Volatility picked up during September. Markets are having a crisis of confidence as suddenly there seems much to worry about: queues for petrol, empty shelves, the HGV driver shortage, higher gas prices and rising inflation. The energy crunch is fanning fears that the current inflationary spike will prove long-lasting. With supply bottlenecks around the globe, there is chat of a return to the stagflation conditions of the 1970s.
With mounting concern that demand will suffer from slower growth, metals prices most reflected those fears. Nickel, for example, fell 7.8 per cent, copper 6.5 per cent and platinum 3.4 per cent. Energy prices, on the other hand, are flying. Brent crude was up 9.3 per cent to $79 a barrel – its highest since October 2018. Gas prices have increased around the world but no more so than in the UK. Since 1 October, spot gas has traded as high as 400p per therm, having averaged 54p between January and May.
The impending tapering of the Federal Reserve's bond-buying programme and fears that inflation may be more persistent reversed the steady decline of the US Treasury 10-year yield. It rose from 1.3 per cent to 1.5 per cent over the month – although still below the 2021 peak of 1.75 per cent reached in March.
Perhaps not surprisingly, rising bond yields led to highly valued growth stocks being hit hardest. The Nasdaq Composite was down 5.3 per cent, reducing its gain this year to 13 per cent. The S&P 500 was not far behind, falling 4.8 per cent. In the Far East, Hong Kong was off 5.0 per cent, but the Nikkei 225 gained 4.9 per cent. In Continental Europe, the German DAX was off 3.6 per cent, the French CAC 2.4 per cent and the Italian MIB down 1.2 per cent. The FTSE All-Share fared relatively well, falling just 1.0 per cent. Its exposure to large oil – BP (BP) and Royal Dutch Shell (RDSB), both up 15 per cent, helped the index. The mid and small-cap indices did less well, with the FTSE 250 down 4.4 per cent, Aim All-Share down 3.8 per cent and the FTSE Small Cap down 2.2 per cent.
In the meantime, with the prospect of higher and more persistent inflation, gold continues to disappoint. It was off 2.7 per cent, leaving it down more than 7.0 per cent this year. Fans of Bitcoin will point to its 66 per cent return this year. Gold may have its day again, especially if the most ardent pessimists' dreams of stagflation come true. I'm happy with my decision to sell most of my exposure to gold at the turn of the year, but don't rule out adding in due course. My current exposure is through the BlackRock World Mining Trust.
The JIC Portfolio scraped home in positive territory for the second month in a row, although the funds portfolio did less well. The JIC Portfolio was up 0.5 per cent, leaving it up 11.2 per cent this year but still behind the FTSE All-Share and FTSE All World. They are up 13.6 per cent and 13.0 per cent, respectively. Since inception in January 2012, the JIC Portfolio is up 355.1 per cent (16.8 per cent annualised) comparing favourably with the 102.2 per cent (7.5 per cent annualised for the All-Share) and 249.1 per cent (13.7 per cent annualised) for the All-World.
My two energy stocks bailed me out in September. Serica Energy (SQZ) was up 46.9 per cent and Lundin Energy (SW:LUNES) 24.1 per cent. Luckily, I added to Serica in July and held my nerve with Lundin Energy when it fell back to SEK 250 in early August. Serica is hitting all-time highs and Lundin Energy, at its highest since January last year, only has another 7 per cent to go to hit all-time highs. Hopefully, third-quarter (Q3) results later this month will help.
New holding CentralNic (CNIC) was up 13.6 per cent. Those were the only three holdings up more than 5.0 per cent. Venture Life (VLG) continues to torment me, falling 20 per cent. There was little new information in its half-year results, but they sparked another wave of selling from despondent shareholders. Central Asia Metals (CAML) was off 11.4 per cent, although it went ex an 8.0p dividend, accounting for nearly 4.0 per cent of the fall. More damage from mining companies saw Sylvania Platinum (SLP) fall 8.5 per cent and BlackRock World Mining (BRWM), 7.4 per cent. Bioventix (BVXP) and SigmaRoc (SRC), both down 5.8 per cent, were the other more than 5.0 per cent fallers during the month. The portfolio's return shows the importance of position size – Serica and Lundin Energy were both over 5.0 per cent of the portfolio at the start of the month, so their strong performance more than made up for the detractors.
