The most eagerly awaited news in financial markets is the monthly inflation numbers. Investors are desperate to call the peak in the current interest rate cycle. On that front, there were mixed messages this month
In the US, April’s year-on-year inflation came in slightly better than expected at 4.9 per cent. Further good news came in May’s reading of 4.0 per cent. Underlying inflation remains stubbornly high, though. The Federal Reserve is concerned about the tight labour market and continues to talk tough despite pausing hikes last week. Even if rates have peaked, they are not coming down soon.
In continental Europe, the news was also encouraging, with better-than-expected April inflation. Nevertheless, the European Central Bank (ECB) increased rates last week and signalled that there is likely to be another rise in July.
The UK, on the other hand, was unambiguously disappointing. April's annual inflation came in at 8.7 per cent, way above expectations of 8.1 per cent. Food inflation was the main culprit. The UK's poor numbers had a dramatic effect on interest rate expectations. With the Bank of England playing catch-up, a pause in hikes is no longer on the cards. The 10-year gilt yield jumped from 3.7 per cent to 4.2 per cent in May. Not good for mortgage rates.
In the US, Treasury yields rose to a lesser extent than in the UK. The US also had to contend with the spectre of default. The debt ceiling limiting how much the Federal government can borrow was at risk of being breached in early June. A great news story, but the markets seemed relaxed – after a bit of horse trading, Congress passed a law increasing the ceiling.
The jump in borrowing costs heightened concerns that recession is on the way. Worries about a slowdown were most evident in commodity markets, where all the primary industrial metals and oil were down. China's disappointing ‘reopening’ was another factor in weaker commodity demand. Zinc and nickel were down 15 per cent; Brent crude was down 10 per cent and copper was down 5.9 per cent. Copper is only down 4.4 per cent this year, but for zinc and nickel the falls are more pronounced at 24 and 33 per cent, respectively.
Equity markets
May saw a mixed bag of returns from equity markets. The winner was the Nikkei 225, up 7 per cent to 30,888. It broke through what some have labelled the "iron coffin lid" at 30,500. Several times over the last few years, it has proved a barrier to further gains. Relatively attractive valuations and an underlying change in corporate culture leading to a greater focus on shareholder value have pushed the index to its highest level since 1990. It is now only 25 per cent short of its all-time high 34 years ago.
The Nasdaq composite was up 5.8 per cent, but that was down to a handful of stocks. Artificial intelligence (AI) has caught the imagination, no more so than with chipmaker Nvidia (US:NVDA). It posted solid quarterly numbers, and the stock rocketed 36 per cent to become the fifth-largest US company with a market capitalisation of $1tn. Maybe I need more imagination, but I won't buy it on 24 times forecast sales. The S&P 500 was up just 0.2 per cent. Continental European markets had a poor time, with the Italian MIB off 5.8 per cent, the CAC down 5.2 per cent and the Dax down 1.6 per cent. The UK also suffered, with the FTSE 100 down 5.4 per cent, FTSE 250 down 3.6 per cent and FTSE Aim down 5.7 per cent. Recession worries have been to the fore.
Gold was down 1 per cent and, at $1,964 an oz, is 4.2 per cent off its April high. Bitcoin was down 7.2 per cent, but is up 64 per cent this year.
Portfolio performance
It was a dismal month for my portfolios. The JIC Portfolio fell 6.2 per cent in May, which means that year-to-date, it is down 11.9 per cent. Even after a poor May, the FTSE All-Share is up 1.6 per cent this year. Since its inception in January 2012, the JIC Portfolio has gained 278.8 per cent, equivalent to an annualised growth of 12.5 per cent. By contrast, the FTSE All-Share (Total Return) Index is up 114.8 per cent, with an annualised gain of 7.0 per cent. Over one year, the JIC Portfolio is down 9.9 per cent versus 0.4 per cent for the index and, over five years, it is up 42.6 per cent versus 15.2 per cent. I’m relieved to see that the JIC Portfolio has recouped all of May’s losses and more during the first half of June.
The performance of the funds portfolio could be better. It was down 5.1 per cent in May, leaving it down 3.4 per cent this year. Over the respective periods, the FTSE All-World (GBP, TR) Index was up 0.4 per cent and 4.7 per cent. Since this portfolio's inception in June 2020, it is up 23.8 per cent compared with 30.6 per cent for the All-World.
My exposure to commodities did the primary damage in May – a recurring theme over the past few months. BlackRock World Mining Trust (BRWM), Harbour Energy (HBR), Sylvania Platinum (SLP), Serica Energy (SQZ) and Glencore (GLEN) were off more than 8 per cent in May. They were not the worst performers, though. SDI Group (SDI) was down 26 per cent following a year-end update on 11 May. The results for the year ended 30 April 2023 were pleasing, but it was its warning that 2023-24 would see little overall growth that did the damage.
