mass producer of all: the Ford Motor Company.

I have also seen several notes from investment writers pointing out that Volkswagen is making good progress with electric vehicle sales and the shares in that business are held in some ‘opportunity’ type funds.

I am not saying anything about the merits of Tesla cars versus other electric cars: I have not owned any EV yet and know that this is a subject where views are often rather partisan and nothing much to do with investment valuations.

What I am saying is that there is now a wealth of evidence that the serious investors in global stock markets are looking forward past the end of the current boom in ‘new’ (now not so new) technology champions. Shares in businesses that actually make profits, have free cash flow and generate dividends are at last coming back into fashion.

As the nobel laureate puts it:

The slow one now will later be fast; the order is rapidly fadin’; and the first one now will later be last

That could be me ‘propehezising’!

Midweek Musings – Home Advantage?

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My theme this week is the impact of currency fluctuations on portfolio returns. I have been aware of this important factor since I first started learning about investments. I can’t predict currency movements in the short term (a whole industry thrives on playing that game), but I think anyone can assess relative currency risk.

Key principles

My bureau de change!

Let’s start with some basics. What makes a currency more or less valuable? Here are some of the main reasons:

  • Security – how capable is the country issuing the currency of sustaining its relative value? A world superpower in economic (not military) terms with open, efficient and highly liquid markets will get the most respect. The USA, UK, Eurozone or Japan offer what are called the ‘reserve’ currencies. China wants to join that list.
  • Politics – is the government behind the currency respected as prudent and unlikely to borrow beyond the country’s means. Such borrowing might come in the form of ‘printing’ money and if there is more of a currency around, its value may well fall. A reserve currency country has more scope to extend its currency base, but not indefinitely
  • Interest rates and their anticipated direction (highly significant) – there are always people and corporations and even governments with surplus cash to deposit for short periods, even just overnight. Naturally, that cash gets placed where interest rates are highest and to deposit the cash, you probably need to have it in the relevant currency. So there is demand for currencies issued by countries with higher interest rates on offer. By the way, this fact is the main driver in the price of Bitcoin, which is non-national commodity asset that can be substituted for currency.
  • Asset prices in the issuing country – if a country has been having a hard time and is thought to have turned a corner, then richer market players will look to pick up assets of all sorts – shares, whole businesses, properties and so on – at bargain prices. To buy those assets they need local currency, so demand will increase. The opposite applies when the perceived prospects for a country turn negative, or just become muddied, which is why Sterling fell sharply after the Brexit vote.

How does that impact on our investment decisions?

How do fluctuations in currency impact investors, in a direct sense?

Most of the time, we will invest in funds, ETFs or shares priced in the currency of the country in which they are issued. Some funds have “hedged’ share classes, but hedging costs money and it not 100% effective, so has not proved popular with retail investors. So if there is a change in the relative value of the currency in which our investment is issued, the value in our investment report, which is in Sterling, will change, irrespective of any other factor.

Imagine we bought GBP1000 of units in a fund that invested only in the USA. Overnight, the value of the fund’s investments goes up while the US stock market is working by 1%. So our investments should be worth GPB1010 next day. Actually, that will rarely be the case.

If the USD dollar went up 0.5% relative to Sterling, our gain would be 1.5% (GBP1015). If it fell 0.5%, our gain will reduce to 0.5% (GBP1005).

Currency values fluctuate by small amounts daily most of the time, but there are exceptions. Generally, there are trends in relative valuation and sometimes (maybe rarely), one can take a view that there is high probability of one currency going up or down relative to another because one is aware of the impact of the factors detailed above.

For example, it was highly likely that Sterling would depreciate between the date of the Brexit referendum vote and the outcome of negotiations and so there was little currency risk for UK investors buying overseas funds. In fact there was a good case for owning no UK investments at all during that period, because there was no direct currency upside in them.

Note the changes in a currency’s relative value will impact on trade and corporate profits, so there is more to understand on this matter, but that is not something we need to cover here.