The JIC Funds' Portfolio was down 3.7 per cent, leaving it up 7.6 per cent this year. Since its inception in July last year, it is up 32.4 per cent compared with 24.2 per cent for the FTSE All-Share and 26.9 per cent for the FTSE All-World. Apart from Baillie Gifford Shin Nippon (BGS), 0.4 per cent, and Chelverton UK Equity Growth (GB00BP855B75), the other 14 positions in the portfolio were down, with 12 worse than the 2.0 per cent drop for the FTSE All-World (GBP, TR) Index. BlackRock Throgmorton (THRG) was bottom of the pile down 7.9 per cent, reducing its gain this year to 23 per cent.
I did five trades in the JIC Portfolio and two in the funds portfolio. Following half-year results from Surface Transforms (SCE), I further increased the position towards my 2.5 per cent target weight. Recent contract wins and news on its more efficient manufacturing plans, requiring less capital investment, gave me the confidence to add. There are still risks such as contract delays, but I think that recent contract wins have demonstrated the reliability and capability of its carbon-ceramic brake discs. In a few years, the valuation starts to look attractive. However, that is some time away, hence my High-Risk rating which, with High-Reward points, to a 2.5 per cent position.
On 14 September, I sold WisdomTree Cloud Computing ETF (WCLD), realising a 50 per cent profit since buying last year. I decided to bank my gain as I feared a repeat of the 25 per cent drop seen earlier this year when the US 10 Year Treasury yield jumped to 1.75 per cent. I also had what I hope will prove a better use for the money.
I bought a new holding in CentralNic at 105p on 14 September. It provides businesses worldwide with tools to build their online presence and win customers and earn revenues online. The company complements its organic growth with targeted acquisitions of cash-generative companies in its industry with annuity revenue streams. The main attractions are that it is rapidly growing in an expanding market. It generates plenty of cash and the valuation looks attractive. It achieved organic growth of 16 per cent, accelerating to 25 per cent in Q2. At 105p, the market valued CentralNic at only 8.3 times its free cash flow for the 12 months ending 30 June. Furthermore, for the current year ending December, it is valued at only 14.0 times earnings per share (EPS). I'm hoping for a rerating of the stock towards 20 times EPS, which, given its growth, would, I think, look reasonable. Directors have large stakes in the business. Although I would prefer the operational management to have a little more skin in the game, the non-executives have a lot of money tied up personally and on behalf of their clients. I expect them to guide management not to do anything stupid.
Later in the month, I reduced SDI Group (SDI) to my target weight of 5.0 per cent (20 September at 201p). Its performance over the past year had taken it to over 6.0 per cent. I think SDI Group is an excellent long-term investment, but valuation had got ahead of itself in the short term. At 201p, it was valued at 30.0 times forecasts for the current year ending 30 April 2022. There is probably scope for upgrades, especially with further acquisitions, but even so, 30.0 looks a little toppy to me. I increased the position in CentralNic with the proceeds.
In the JIC Funds' Portfolio, I sold the WisdomTree Cloud Computing ETF and reinvested the proceeds in the iShares USA Value Factor ETF (IUVF). I think it makes sense to increase one's exposure to 'value' given the rising US 10-year Treasury yield. Having missed it last year, the drop in the yield over the summer gave me a second bite at the cherry.
Central Asia Metals increased its dividend by 33 per cent with its interim results. Free cash flow of $48.9m benefited from higher copper and zinc prices. Robust cash flow allowed it to reduce its net debt to only $10.1m. A couple of years ago it was over $100m. On current forecasts, the shares yield around 8.0 per cent for 2021. That looks super value for a company with virtually no debt and strong cash flow. It is one of the lowest-cost copper producers.
In a similar vein, Sylvania Platinum declared a dividend of 4.0p for its year ended 30 June, 2021. Group net profit increased 143 per cent to $99.8m and year-end net cash (with no debt) increased to $106.1m. The board is evaluating whether to pay another windfall dividend in February next year. The share price has come off as platinum, and rhodium prices have fallen from the high levels seen in the first half of 2021. The main reason for the fall is the global chip shortage, leading to a worldwide slowdown in car production. Industry experts predict a recovery in Q4, but even if it takes longer, the rhodium price is still nearly double what it was in the summer of 2020 and four or five times that in 2019. Cash flow at Sylvania remains robust as, like Central Asia Metals, it is a low-cost producer.