Its Atik Cameras business, which benefited from Covid-related orders, is unlikely to see new orders in the current year. That is an £8.5mn hit to revenues. FinnCap left its forecast revenues unchanged at £71mn, but reduced pre-tax profits and earnings per share (EPS) by 17 per cent and 21 per cent, respectively: £9.8mn (versus £12.4mn) and 7.3p (versus 9.3p). At the then price of 175p, the shares were on 23.9 times April 2024 forecast earnings. At the current price of 130p, the shares are valued at a more reasonable 17.8 times April 2024, but to make headway, it needs to get back on the front foot. Another earnings-enhancing acquisition would help, or perhaps some evidence that it was overly conservative in its forecast for the year ahead. I like the management and the buy-and-build strategy and hope my judgement that this is merely a hiccup along the way proves correct. After all, its larger competitor, Judges Scientific (JDG), did not go in a straight line from £11 to £94 over the past 10 years. Several times the share price fell more than 30 per cent and, on two occasions, by more than 50 per cent.
IG Design (IGR) was down 16.9 per cent. That was due to the continued fallout from its 20 April trading update. Nervousness about the US economic outlook might also be weighing on sentiment. Results were due out on 20 June, and I look forward to hearing more about the margin recovery and the improved cash flow and balance sheet. Hopefully, there will be encouraging news on current trading. At this stage, I'm sticking with it, pinning my hopes on a return to dividend payments in the current year ending April 2024 and a single-digit earnings multiple to April 2025.
It was not all bad news. Three of my holdings were up. Niox (NIOX) gained 35 per cent and is now up 71 per cent this year. Its 18 May update demonstrated good momentum in the business. In the first four months of 2023, it saw a 28 per cent increase in its core clinical business. With its vast potential, the US market achieved 16 per cent growth. Its cash balance increased to £22.3mn on 30 April, and it anticipates commencing dividend payments. I expect it will enlighten us about the timing and size of the dividend in its first-half results. Forecasts were substantially upgraded – for 2023, earnings estimates jumped 30 per cent from 1.47p to 1.95p. I would struggle to buy Niox on a prospective price/earnings (PE) ratio of 31.3, but there is clear momentum in the business and enormous potential. The PE will drop to 25.5 in 2024. I'm happy to stick with it.
ME Group (MEGP) was up 7.0 per cent. On 1 June, we found out why. Trading so far in 2023 has been strong – it said that in its first half ending 30 April, revenue was up 24 per cent and pre-tax profits 35 per cent. The full-year forecast was upgraded by between 7 and 10 per cent.
I look forward to first-half results in mid-July and seeing what it does to the dividend. Another special, perhaps! The shares look super valuable to me on an October 2023 PE ratio of just over 10 and at least a 4.4 per cent yield.
The funds portfolio performance
Again, commodity exposure did the damage. BlackRock Energy & Resources Income (BERI) was down 12.1 per cent, Global X Copper Miners ETF (COPX) -11.6 per cent and BlackRock World Mining Trust -10.3 per cent. VT Argonaut Absolute Return (GB00B7FT1K78) was the only one of my 13 positions in positive territory at +2.5 per cent. Others were down marginally, such as Polar Capital Global Healthcare (PCGH), -0.6 per cent, Smithson (SSON), -1.7 per cent and Chelverton UK Equity Growth (GB00BP855B75), -1.7 per cent.
Activity
A busy month. Things had to change. Patience is a virtue in investment, and you can't expect your portfolio always to perform well. However, there is a limit. The balance of my portfolio meant that too many of my positions were seriously underperforming. Was I guilty of having my head in the sand? I formally introduced what I'm calling ‘falling price reviews’. It is a price for each stock at which you might set a stop-loss. Automatic stop-losses are an essential tool in the box for shorter-term traders. They can, however, lead to poor decisions for longer-term investors. When a stock hits my falling price review, it is time for a thorough reappraisal. This culminates in the simple question: “If I didn't own it, would I buy it? (If no, sell it; if yes, how much would I buy? If less than the current weighting, reduce. If more than current weighting, add).”
This led to a few difficult decisions and the complete sale of two holdings. I sold Kistos (KIST) (22 May at 256p) and Gulf Keystone (GKP) (26 May at 128p) as I could not answer yes to the last question on my checklist. Harbour Energy survived due to its very cheap valuation, and, at 218p, it was returning 17 per cent to shareholders, half through dividends and half through buybacks. I am happy to maintain my oil and gas exposure through Serica Energy and Harbour. The losses on those two sales push them into the top 10 losses that I have recorded in the JIC Portfolio since its inception in January 2012. I'm hopeful that the rigour provided by my falling price reviews will lead to me cutting my losses sooner, and that there will be no new additions to the top 10 losses list for some time.