Sterling as the Phoenix

Anyone who looks at their portfolio regularly will have noticed weaker performance in terms of valuation numbers from global equity funds over recent weeks. This is mainy because Sterling has been appreciating steadily. The UK Pound Sterling index is a measure against a weighted basket of other currencies and it is up from about 127 to 138 since 6 months ago, nearly 9%. That is quite a headwind for valuations of stocks listed in other currencies.

Why is Sterling going up so steadily? There are multiple reasons which fit in with my criteria above.

Should we be carrying the torch for British businesses?

The final ‘doing’ of Brexit has reduced political risk, even if there is no economic boom yet. The success of the vaccination programme in the UK has been taken as implying an early re-opening of the British economy.

Interest rates rising is not likely to be a baked in expectation yet, so that is one NOT yet applicable factor. But there may be a growing anticipation of higher inflation, which would be followed by higher interest rates – the data points that way.

I suggest that main reason is that UK assets have become outstandingly cheap and overseas investors, slighly jaded with the big US tech firms and worried about the huge cash flows into non-profitable new ventures listed on the NASDAQ, are thinking about buying some old fashioned ‘value’ businesses that sell stuff all over the world, make profits and pay dividends (and as an aside, may be ripe for takeover). So I guess that an inflow of foreign capital is one driver behind the appreciation of Sterling.

Now if a lot of other people want to buy UK company shares and our profits from overseas investments are being cut back by a possibly long running increase in the value of Sterling, maybe we should be looking close to home if we are keen on getting some assets at good prices with no currency risk?

That has already quite a reversal of tactics for me. But as J M Keynes suggested, when the facts change, you need to change your mind.

I think UK investments, carefully researched with some of the contrarian techniques I have explained before, would be a logical inclusion on any shopping list for those wanting to put money into the market or bank some profits from their momentum led tech funds. And there will be no direct currency risk!

Midweek Musings – Let’s get started!

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It seems to be ‘de rigeur’ to use the phrase ‘Let’s get started’ or similar at the start of a YouTube video and who am I to fight fashion?

This new format will on occasions cover a little more ground than its predecessor but it is still my ambition that you can take it in over a leisurely cup of coffee. More detailed analysis will appear in the subscriber only monthly WAtching Brief, and if requested, by the addition of longer reads to the main permanent site content. There will be plenty of fund specific content to give you ideas to follow up if they are of interest.

I had decided to omit my usual graphics too, to use the minimum of screen real estate because I expect some people will read this on their smartphone, but if that disappoints anyone, please comment as usual. Feedback is welcome and acted upon. The initial reaction I got was that the graphics helped with readability, so I added some in! I will adapt as appropraite if there is more feedback.

This weeks theme – diversifying your equity holdings. How about Fintech?

Inflation reborn?

As I have already explained in recent posts, the yield on US Treasuries has been slowly climbing, such that the long end of the yield curve is around 1.5%. This has been happening for about 6 months but a whole swathe of data on inflation has made market participants begin to accept that higher interest rates are coming in the medium term. Central bankers are doing their best to suggest that they are in no hurry to raise rates, but some of the inflation numbers are striking.

I saw a presentation earlier this week, a European focused one, where data was presented showing raw material prices increasing annually now at over 3.5% and for some minerals, much faster than that. Food prices are also moving up sharply and most readers will already know about the huge jump in the cost of renting shipping containers. Add to that a big jump in crude oil pices and a massive overhang of consumer savings on deposit at banks, likely waiting to be spent as soon as the world opens up to travel and shopping, and predictions of significant price inflation seem logical.

Asset class selection

As most of my readers will know, rising interest rates are bad news for fixed income investors, because the value of securities already issued moves in the opposite direction to interest rates. Precious metals, if not in demand in industry or for retail consumption, will also lose value because they have no yield. Deposits of cash will earn better returns but initially that is almost bound to be below the rate of inflation.

This classic model of a lower risk diversified portfolio from around 3 years back now looks seriously in need of revision, although many components will have done well enough

Of the major asset classes. one is left with equities and physical property. The latter is an asset that could do well if the actual properties are carefully selected but most mature funds will own too many retail shops and conventional office blocks and not enough logistics warehouses and server farms.

