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Private Investor's Diary: Inflation concerns growing

John Rosier has an eye on inflation, but is staying fully invested for now.
Private Investor's Diary: Inflation concerns growing

Inflation fears begin to take hold

The topic of the month in May was inflation. Anecdotal evidence and hard data showed that inflation was picking up as economies re-opened. The main argument was about how high it would go and whether it was a temporary phenomenon or something more lasting. So far, the Federal Reserve is sticking to the line that it expects it to be transitory and that its main priority is to ensure economic recovery and higher employment. It seems that the bond market agrees. The US 10 Year Treasury yield fell slightly over the month and at its current 1.5 per cent, is some way short of the 2021 high of 1.74 per cent on 31 March. On the other hand, the gold price suggests that some investors are less optimistic and are buying insurance. The gold price rose 7 per cent to its highest level since early January.

Equity markets made further progress with Continental European markets especially, in fine fettle. The CAC 40 gained 3.4 per cent, the Italian MIB, 2.9 per cent and the DAX, 2.5 per cent. The Nikkei 225 was up 1.2 per cent, but in the US, while the Dow Jones at 1.9 per cent and the S&P 500 0.5 per cent were in positive territory, the tech-heavy Nasdaq composite was down 1.5 per cent. In the UK, the FTSE 100 crept above 7000 for the first time since March last year. The All-Share was up 1.1 per cent, taking the gain this year to 10.9 per cent.

Commodity markets continued to perform well with a growing realisation that a huge deficit is looming in so-called "green" or "battery" metals such as copper, zinc and nickel. Copper gained 4.7 per cent and is now a third this year. Zinc was up 4.6 per cent, and nickel, 2.4 per cent. Oil was also strong, with Brent crude up 3.7 per cent and looking like it wants to break through $70 per barrel. The long-term outlook for oil might not be brilliant given the move to green energy sources and electrification.  But in the short to medium term, the outlook looks rosy. Like metals, there has not been enough exploration to meet demand which continues to grow.

 

A mixed performance

Further progress for the JIC Portfolio, but the Funds' Portfolio edged back a little. The JIC Portfolio was up 1.6 per cent, just ahead of the 1.1 per cent for the FTSE All-Share (TR) Index. At 12.4 per cent this year, it is a little ahead of the All-Share's 10.9 per cent. Since its inception in January 2012, the Portfolio is up 360.2 per cent (+17.6 per cent annualised), comparing favourably with 97.5 per cent for the All-Share, (7.5 per cent annualised) over the same period the FTSE All-World (GBP, TR) Index is up 230.2 per cent or 13.5 per cent annualised.

The star of the show in May was K3 Capital (K3C). Its gain of 14.6 per cent followed April's 14.8 per cent. No other positions were up more than 10 per cent, and the worst faller was Biotech Growth Trust (BIOG), which ended the month 6.9 lower.

Following K3 Capital's "ahead of expectations" trading statement in April, the only other news was that it had secured debt facilities of up to £15m from HSBC on a three-year initial term. Hardly earth-shattering, but it does indicate the ambition of management to grow the business. Further acquisitions are likely. Given their track record of doing value-enhancing deals, shareholders should welcome them.

The JIC Funds Portfolio was down 0.8 per cent 1.0 per cent for the FTSE All-World GBP Index. It is up 7.2 per cent this year, a smidgen ahead of the 6.9 per cent for the Index. Since its inception, last June, the Funds' Portfolio is up 31.9 per cent vs 20 per cent for the All-World and 21.3 per cent for the All-Share. The worst position was again Biotech Growth Trust and, not surprisingly, given the returns of European markets, BlackRock Greater Europe (BRGE), 2.7 per cent, was the best performing position.

 

Back to dealing

After a two-month drought on the dealing front, I made a few changes to the JIC Portfolio. Following a strong rally in Renew's (RNWHshare price, I trimmed the position to 4 per cent (24th May at 658p). It remains a good investment, but above 650p I felt the short-term upside was limited. I reduced my reward rating to medium, which with my Medium Risk rating points to a 2.5 per cent position. I moved to 4 per cent to start with, and the next move will depend on the share price. Should it rally further towards 700p, I may reduce further to the target weight. If, however, it drifts back to 600p, I might be tempted to rebuild the position.

I added to De La Rue (DLAR), taking it up to 6.5 per cent (24th May at 188p). The share price had drifted back since its positive year-end update leaving it on a very cheap valuation, in my view. I changed the risk rating to Low, with High Reward points to a 7.5 per cent position. I justified Low Risk based on its more robust balance sheet following last year's capital raise. I do accept that I may be pushing the boundaries a little, and some might think that with a significant pension deficit, that this is a step too far.

