Monthly commentary
Monday mashup – crystal ball gazing? Or forecasting?
It is easy enough to work out what investors have to worry about at the moment and to give those risks a rating on probability of causing problems – even to guess when the problems will emerge. For example:
- The US elections – happening very soon and a risk if there is not a clear win for Trump or Biden and Trump refuses to depart even though the polls say he has lost. I don’t think which candidate wins will make much difference on its own to US stock markets, but a constitutional crisis would.
- Covid 19 – a risk that stock markets are in effect ignoring because many players like the consequent pouring out of nearly free money that is either in effect being invented, or which will be a burden on future tax-payers (which won’t include them, of course!). This Nelson like way of viewing global economics will maybe win a battle, but like Nelson, the corporate warriors won’t be able to avoid a bullet for ever. When it will come is unclear, but I suggest this is a medium term risk.
- Related to the above is over valuation of shares – the detachment of many companies’ valuations from a logical base and therefore the undermining of many established rules for making sound investments. This looks to me like a repeat of various past periods in recent history. Such bubbles of investment naivety usually burst without much warning. That could be any time soon.
- And finally for Brits only (and maybe with lesser consequences for Europe) – Brexit. This one has a very easy to observe time scale. We will probably know in less than a month whether or not a deal is really going to happen and even if that is strung out as some suspect. we are going to know by Christmas. The emails I have been getting from the Foreign Office as an EU resident Brit suggest that a least that bit of government is certainly expecting no deal.
None of the above will be new to readers, I am sure, but I find it helps to keep the simple facts in mind when fighting one’s sub-coscious biases, like the Fear of Missing Out (FOMO).
Of course, there are always risks, including ‘Black Swan’ events that might dent our invested wealth and blow our plans off course.
What perhaps is unusual at this time is that it is so easy to see so many risks and know that the market is not properly ‘discounting” them (ie allowing for them in valuations), except perhaps the last one, Brexit.
With the exception of some international mega cap businesses and selected mid and small cap firms, the UK stock market has performed very poorly for some time now. The relative performance of the main UK indices has been awful.
Because the Brexit risk is rapidly coming to a head, one might take the view that whatever happens, the removal of uncertainty and the ‘happening’ of the consequences of Brexit in full in 2021 will make investing in the UK a much more attractive proposition, because whenever there is major change, there are winners as well as losers. We can look for fund managers that we think know how to pick winners in a recovery situation.
I have thought for maybe 2 years that I wanted to participate in this opportunity. I bought UK value (ie out of fashion) and smaller company funds in late 2018 and 2019, thinking that the new Government was going to ‘get Brexit done’. In essence, although I did not wholly trust Boris Johnson, I though his election would unlock the Brexit process. For a while this seemed to have been a good call, but things went pear-shaped.
Even allowing for Covid 19 being a major spanner in the works this year, I was in any case misguided. I have only made money on the smaller companies fund, and given up and sold out of the value funds, because I expected to lose even more money in the near term. I would rather reserve the money in a defensive fund and buy at even cheaper prices. That sort of timing call has risks, of course, which is why I have titled this post as I have done!
I do not think any differently about the consequences of Brexit , only that my timing in buying into the most sensibly valued major stock market in the world was wrong (that happens to all investors sometimes, even the greatest). So I am once again looking for opportunities to buy UK shares at really cheap prices in the near future. I will publish some of my research soon!
Monday mashup – the everlasting active vs. passive debate
A refresher
Readers will likely know that investment funds are usually managed, either to own stocks in a specific country or industrial sector, or to manage a mix of assets (multi-asset). Investors pay fees, often quite high fees, because they think managers will apply skills to improve total returns and control risks.
Some years ago an American called John Bogle suggested that in the US fund managers actually delivered returns below that of their benchmark, say the S&P 500, most of the time. He then launched a business called Vanguard that offered investors a much cheaper way of investing by just buying an investment that more or less replicated the benchmark index.
There is more about this in detail in the article “Investing without management’ which can be found by searching using the key word “Passive”. This post is one for subscribers only.
There are other posts addressing the issue from different angles, including one of the first ones I ever wrote in March 2018, explaining how tracker funds tend to be more volatile
Recent Evidence
The research company Morningstar has reported on the relative performance of the average managed fund versus the average passive (tracker) for some years and recently released their European Active/Passive Barometer which looks at data over the last 10 years across all world markets. It is a 30 page document but one can pull some interesting data from the Executive Summary.
