Its Not Harry

Comment and opinion for retail investors in the UK

Monthly commentary

Monday mashup – parallel universes

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Is this a dream?

I have to confess at the start of this piece that whilst I am more than happy to offer you a report of the latest thinking on asset allocation decisions from the experts at Morningstar and my take on their observations, I do so whilst at the same time finding it impossible to rationalise the disconnect between the valuation of global shares (in the main) and the likely economic conditions that will prevail over the rest of this year.

I am not suggesting that I know when the Covid-19 pandemic will end or how it will progress. I am simply observing that what has happened already – ie the known level of economic damage – cannot be seen in any conceivable way as leading to anything other than recessions in all main global economies.

I think we know that much for certain, yet stock market players seem to believe they can see their way through that to justify valuations that were already overly high before any of us even knew what Covid-19 was.

What has just changed?

As I have suggested before, the medical news about the pandemic leads the economic news, so countries that have see a downturn in new cases, or even been able to contain the spread to very modest levels (like New Zealand) are able to relax quarantine restrictions. That is good news of course, but hardly implies a restart of the global economy.

Perhaps more disturbingly, in those countries where the more hard-faced capitalists or free market libertarians have sway (eg the USA and maybe the UK) or egotistical near dictators run the country (eg Belarus, Brazil), the vulnerable elements of the population have been thrown under the bus of perceived national interest (economic or pseudo patriotic).

Are we heading off in a new direction?

That being the case, we enter a new phase. If relaxing lockdown prudently or imprudently restarts some consumer activity, the depth of the recessions will be mitigated in the short term at least.

But if the pandemic accelerates (and I think few people understand exactly how dramatic that would be), then the alternative outcome would be even worse than the one that has come to be universally called ‘unprecedented’.

For the moment, some people obviously want to invest money. They may be better judges of the situation than me. If you were investing now, you might like to see what has happened in markets so far this year.

Observations from the Morningstar team in Europe

Commentary from MorningstarDownload

I have provided above a link to the full commentary for those who are interested. It is 11 pages long but includes various interesting charts. As I had the advantage of listening to a webinar giving the writers’ views directly, I offer the following extracts for your enlightenment.

  • The initial heavy sell offs in equities were reinforced by concerns about the willingness of central banks to inject liquidity and stimulate money flows. That prompted a classic rush to safe haven assets like US Treasuries, but investors soon started selling off government bonds to raise cash.
  • For a short period the only asset anyone wanted was cash. I think this was partly because people could see companies wanting to borrow and being prepared to pay much higher rates of interest just to build cash flow reserves, so plenty of attractively priced bonds were going to be issued and the big players wanted to take those up, having made large profits when the same thing happened in 2008.
  • Gold was generally an asset in favour, with a short interim sell off (possibly caused by central banks raising liquidity, but that is my speculation).
  • So at a high level, assets that sold off most were equities and high yield bonds. Emerging market equities sold off the most (they almost always do in such a situation) but the UK was not far behind because the UK is currently a market unpopular with international investors because of Brexit uncertainty.
  • In the ‘active vs passive’ funds comparison, good growth funds in the very biggest names and technology did much better than the index trackers, but most other equity funds did worse. This is hardy surprising as many trackers are automatically heavily exposed to the mega cap shares (ie largest companies).
  • In Europe earnings downgrades (ie company profit expectations) were the worst since 1974.
  • The momentum factor (good stocks keep doing well, bad stocks keep doing badly, to simplify) continued to be a noticeable influence.
  • ESG (Environment, Social and Governance) filtered stocks were favoured. This is a trend I have commented on repeatedly.

In summary, you will have had the least painful investment experience in the last 3 months if you had a portfolio biased towards large companies, technology stocks, quality companies (a vaguish concept) and those with strong ESG ratings. And plenty of cash.

I think my readers will not be overly surprised to learn that portfolios built that way look stronger in the current climate and in my view all those factors are relevant for the near future.

In the medium to long term, one ought to be able to pick up bargains that result from this shift. Momentum as a factor has had a very long run while value, companies out of favour but with strong business models, has been hugely negative.

There will in time be a refocus on companies that will do well in a recovery. They may still be in the more modern industrial sectors, have high ESG rankings and be assessed as having some ‘quality’ factors, so I am not saying that current criteria will cease to be relevant, but I think the target companies will perhaps be smaller. That concept may inform your fund research.

Monday mashup – markets buffeted

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Since I wrote my May briefing a couple of market trading days ago, the upward trend has reversed and the news over the weekend that the legendary Sage of Omaha, Warren Buffet’s Berkshire Hathaway fund has taken big losses and he has sold all his airline stocks at a loss is hardly cheering. What perhaps is more significant is his comment that he is not putting money into the market because he can’t find anything attractive to buy.