Outside the mining sector, Renew Holdings (RNWH) issued a short and sweet year-end trading update containing those beautiful words "materially ahead of current expectations". It looks as though earnings will be around 9.0 per cent ahead of prior expectations.
Richer, Wiser, Happier
In my aim to become better at this game, I regularly read investment books. Long-time readers of this column will remember that I introduced the risk and reward ratings after reading Excellent Investing by Mark Simpson.
I have just finished Richer, Wiser, Happier by William Green. Published earlier this year, it is the finest book on investment that I have read in a long time. Green, a journalist, records his meetings and conversations with some of the greatest investors – some well-known, such as Warren Buffett, Charlie Munger, Sir John Templeton, Joel Greenblatt, and Howard Marks, and some less so, such as Monash Pabrai, Nick Sleep and Zak Zakaria to name just a few who feature in this superb book.
It is full of bon mots:
· For a start, don’t pay too much. Don’t go for businesses that are prone to obsolescence and destruction. Don’t invest with crooks and idiots. Don’t invest in things you don’t understand.
· Make your mistakes non-fatal – its fundamental to longevity. And ultimately, that’s what success is in this business, longevity.
· What we need is a selection of sensible habits that are directionally correct and sustainable – habits that give us a marginal advantage that will compound over time.
· I like people admitting they were complete horses’ asses. I know that I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.
· Golden rule for risk management – know what you own.
There are several common threads, that to a greater or lesser extent, run through the managers’ approaches:
· Single-minded attitude to achieving success
· A willingness to stand back from the crowd and the perpetual “market” noise
· A disciplined approach but with a willingness to learn and adapt their approach over time
· Valuation is key, i.e., buy when the risk/reward is clearly on your side.
· Don’t just look at the upside - the downside is more important.
· Mental fortitude and resilience – all, of them experienced times of poor performance (Monash Pabrai; “All of the best investors share one trait - the ability to take the pain”).
There is an interesting line from Joel Tillinghast - “I refrain from talking too publicly or too frequently about my holdings because that would make it harder to change my mind and admit I was wrong”. I understand exactly where he is coming from, given that I publish my diary on www.jicuk.com and write this monthly column in Investors’ Chronicle. I’m not going to stop sharing my diary so am going to have to live with it. Readers should be prepared to see comments along the lines of, “I know I was bullish on this stock when I wrote about a few months ago, but I have changed my mind due to... and have sold”.
The book also prompted me to question whether there should be a place for high-risk stocks in the JIC Portfolio. Is the risk/reward of a high-risk/high-reward stock worth its place in the portfolio, even if it is only a 2.5 per cent position? It may be exciting to hold these stocks but is it the best use of my capital? Something to ponder. I also think I should tighten up my criteria for judging risk. When evaluating my risk rating on a stock, I have tended to focus on jurisdiction and its financials, ie how strong is the balance sheet, how much debt does it carry, how strong is its cash flow. I think my risk rating would benefit from adding a couple of new elements: valuation and business momentum. A low-risk rating would suggest strong financials, a valuation that is firmly on my side (there is limited downside should things go wrong) and strong momentum in the business.
Ultimately, I’m aiming for greater clarity and the flexibility to change my mind in the face of shifting evidence. Any changes I make to my approach should be seen as a natural evolution and certainly not a revolution – just some tweaking to try to improve the outcome, ie performance.
There is currently much to worry about, but as always what should concern us more are the things we don't know about. As Warren Buffett said in 2010: "People say it's a time of great uncertainty. It was uncertain on 10 September 2001; just people didn't know it. So, take uncertainty as being part of being involved in investment. But uncertainty can be your friend. I mean, when people are scared, they pay less for things."
The current bout of volatility feels as though it might continue for a little while. However, it also feels as though too many people are bearish. Maximum bullishness typically marks the top of the market. With five months of the fallow summer period gone (1 May – 31 October), the JIC Portfolio is down 1.1 per cent. Perhaps I should have gone away, but it's too late now and I look forward to what the coming months have in store. There is one thing for sure: for the time being, I'll be maintaining a reasonable exposure to oil and gas companies.