Results published on 26 May slightly exceeded expectations. Chief executive Clive Vacher has demonstrated that the business is on a sounder footing and is now positioned to take advantage of growth opportunities. He expressed confidence that it would achieve its guidance of £100m revenue in Authentication in the current year ending March 2022. That's up 29 per cent on last year's £77.6m. De La Rue’s board also expects to recommence paying dividends in the 2022/23 year. It seems to me that management is confident that the ongoing recovery in the business will generate sufficient cash to cover the pension payments whilst leaving enough money to meet the company's requirements, pay its tax bills and pay a dividend to shareholders. On current forecasts, the shares are valued at 12 times March 2022 EPS forecasts, falling to around 9.3x March 2023 and under 8x March 2024. On 26th May I added again at 192p, taking my position to 7.5 per cent of my portfolio.

Late in the month I sold Syncona (SYNCat 216p. I hope this is not a case of running out of patience just at the wrong time, but I needed cash for a new acquisition. It was the only losing position in the JIC Portfolio, and I was not convinced that it would perform in short to medium term. I'm happy to focus my exposure to biotech and healthcare through Biotech Growth Trust and Worldwide Healthcare Trust (WWH).

In any case, I have greater confidence that my new position, Supreme (SUP), will perform over the remainder of 2021. I bought a 2.5 per cent position in Supreme on 25 May at 191.4p. Supreme supplies products across five fast-moving categories, such as batteries, with 20 per cent market share in the UK. Other main categories are lighting, Vaping, sports nutrition and branded household consumer goods. It has an extensive retail distribution network and employs a vertically integrated strategy. It floated on Aim in February at 134p.

It caught my eye because it has several characteristics which I seek. It seems like a quality business in that it generates a return of 65 per cent on capital with margins in the mid-teens. It is highly cash-generative, enabling it to both fund growth in the business internally and reward shareholders. In the trailing 12 months to 30 September 2021, earnings per share of 10.4p translated into operating cash flow per share of 12.2p and free cash flow of 10.9p. It is forecast to grow sales at 33 per cent for the year just ended to 31 March with earnings per share growth of 18.8 per cent. For the current year ending March 2022, earnings per share are forecast to grow by 16.3 per cent. The valuation looks attractive on a March 2021 PE ratio of 16.1 times, falling to 13.9 times to March 2022. The dividend yield is forecast at 3.1 per cent, rising to 3.6 per cent for the current year. The CEO, Sandy Chadha, owns 56 per cent, and it has an excellent shareholder list, including Canaccord Genuity, BlackRock, Slater, and Premier Miton.

Results are imminent and, given the trading update on 4 March, I'm hopeful that there might be room for forecast upgrades. I ranked it as High Reward (valuation looks enticing given the growth). I think it merits a medium-risk rating, but until I get to know it a little better, I have started it as high risk. High risk/high reward points to a 2.5 per cent position for me.

 

No.NameEPICMkt. Cap (£m)IndexRisk  Low, Med, HighReward  Low, Med, High% of  Port.My target  %Total return so far %
1BlackRock World Mining Trust PLCBRWM1,183FTSE Mid 250LH9.17.569
2Sylvania Platinum Ltd SLP357AIM All-ShareMH7.55.0153
3K3 Capital Group PLCK3C257AIM All-ShareMH6.85.064
4De La Rue PLCDLAR355FTSE Small CapLH6.77.525
5Venture Life Group PLCVLG115AIM All-ShareLH6.67.522
6Worldwide Healthcare Trust PLCWWH2,401FTSE Mid 250LH5.97.536
7Biotech Growth Trust (The) PLCBIOG562FTSE Small CapLH5.77.585
8SDI Group PLCSDI187AIM All-ShareMH5.65.0154
9Lundin Energy ABLUNES6,847 MH5.65.035
10Anglo Pacific Group PLCAPF310 MH5.25.09
11Central Asia Metals PLCCAML479AIM UK 50, AIM 100, AIM All-ShareMH5.05.039
12Baillie Gifford Shin Nippon PLCBGS703FTSE Mid 250MH4.15.088
13Bioventix PLCBVXP211AIM 100, AIM All-ShareLM4.05.096
14SigmaRoc PLCSRC236AIM All-ShareMM3.72.597
15Renew Holdings PLCRNWH500AIM UK 50, AIM 100, AIM All-ShareMM3.72.559
16Supreme PLCSUP238 HH2.62.57
17L&G ROBO Global Robotics and Automation UCITS ETFROBG  HH2.32.525
18Serica Energy PLCSQZ311AIM 100, AIM All-ShareMM2.12.532
19JPMorgan Emerging Markets Inv Trust PLCJMG1,585FTSE Mid 250MH2.15.014
20WisdomTree Cloud Computing UCITS ETF USD AccWCLD  HH2.02.517
21Calnex Solutions PLCCLX95AIM All-ShareHH1.92.5-4
22Surface Transforms PLCSCE131AIM All-ShareHH1.82.523
23Cash depositCD  LL0.1 0
          