I read an article by a financial journalist making the same points as me about the hollow value of start-up companies. The writer, whose elegant prose proved why he is a journalist on a national paper and I am an investment analyst, added one point I failed to make: the reason many start ups grow so fast is that they offer customers $10 worth of services for $5 and that makes it pretty easy to acquire customers. And burns capital at a terrifying rate.

I have to confess I once did that! My then employer’s marketing department had set its managers targets for selling all sorts of accounts – just because that is what marketing departments do. My branch was not well placed to open the required number of “little saver’ childrens’ accounts per month because of our location and client base. That of course was not an excuse that satisfied the regional sales manager (ex-insurance company).

The reaction of anyone who has ever has to account to a sales manager

We had access to certain promotional goodies, so I ordered up the full allowance of Parker ball point pens and then sent out into the pedestrian precinct the better looking young members of staff wearing the sashes provided for events, telling them to offer a pen to anyone who had kids with them if they would open an account for one Pound.

Of course, as the pens were worth more than twice that even in the 1980, the outcome was a 100% success. My branch was even awarded a commendation in the monthly marketing bulletin.

If only I had understood that corporate operations were frequently that stupid, I might by now be a billionaire!

Watching Brief – April 2020 (m)

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Pottering About

I am conscious that the world is changing
fast in many ways as everyone tries to handle the Covid-19 crisis and its
implications at a rapid pace and so any analysis written once a month has a
very short ‘best before’ period! 

But I suppose that some analysis, even if you disagree with it, is better than none at all, or a page of bland clichés such as I have seen issued by some advisors!

I have been issuing frequent blog posts reacting to news flow and introducing ideas that I believe are worth pondering on now as a preparation for future action. 

What to think? I can only review that facts, assess the probabilities and attempt to draw conclusions, but I am no better than anyone else at prophecy.

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Monday mashup – Desperate measures?

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This morning a coalition of central banks in the most influential countries in financial market terms has announced a huge package of liquidity support and lower interest rates, yet markets have opened with sharp falls.

This is for much the same reason as when I wrote my blog entitled ‘Fed mis-step?’. The dramatic scale of the assistance package prompts market participants to think that the situation is utterly desperate.

I think the news will remain bad for a while, but they say that it is always darkest before dawn.

On the other hand, at times like this where there is overwhelming systemic risk, fixed income assets start to lose value rather than offer their usual diversification characteristics, because no-one wants to buy anything. That creates a liquidity crisis, which is rather like throwing a tool bag of spanners into the global financial system. So the authorities have to try and avoid that and their actions today are consistent with that threat.

My current assessment, which of course evolves as the world reacts to the potential progress of the virus, is that equity valuations will keep falling until there is evidence that the drastic preventative measures have worked.

That means that share valuations will likely be the most ‘over-sold’ they have been in my lifetime at some point and if the virus recedes, investors with cash will need to act quickly to pick up bargains.

It has to be remembered that it is the potential threat of a massive pandemic that is driving negative sentiment – the actual number of cases is very small relative to population and the number of deaths is minuscule as a proportion of populations – at the moment. So if the illness caused by the virus is more or less contained within the resources available, which will vary from place to place, the eventual relief will be massive.

Of course, this virus may be the start of a long term fundamental change in human activity. Consumerism has become the opium of the people, succeeding religion in Marx’s aphorism and capitalism is now about 70% driven by consumption. If that falls away permanently, a recession would be truly structural and last a long time.

Such major structural changes are in fact normal – think of how the world differs from that of the Victorian era, the interwar years or even the 1960’s. The current cycle of economic restructuring and resource sharing began in the 1980s in my judgement.

One could propose that global financial systems are in the end always regulated by social or human issues and that the returns to capital had been lately pushed to out of proportion levels relative to other stakeholders, like ordinary people and the environment. That is not to propose that there is better way of managing economic resources than capitalism – just that the balance of interests has been due for a correction for a while.

Watching Brief – March 2020

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Pottering About

Defenceless Markets?

I was surprised to see that I had already written about the implications of coronavirus a whole month ago.  The dramatic market sell off we have seen in recent days reflects the fact that the spread is now accelerating, in terms of locations, even if the case numbers are increasing less in China.

Virus spread maps have become a new fascination for some

I have commented on numerous occasions since I launched this web site almost 2 years ago that markets were taking a very optimistic view about profits growth and that the emergence of a significant negative factor that would threaten a global recession would see a dramatic set back. 

Whilst it has been possible and indeed profitable to ‘ride’ the momentum a little since central banks did their about turn on interest rate policy about a year ago, the advent of an ‘unknown’ could be expected to force an eventual reality check.

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