I am sure that everyone reading this owns a good range of equity based funds, probably with core holdings in the major markets of the world and some tactical sattelite picks. Looking to add further diversity to this asset block is worth your attention, given that the alternatives are not attractive and the track record of complex derivatives driven absolute return funds is in the main absolute in the sense of being absolutely awful!

Is now the time right for Fintech?

Funds investing in financial businesses have been around for years, mainly owning banking, insurance company and wealth management company shares. That makes sense because financial services is a huge part of some economies like the UK and those sort of busineses are subject to very high levels of regulation, so must surely be less risky (post 2008).

But the application of technology to financial services is making as much difference as the application of steam power did to agriculture a couple of centuries back or the invention of mass production did to the availability of motor cars. Can we invest in that process of change? Of course we can and the overall shorthand is Fintech.

There are not so many financial funds on offer to retail investors but I found a few (not all will be on your favoured trading platform – that is another thing to check).

Below is a downloadable link to a Trustnet fund comparion I prepared, using the well known Fundsmith global equity fund as the benchmark, which I think is realistic. The funds I chose are really quite different in character and the correlations not too strong, bearing in mind that these are all equity funds with a global stock universe.

Example-Financial-Funds-vs-Fundsmith-1Download

As always, I am not recommending any fund and I would suggest that you take a look at the top 10 holdings, recent volatility and the typical market capitalisation of the holdings (using the Morningstar Equity Style box) because they will demonstrate quite a difference between the funds.

Jupiter actually offer 2 funds with the same manager. One is a very old fund – Financial Opportunities, the other (Financial Innovations) much newer. The innovations funds fits my idea of Fintech, but is much more risky, with the usual potential extra return and risk of heavier losses.

Im addition to the 3 in the chart, I also found these funds:

  • Jupiter Financial Opportunities – widely available UK listed, diverse large cap growth fund
  • Fidelity Global Financial Services – Luxembourg listed, mega cap bank and insurance led value fund
  • Black Rock World Financials – Luxembourg listed, similar to Fidelity with more bias to insurance companies
  • ASI Financial Equity – small UK listed fund, looks quite diverse , no named manager

There are of course Fintech ETFs (there are ETF’s for just about anything imaginable as a legitimate investment!), but I could find none offered with a UK domicile and only one with an Irish domicile, trading in US dollars and tracking the KBW NASDAQ Financial Technology Index.

Many of the real Fintech businesses are not unlike other new generation technology companies in car sharing, food delivery, internet gaming and so on. In other words, they don’t yet make profits, may be run by very charismatic people who frequently come from countries well East of London and survive on endless funding rounds. So investing in the innovative end of the financial services sector would have to be classified as high risk. But some very mainstream funds from investment houses like Baillie Gifford have been backing businesses that look pretty similar, as have many individuals with their ‘free’ trading apps. The latter may be a permanent feature of stock market pricing, so some suggest and that will help support more adventurous businesses and their share prices.

Other companies, especially those in internet shopping and money transmission services are longer established and profitable.

I repeat that I am not recommending an investment in this area to anyone, that is not my function, but I am suggesting it is an interesting area for research.

I can say, only in the interest of transparency, that I have invested in the Jupiter Financial Innovations fund. It is not uncommon for me to dip my toe into the water after completing a research exercise. Some times I wish I had not!

Monday Mashup – gold: hold or fold?

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The price of gold bullion has declined steadily in US dollar terms for some months since its peak last Summer. A decline in the value of the dollar relative to Sterling will have added an extra loss for investors reading this post, and that includes me!

Readers who own gold bullion may therefore be asking the question in the title.

Why own gold and what about Bitcoin?

I own gold bullion because some 9 months or so back, I wanted to have an asset that was not correlated with global equities and would retain value if the pandemic got totally out of control. Fixed income and physical property investments did not look like offering much value then (and they still don’t) and there was obvious demand for gold.

Gold is a commodity and generally commodities (which include cryptocurrencies like Bitcoin) don’t pay an income and won’t be worth more because an enterprise does well. The price is directly and only determined by supply and demand.

Because high value minerals like gold and high complexity assets like Bitcoin are hard to mine and bring to the market (for completely different reasons of course), the supply side is known to be limited. So in making an investment bet on such assets, one is always taking a view on the demand side of the equation.