 

Other News

SDI Group (SDI) updated the market on 26 March ahead of its year-end. It was another stunning trading statement following on the heels of February's update. It led to upgrades of around 10 per cent to pre-tax profit forecasts from £6.7m to not less than £7.4m. At first glance, the share price might look up with events but I think there is room for upgrades to next year's forecasts, especially if the company makes further acquisitions. Thus far, it seems to have made excellent acquisitions for which it has not overpaid and has then integrated them successfully into the group. With its investments, it has been a case of one plus one equalling more than two.

Calnex Solutions (CLX) produced excellent results, but the outlook statement was a little underwhelming. It seemed at odds with the confidence of the CEO about the outlook. The trading backdrop is strong with the 5G mobile rollout gathering pace. I suspect this is a case of keeping expectations under control. It is only two months into its financial year, and I'm hoping that forecasts will drift upwards later in the year. So, I'm not adding to what has become a losing position yet, but am watching closely. On 19 May, SigmaRoc (SRC) issued an upbeat trading update. I'm not tempted to sell despite the share price being up 135 per cent over the last 12 months. I read more and more about inflation in the building materials sector.

 

Sell in May?

Last month, Chris Dillow wrote a thought-provoking piece in the Investor’s Chronicle.  The bottom line was, “equity returns are seasonal, like it or not”.

He points out that seasonal investing, where one sells on May Day and buys back on Halloween, worked well in the last year. You would have avoided a 2.5 per cent loss over the May-October period and got back in for a 26 per cent gain from November to this April.

Looking at the longer term, figures show that since 1966 the All-Share has delivered a total return of 7.9 per cent per annum during the winter period v a loss of 0.6 per cent during the summer months.

Dillow rightly points out that seasonal investing does not work every time – “in finance nothing is 100 per cent successful – but often enough to make money over the long term”. He posits several theories for this phenomenon, but I won’t go into that now. The question for me is, what to do about it, if anything?

I guess, if one just held an index tracking ETF, one could try and capture this by selling on 30 April and buying back on 31 October. There’s a certain appeal to spending the summer away from the markets and improving one’s golf swing or whatever. While accepting the summer months might be more difficult, my approach is to a) focus on the longer term and b) continue to try and pick investments that will produce positive returns even if the market background is less than helpful.

For example, the FTSE All-Share may have given up 2.5 per cent between 1 May and 31 October 2020. but the JIC Portfolio returned 14.4 per cent over that period and I fitted in the Cotswolds Way and the Hebridean Way to boot.

Dillow also points out that the seasonal effect broke down recently. From 31 October 2019 to 30 April 2020, (the emergence of the pandemic) the All-Share lost 17.6 per cent. The JIC Portfolio was up 2 per cent, helped by a strong autumn and a very strong bounce-back in April.

Since inception of the JIC Portfolio in January 2012, there does appear to be a seasonal effect with the winter period averaging a return of +11.4 per cent, (median 11.5 per cent) and the summer period +6.6 per cent (median 3.9 per cent). Also, six of the winter periods are ahead of the succeeding summer periods, with just two behind, 2018 and 2020.

So, what does this tell us about the immediate future? I think not much, although given the 30.9 per cent rise in the most recent winter period to 30 April, if I was a betting man, I would put my money on the next six months not being as good.  

I will continue to focus on holding the right mix of investments and in trying to get the market to work for me rather than against. By that I mean, buy on red days when, often on very low volume, stocks are marked down, and if I want to sell, do it on a blue day. In other words, not get buffeted around by market gyrations.

 

Outlook

I think the main risk is that the market is being a little too relaxed about inflation. If it gets going in the new few months, it could cause a bit of a sell off. I think, however, I would rather be in equities than government bonds in that situation; not all equities but those that should benefit from inflation. I return, therefore, to my high exposure to commodities. Including oil & gas, I have 35 per cent of the portfolio invested in this area. Companies like SigmaRoc are price givers rather than takers.  For the time being, I remain happy to be fully invested but, on an extended run, might be tempted to raise a little cash. It is most frustrating when there is a correction and one has no firepower.