This is relevant right now because we are at that time of the year when the winter and spring stock market tailwinds have habitually turned into headwinds over the summer and early autumn. In fact, the UK equity market has fallen in no fewer than 16 of the past 47 years in the six-month period between the end of April and the end of October. It also explains why the average gain over this period of less than 2 per cent is woeful compared with the 13 per cent return in the six-month period between Halloween and May Day. That's not to say you can't make money over the summer months as the experience of 2009 clearly showed, albeit those gains were made in the early stages of a new bull market. It's just that you have to be more discerning in your stock selection.
One way of mitigating risk is to focus more on the defensive sectors that have historically done well over the summer months, and less on the cyclical and value sectors that turn out to be the laggards after outperforming over the winter and spring months. The defensive sectors are utilities (water and electricity companies); pharmaceuticals; beverages and tobacco. This way if the general market continues to rise you have exposure to the sectors that have historically done well at this time of year. However, if equities struggle to make headway then at least you have some weighting towards the segments of the market that can be expected to outperform.
It's also well worth maintaining a watchlist of shares in cyclical and value sectors, with a view to picking up a summer bargain. That's because, if markets put in a lacklustre performance, or if there is a market correction, the shares likely to pull back most will be in the cyclical and value sectors that have stormed away over the winter and spring. So, we can take advantage of any summertime price weakness by selectively picking up quality companies at favourable prices, before these value and cyclical shares resume their upward trajectory at the end of the third quarter. And that is exactly what I intend doing over the next three months, by focusing on special situations priced on anomalous valuations.
Target special situations
Irrespective of the market headwinds, if a company is a sound investment proposition then it is my firm view that the valuation anomaly will, in the fullness of time, correct itself as soon as a sufficient number of like-minded investors acknowledge the opportunity on offer. I have some history here.
For instance, shares in Aim-traded carbon emissions investment company Trading Emissions (TRE) dipped to 19.25p last summer ('Time to capitalise on LMS', 25 June 2012), well below my advised buy-in price of 25.25p in February 2012. This was despite the fact that the company had "net cash of 25p a share, a private equity portfolio with a book value of 56p and a carbon portfolio with a negative net worth of 7p a share". The advice paid dividends quite literally. In fact, anyone buying last June has almost doubled their money. Even if you had bought when I first recommended the shares at 25.25p in February 2012, the current share price is still 50 per cent above your carrying value after factoring in the 6p-a-share capital return in January.
Moreover, with a further distribution to shareholders "expected to be announced in the second quarter this year", and the company actively looking to dispose of the portfolio of carbon and private equity investments, the shares are worth holding on to at 30p - a 40 per cent discount to pro-forma net asset value of 52p a share. I would await news on the size of the distribution.
This was not an isolated example either of the rich pickings that can be had by selectively stock picking summertime bargains. For instance, last summer I also recommended buying shares in numerous value plays, including: Indigovision (IND), Netcall (NET), Spark Ventures (SPK), and LMS Capital (LMS).
Hot property
Some of the gains racked up by value sectors over the past six months have been quite sensational and no more so than housebuilding. This fully justifies my decision to recommend buying the eight FTSE 250-listed companies in the sector at the start of the year. When I last updated the holdings, they were showing an average gain of 21.9 per cent on an offer-to-bid basis ('Full house', 25 March 2013). I advised selling two-thirds of each holding and running the balance until the end of April with specific target prices in mind.
FTSE 350 housebuilders' performance in 2013
| Company | Opening offer price, on 2 Jan 2013 | Bid price, on 25 Mar 2013 | Percentage change since 2 Jan 2013 | Offer price, on 30 Apr 2013 | Percentage change since 2 Jan 2013 |
|---|---|---|---|---|---|
| Taylor Wimpey | 67p | 90p | 34.4% | 96p | 43.3% |
| Barratt Developments | 210p | 267p | 27.0% | 321p | 52.9% |
| Persimmon (see note 1) | 814p | 1,033p | 26.9% | 1,110p | 45.6% |
| Bovis | 579p | 725p | 25.2% | 780p | 34.7% |
| Galliford Try | 748p | 928p | 24.1% | 991p | 32.5% |
| Bellway | 1,046p | 1,203p | 15.0% | 1,393p | 33.2% |
| Berkeley | 1,786p | 1,998p | 11.9% | 2,139p | 19.8% |
| Redrow | 170p | 188p | 10.3% | 213p | 25.3% |
| Average gain | 21.9% | 35.9% | |||
| FTSE 100 Deutsche Bank Short ETF | 678p | 630p | -7.1% | 620p | -8.6% |
| Outperformance | 14.8% | 27.3% | |||
| 1. Return adjusted for the issue of 'B' and 'C' shares worth 75p a share | |||||
The good news is that the target prices have all been hit and we are showing a gain of 35 per cent on the retained holdings. This means the total return on our original investment is over 26 per cent in only four months. That performance is three times better than the market and is good enough for me. On valuation grounds, and given the aforementioned seasonal factors, I would advise banking these handsome gains.
Finally, over the next few weeks I will try to update all the share recommendations I have given in the past six months. My next column will appear online at 12pm tomorrow.