Money ‘rotates’ around asset classes over time

What’s changed?

This is the key to working out the completely opposite path of returns for gold and Bitcoin over the last few months. We have less demand for gold (more on that later) and more demand for Bitcoin.

The latter has a new champion with a big fan base in the form of Tesla’s Elon Musk, who has invested shareholders’ cash into Bitcoin in a big way.

The other reasons for Bitcoin demand rising I can only guess, but I would suggest it is possibly our old friend ‘herd mentality’, plus a bit more of a reported positive attitude from blue chip investment houses, although not reserve banks!

The reduction in demand for gold can be attributed to several factors. The main one is that the pandemic risk is thought to be much reduced, so avoiding national ‘fiat’ currencies is less important. Another is that interest rates on US treasuries are slowly rising, implying a market expectation of inflation and/or a slowing of US government money printing in the mid-term – surely inevitable.

Although gold is an excellent inflation proof asset in the long run, it has no income yield. When risk free (as is the convention) assets like US treasuries also have no yield and could lose capital value on a rate rise, gold looks attractive.

When interest yields pick up, the short term investor would rather have the income now than the inflation proofing later, so money rotates away from gold to lower risk (now improved) yield assets.

If such investors exected a sharp rise in interest rates, they would hesitate to buy the fixed income assets, because of the anticipated capital loss, so the markets are telling us that they only expect gentle rate rises over a long period. There is some debate about that, but the collective psychology of the market is always right for the time being!

So, what to do?

One could take the view that gold is a useful core portfolio asset, offering security and diversity and over the long term is both a volatility damper because of the low or even inverse correlation with global equities, and it will serve as an inflation hedge. In that case, it makes sense to keep a modest asset weighting.

Should you invest in crypto currencies instead?

I am not qualified to add to the view of regulators and cental bankers who suggest that although these new assets are very similar in character to precious metals, the way they are traded is probably not unlike the trading of the shiny stuff back in the 19th century at the ‘gold rush’ sites. Some people made fortunes, some went on to control large parts of the market and most people were financially wiped out. In other words, retail investors ought to stay away for now.

Another point of view would be that the vaccine programmes are going well, Covid-19 infections are coming down, there will be no real double dip recession and instead a consumer boom will drive up prices and in time interest rates. That proposition would imply that owning equities, even though they are currently expensive in many markets, or even well selected property assets, is a better tactical (ie short term) option and both fixed income and conventional commodities are not likely to make money.

If you are of the latter more optimistic frame of mind, you ought to think about controlling volatility in other ways within an equity portfolio. Investing in infrastructure is something that comes to mind, given that we expect high levels of government spending, or adding heavier weightings to healthcare funds, perhaps? I am not sure I know the full answer at the moment.

I did it my way?

As for me…..

You might expect me to tell you what I will be doing.

The answer is that I will not add to my physical gold holdings and as I have cash to put into the markets when I see opportunities, the relative weighting will go down.

Aside from that, I personally see no case for selling out, but my circumstances and portfolio will not be the same as yours, dear reader, so if you own gold, you need to make your own mind up!

I hope these comments help.

Monday mashup – too much cash in the system?

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I was prompted to read the explanation offered by NS&I (National Savings) on their web site after being alerted to it by my co-attorney who was trying to deal with a savings certificate maturity for my elderly father. In essence it says they are too busy to cope because everyone wants to put money with them.

I personally have long ago given up looking for the best interest rate on my deposit money, but I don’t have that much outside of my pension fund and trading portfolios. Some of my readers will have large sums on deposit and want to see some return on it. Would you be dealing with NS&I when their ISA savings rate (which seems to be their main promotion) is 0.1%?

I realise, of course, that most people will treat the 1% tax free return on the Premium Bond prize fund as enough to take a punt. The limits for Premium Bond investment are now generous enough to soak up quite a large chunk of reserves. I suspect it is sale of these bonds and the potentially accident prone (from an administration point of view) decision to switch prize payment to direct bank credits only that is behind NS&Is recruitment of an extra 260 staff.

With even august and secure institutions like Nationwide Building Society offering 0.5% (according to my quick scan of Moneyfacts) on their triple access account, then there would seem to be no reason to put money with NS&I other than in Premium Bonds. Or is there?