As might be expected, if investing in the main US markets, you might as well pick a low cost tracker because over 10 years only 5.6% of active Large Cap Blend funds survived (ie were available right through the period unchanged) and beat the average passive fund. 30% of small cap equity managed funds did better.
These sample extracts confirm something: fund managers can’t easily add value in markets that are extremely heavily researched and where any one can access all that they need to know about the market components. The more specialised and less researched a market is, the more chance there is for a manager to make money ahead of his benchmark.
It also follows that managers who are not benchmark aware might take very ‘active’ positions (ie go out on a limb) which will add ‘beta’, a separation from the market trend) for better or for worse. A good recent example of that was the Baillie Gifford group owning very large amounts of Tesla stock.
So it is no surprise that on a year to date basis the active funds that come out best are in areas like Korean Equity, Russian Equity, Austrian Equity and various others. One larger market segment where managers seem to do better is the UK mid cap classification.
The UK mid cap sector is interesting because the Brexit overhang means that some stocks in the index will be hugely out of favour and others will look like great value because they are Brexit ‘independent’. It would I suppose be a challenge to create a reliable ‘Brexit beneficiaries’ benchmark (although it may have been done – I have not checked), so well run managed funds have an advantage.
Interestingly, the UK mid cap sector is one where managers have done very well relative to the average passive fund over all period up to 10 years, so this is not just a Brexit related result. Having favoured the Standard Life (now ASI) UK Smaller Companies fund on and off over that period, I am not surprised.
So which to buy – active or passive?
I hope it will be obvious from my comments above and the more detailed articles on this site that I am open minded about these two investment options but would take the view that a passive fund is most likely to serve investors best when it tracks a well known large cap index.
For more focused asset weighting calls, a good manager will probably earn her or his keep.
A final thought is that in investing in funds with mainstream benchmarks, one is in effect taking a decision to go along with the crowd. That is fine and a way of playing the momentum factor, but recent experience suggests that benchmark independent fund managers like Terry Smith at FundSmith and Stephen Yiu at Blue Whale make the most money for their investors.
To balance that, one cannot forget one Mr Neil Woodford’s wandering away from his supposed benchmark and the consequences of that streak of independence!
Monday mashup – an Autumnal chill in the air
After a relatively non eventful August for markets (the steady climb in US market indices being almost volatility free of late), September kicked off with a bang.
Two declines and some stutters
Readers will have noted the sharp sell off, especially of the NASDAQ, last week, sharp enough to break some short term trading records, although only taking index valuations back a few days in reality – just very suddenly.
The fall in the dollar (until this morning, which change I don’t yet understand) suggested that markets were taking the same view that I expounded in my monthly commentary: that US interest rates are not rising any time soon and the the Fed may be the most accommodative of the global central banks.
This morning we see a very sharp sell off in the Japanese conglomerate Softbank (about which business I have written before). This is a business that appears to be operating to make money from trading the shares in other firms, not actually being interested in operating them. Such ‘corruptions’ of management as I would phrase it usually end in tears.
Other troubling stories are also rumbling around, like suspension of a rather obscurely run set of funds sold in the UK by Nataxis H2O, but after intervention by the French regulators.
Baillie Gifford, whose enthusiasm for Tesla stock seemed to be one of the main driving forces behind the share’s literally incredible rise have now sold out a large chunk of their holding and that spooked the markets too.
They say that the price rise had put the investment into an overweight and that must be true, but I wonder if even the manager of The Scottish Mortgage Trust (which now seems to be absurdly named given it invests mainly in US and Chinese technology and consumer services) has decided that he has travelled long enough on a bandwagon that he was helping to propel along with his legs over the side.
A technical helper on the extra volatility
Readers probably know that there are these days many millions of people trading in shares using newer technologies (mainly apps) who are without that much experience. I am not talking about people who build and maintain long term portfolios of funds but those who are often called ‘day traders’.
Because such people are often looking for a better life than one that has maybe not gone too well so far, they frequently start with very little capital, maybe even borrowing to get started. That makes it attractive for them to buy derivatives, rather than actual shares, because you get a large market exposure for not much money that way (ie you are ‘geared’). Courses are offered to people by experienced professionals to help them get started, but in my experience, even people sensible enough to take the training have only a limited understanding of what they are getting into.