I also trimmed BlackRock World Mining to 5.0 per cent on 24 May at 612p. In this case, realising a decent profit. Another complete sale was CentralNic (CNIC) (on 3 May at 118p), booking a reasonable profit. I sold because the market does not seem to trust it – despite producing what looks like excellent results, it struggles to attract new buyers. That is partly due to the company struggling to explain how the business works. My other concern is how AI might impact the business. The company would have us believe that AI is an opportunity. It may well be, but it could also be a threat. It is worth looking at all your positions where this could have a detrimental effect. It is the only one of my positions where AI concerns me – there are too many unknowns. All the others make or extract things.
I added two new positions: IG Group (IGG) and RS Group (RS1). Last month, I noted the opportunity that was emerging to improve the portfolio's overall quality by adding quality compounders at attractive valuations. These two stocks meet that criteria. IG Group, the UK-based financial technology company best known for its spread betting platform, was bought on 4 May at 719p. It generates a return on capital and equity of 20 per cent-plus, has operating margins in the 40s and generates loads of free cash flow. Growth has also been impressive. Why now? The valuation looked compelling on 7.5 times forecast to May 2023 and a prospective yield of 6.4 per cent. Analysts have upgraded earnings estimates over the past three months. Unless it publishes a year-end trading update, the next news should be its results in July.
RS Group, the distributor of industrial and electronic components (bought on 25 May at 796p), has similar characteristics. It boasts a return on capital and equity in the 20s, generates plenty of free cash and has demonstrated good long-term growth and shareholder returns. A 40 per cent drop in the share price since September 2021 left the valuation attractive – a free cash flow yield of 7 per cent, a March 2024 PE ratio of 13, and a yield of 2.7 per cent. Seeing the chief executive buy £250,000-worth of stock the day before my purchase was encouraging.
I look forward to a Q1 trading update in early July, but in the meantime, I will pick up a 13.7p dividend – ex-dividend on 15 June.
There were three other trades. I added to SDI Group (11 May at 149p), Harbour Energy (11 May at 239p) and Shoe Zone (SHOE) (16 May at 208p).
In the funds portfolio, I sold my Gold Mining ETF for a small profit. I bought Schroder UK Mid-Cap (SCP), enticed by the discount to NAV of around 10 per cent and added a new position giving me exposure to Japan, the Nippon Active Value Fund (NAVF).
Other news
Sylvania Platinum announced a new buyback of $10mn stock on 2 May and Shoe Zone a further £2.5mn buyback on 31 May. Earlier in the month, Shoe Zone published solid H1 results. Harbour Energy's Q1 update was reassuring, with continued robust cash flow backing up its dividend and buybacks. NextEnergy Solar Fund (NESF) announced an 11.3 per cent increase in its dividend for the current year ending 31 March 2024. It currently yields 8 per cent.
Renew Holdings' (RNWH) half-year results were excellent. The dividend was increased by 5.8 per cent. The outlook statement was positive, with a strong order book. Bloomsbury Publishing (BMY) published excellent full-year results, beating expectations on the last day of the month. Revenue was up 15 per cent and earnings 18 per cent. Bloomsbury Digital Resources continues to show robust growth, with management aiming for 40 per cent growth from this division over the next five years. It increased the total dividend by 9.4 per cent. My conclusion on the day was: "On current forecasts to February 2024, the shares yield 2.9 per cent (but I doubt it will increase the dividend by less than 1 per cent) and are on 14.2 times earnings (but again, those numbers look far too low). Management seems to be doing everything right to grow sales and improve margins. Margins, return on capital and return on equity have steadily improved each year (including during Covid-19). Medium Risk/High Reward still feels appropriate to me. My target is 5.5 per cent. I'm at 5 per cent, so I am a happy holder. I would be happy to add if my position were below target, especially as selling yesterday drove the share price down to 410.5p."
Outlook
Difficult markets with a lot of gloom around. Everyone is worried about a recession. With just seven stocks responsible for the rise in the S&P 500 this year, the fear of missing out makes it tempting to buy some exposure. However, when I see that the market capitalisation of Apple (US:AAPL) at $2.9tn is more than the combined value of the constituents of the FTSE 100, I know where I would rather be invested. I remain fully invested but actively trying to improve the portfolio's quality. That should have the added benefit of reducing its risk profile. I'm identifying high-quality companies at attractive valuations, such as May's new additions, IG Group and RS Group.