It can take a while to hunt down the best deposit accounts and check out how secure the bank is.

I suspect the large number of people who currently have much more money to hold on deposit than the FSCS protection of GBP85000 may get very tired of dividing their money up between multiple institutions.

I notice that many of the best interest rates on offer as shown on Moneyfacts are from some pretty new or specialist banks. One would need to know something about their security before making large deposits with them, I suggest.

One I checked out just because I knew of it from some years back – as a lender. That was Hampshire Trust plc. It appears to be totally sound as a business but it does specialise in development finance lending. Its reserves are well in excess of the statutory minima and it has a good chunk of liquidity on call with other banks. Having said that, in my personal judgement, a severe and sustained collapse of the property market might leave this bank with serious problems. You may take a different view after reading the company’s accounts.

My suspicion is that with interest rates being low and being likely to stay low, some people are valuing security and the certain ability to get their money back as more important than the odd fraction of a percent on the interest rate.

If you have the time and can do the research, and don’t mind dividing your money into GBP85k pockets, assuming you have more than that, you will get rewarded with a few quid in interest (after tax on larger sums, of course).

But I reckon that NS&I is sucking in plenty of funds from the public to help with the governments record borrowing, and in the main it is borrowing from citizens at virtually no cost. NS&I is the only absolutely secure home for a surfeit of cash.

Monday mashup – the (US) researchers view of 2021

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I commented in a member only blog post last week that I was little taken aback by the apparent optimism of Morningstar research professionals who presented a view of the US economy’s prospects for 2021. In fairness, they used plenty of supporting data, although of course, no-one has future data! Analysts will be using trend patterns and other statistical methods as well as economic and market theory to extrapolate the future.

Things are looking brighter – or are they?

Here are some extracts from their QI Market Outlook documents that I thought might be of interest. You may raise an eyebrow at one of two predictions!

  • US GDP will rebound by 4.7% in 2021.
  • Vaccine distribution (in the USA) will roll out in the first half of 2021 and be widely distributed by the third quarter.
  • Interest rates (again USA) will stay lower for longer with federal funds rates at 0% until 2024, but longer term rates may drift up this year – a relevant point for fixed income funds with long duration.
  • The huge amounts of corporate debt issued in the USA will slow down as the pandemic ends.

Morningstar’s market valuation standard has the US Equity market 8% over-value, driven by the mega-caps like Apple and Tesla. Tesla and Netflix are unsurprisingly reported to be hugely over-valued (around 150%). Value shares are on the other hand looking to be under-priced, especially at the smaller cap end of the market.

It is anticipated that 2021 will set new records in private equity fund raising.

SPACs (see my separate comments on these funding vehicles in the Watching Brief for January) have raised a large amount of capital which can be geared up to fund plenty of acquisitions (at high prices?).

Oil and energy stocks are the most ‘still’ sold off with the sector down more than 20% over 2020. The analysts expect the global glut of oil to get soaked up and the sector (in the USA) to recover.

All the above suggests a ‘back to normal’ US stock market with reasons to buy into oil and energy companies. That is something you may have noticed in the top 10 holdings of UK recovery and opportunity funds.

The pessimists’ camp – much reported in the UK news media that I see – takes the view that there are many red flags and other behavioural indicators that a market meltdown is more than likely, so making subtle calls on asset classes, stock sectors and so in is a bit irrelevant. This point of view ‘feels’ right to me, but that may be a result of my UK (and thus Brexit influenced) point of view.

Personally, I am 60% or more in the pessimists camp, but less so than I was 6 months ago. I suggest that no-one can know for sure what will happen in 2021 so a carefully balanced mix of good value assets, with diversification across the main classes and prudent use of cash reserves remains appropriate in the near term. If the optimists are right, there will be time to get more money to work in the right assets later in the year.

One theme that is rather more relevant to European than US stocks is ESG. The sustainability theme will be the most important for some years now, in my judgement. So if you want to buy funds, look for value, small cap and sustainability! Europe may well be a better place to start than North America or Asia Pacific. Not quite a needle in a haystack, but a challenge.