One of the safer ways to play the markets with a small sum of money is to buy call options. For a premium that is much less than the price of the share or index you want to back, you buy the right (a contract) to purchase it (or a fixed number of shares in reality) at a future date at a given price. If the price is higher than the contract price on that date, you make a profit which might be a huge multiple of your small stake. If it lower, you let the contract lapse and lose your (hopefully) small stake.
Because the other party can just pay you out the excess profit on the shares if they are worth more than the contract price, rather than delivering the shares to you and obliging you to do the selling, the existence of such options in effect increases the number of transactions in those shares above the level of the real stock actually being traded
I can explain more, with examples, for any subscriber who wants a more comprehensive explanation, or you can take a look at Investopedia.
Heads they win, tails you lose
The reason for adding this educational note is to get you to think about the other side of the deal – the business that ‘writes’ the option. You might think that if you are buying a call option based on a share price rising and will profit if it rises a lot, the guy on the other side of the deal must be expecting it to fall and to be fleecing you for the premium when he is proved right.
That may be true, but actually, the other party may already own the share or index, or be capable of buying it and so has the risk of it rising covered.
If the share price goes up, they do only make the gain up to the option price because the excess goes to you, but that may be all they want in a rising market, bearing in mind that all the time they are collecting premiums (which might give them an income of 4% per annum, for example).
If we take a slightly deeper look at what happens when markets suddenly turn around, we shine a light on heightened market volatility. If your counter parts sees markets turning and a pretty high chance that you won’t make money on your contract, they are likely to sell the asset. They don’t need it to cover the risk of paying you out and they will look to bank any profit they have already accrued. They may even start ‘shorting’ the share.
So, without going into too much detail, we can say that the enthusiasm of a significant bunch of new investors for option contracts, which effectively multiplies up the trades in shares at market inflection points, is likely to also multiply volatility.
My balloon ran out of gas
Another well established influence on the markets is the ‘reversion to mean’ effect where the price of an asset will fall back sharply to its long term trend level when there is a relatively minor change in sentiment if it has moved a long way ahead of trend. Recent changes in the price of gold bullion can be seen doing exactly that if you take a look at a graph for the last few weeks
These influences on volatility are like weather effects: a chill in the air, a dark cloud, a few drops or rain, even a rumble of thunder. They may only be transient, but they might also mean the end of Summer. It is best to look out your umbrella and even check where you put your heavy coat.
This is a notoriously hazardous time of year for investors. If you are sitting on worthwhile profits, you need to consider the relative risk of missing out on more upside versus the consequences of a sharp correction.
If committing cash to the markets, prudent investors will always want to be sure that the current price is good value. That may be so in some cases be the highest price ever paid so far, but that will not often be true.
It is always easier to make money buying when everyone else is scared after a rout. You may have to wait years for such an opportunity but keeping some cash on hand will be well rewarded in time.
Watching Brief – September 2020
Monday mashup – Look at the detail
It is easy enough to find quotes from ‘experts’ suggesting that stock markets have gone mad. Indeed I have written on several occasions attempting to explain why stock markets seem to be doing better than one would expect when we are are now into recessions in most developed economies, with probably worse to come.
But it pays to re-check the actual facts from time to time. Although some share prices have shot up, most of the time that is the claimed “V” or similar recovery shape from deep lows. Here are a few broader facts (data taken from the BBC):
- The S&P 500 (the main US equity index) tech sector is up roughly 25% this year.
- The energy sector of that index is down about 37% and the financials group down 20%. Overall the market as expressed by this index is up a little on its February 19th record.
- Over half the shares listed in the S&P500 are trading lower than they were at the start of this year
- The FTSE 100 is 20% LOWER than its January high.
- The French CAC 40 is also down about 20%
- The Japanese 225 index is within 4% of its pre-crisis high (that will be in Yen terms)
An analyst at the Dow Jones index company is quoted by the BBC as saying that the risks of the US election and the potential for disappointment if the recovery already anticipated by the market does not happen are reasons for caution.
My take is that in many developed countries there is no real chance of an economic recovery in the next few months.
I would expect a ‘lagged’ impact from the Spring lockdowns across the world and the temporary burst of consumer spending that is only a release of built up frustration to fizzle out as job cuts and reduced salaries begin to be felt.
The businesses that have benefited from the lockdowns will in some cases now see tougher competition. It has been reported that traditional retailers, having been forced into upping their game online, are now taking market share from Amazon.
That does suggest it is a good time to hold shares in businesses specialising in online retail technology and distribution, something some fund managers will have picked up.
I hope I am wrong, but I am deferring my hoped for return to optimism.