Looking beyond the mayhem

Markets plunged in the first half of the month, bottoming during the week beginning 16 March. There was then a strong recovery, lifting markets some 10-20 per cent off their lows. The rally between 24 and 26 March was the best three-day rally for the S&P since the 1930s. The S&P 500 ended the month 17.7 per cent above its 23 March low, but still down 12.5 per cent in March and 20 per cent from the start of the year. The Nasdaq 100 fared better. It was down only 7.6 per cent in March and 10.5 per cent in the first quarter (Q1). Many of the tech companies, such as Microsoft (US:MSFT), Netflix (US:NFLX) and Amazon (US:AMZN), are expected to be both short- and long-term beneficiaries of the current crisis. Netflix and Amazon were among the 14 companies in the Nasdaq 100 that were up in Q1. In continental Europe, the German Dax was off 16.4 per cent, the French CAC lost 17.2 per cent and the Italian MIB fell 20.4 per cent. In the Far East, Japan was off 10.5 per cent and the FTSE China A Index down only 6.0 per cent as life slowly started to return to normal.

In the UK, the FTSE All-Share (Total Return) Index was down 15.1 per cent, and 25.1 per cent lower over the first quarter. The All-Share return was flattered due to its domination by FTSE 100 companies. Further down the size spectrum returns were far worse. Fears that smaller, more economically sensitive companies would be hit harder by a sharp contraction in the economy saw the FTSE 250 Index down 22 per cent (31.0 per cent Q1 fall). The Aim All-Share was down 20.4 per cent (off 28.8 per cent over the quarter).

Meanwhile, there was chaos in the oil markets. Russia’s decision not to agree to production cuts led to Saudi Arabia’s determination to teach the country a lesson. It announced a substantial increase in supply to an already oversupplied market. This caused the price to crash from $50 a barrel on 5t March to a low of $24 on 1 April. Back in January, the cost of oil peaked at over $70 a barrel.

Government bonds benefited from the uncertainty. The US 10-year Treasury yield dropped from 1.9 per cent on 1 January to just 0.5 per cent on 9 March. The flight to safety helped the US dollar. Sterling fell to 1.14 at the height of the panic before rallying to 1.24 by the end of the month. It was still down 6.4 per cent in Q1.

Gold also performed well over the period. It was up 1.9 per cent in March and 4.8 per cent in Q1.

Performance:

By far the worst month in the JIC Portfolio’s 99-month history. It was down 16.1 per cent compared with a 15.1 per cent drop for the FTSE All-Share (Total Return) Index. That leaves it down 22.3 per cent this year compared with a 25.1 per cent fall for the All-Share. Since inception in January 2012 it is up 50.5 per cent, (7.8 per cent annualised), still comparing favourably with the 24.2 per cent return of the All-Share, (4.1 per cent annualised).

During January and February, regular readers of this column will know I was worried that the markets were being too complacent. My main concern was that the impact on western economies from supply chain disruptions due to Covid-19 in China was being largely ignored. I had increased cash to 16.0 per cent, and my exposure to gold to 15.0 per cent through a physical gold ETF, gold mining ETFs and Anglo Asian Mining (AAZ). I did not for one minute envisage the mayhem that has been caused by it spreading outside China. Nor to be fair did the World Health Organization (WHO) or indeed The New and Emerging Respiratory Virus Threats Advisory Group (NERVTAG). At its 21 February meeting, it decided not to raise the current Public Health England risk assessment from moderate to high.    

Three of my holdings were up in March. Aberdeen Standard European Logistics (ASLI), which I added to the portfolio on 28 February, was up 7.3 per cent and went ex-dividend 1.27p. The main attraction here was the dividend yield of over 6.0 per cent. The Wisdom Tree Physical Gold ETF (PHAU) was up 1.4 per cent and my largest position, Worldwide Healthcare Trust (WWH), was up 0.5 per cent. Other than that, everything else was, to a greater or lesser extent, down.

The worst performer was RockRose Energy (RRE). Embarrassingly, I have made a round trip in this stock. Down 56 per cent in March, it has given back all the gains since I bought a year ago. An oil price below $30 a barrel, if persistent, would cause it problems. The risk is that it would not generate enough cash to make further investment in maximising production worthwhile. It would also be likely to bring forward the date of decommissioning, and again there would be a risk of a cash shortfall to meet these liabilities. Having failed to cut on the way down, I decided to stick with it. Why? While oil in the $20s a barrel would be harmful to RockRose, it would also be unsustainable for Saudi Arabia, Russia or US shale producers. Eventually, an agreement will have to be reached, and as I write, one has been. If the agreed production cuts prove insufficient, I am sure OPEC+ will return to the table. In the meantime, RockRose has no debt and cash resources which it is guarding. Capital expenditure in 2020 will be cut, and in the short term it has hedges in place protecting its income at these lower prices. It ended March at 618p a share. It’s pleasing to see it has bounced back to 965p. My main mistake here was my Risk rating of Low. It should have been at least Medium, which, somewhat after the horse has bolted, I have moved to.

Other notable fallers: SigmaRoc (SRC) was down 51.5 per cent, with a big sell order overhanging what is an illiquid stock. The company looks exceptionally cheap compared with other aggregates companies. Duke Royalty (DUKE) was down 49.5 per cent on concerns that some of its royalty partners would be hit by the current lockdown. Undoubtedly, income will be down in the short to medium term. Duke points out its operating costs are low, and it should be able to pay a dividend in 2020, albeit less than in 2019. Games Workshop (GAW) was down 31.3 per cent as it closed all its operations while the lockdown is in place. I expect it will stage a strong recovery once its shops and website reopen for orders. Renew (RNWH) was down 23.9 per cent. Much of its business is in maintaining critical infrastructure. Some work, however, is being delayed until the shutdown starts to be relaxed. SDI (SDI) was off 22.2 per cent and Anglo Asian Mining (AAZ) fell 21.8 per cent. Anglo Asian Mining announced a suspension of gold sales as it could not fly gold doré to its Swiss refiners. It has since reported that a shipment has been made, and it has been paid.

Activity:

A busy month, with 18 trades in all. Thirteen of them were buys as I moved to a fully invested position. It was a combination of factors that gave me the confidence to put the cash in the portfolio to work. The pace of the fall suggested panic had taken hold. Many traders were keen to get out and move to the safety of cash. The fall in UK indices between January and 12 March was higher than in any three months since the South Sea Bubble in 1720. It felt like a lot of capitulation took place on Thursday 19 March. But that was just a judgement from watching share prices and the volume of shares being traded. Evidence came from looking at sentiment indicators. An old favourite, the ratio of outstanding put options to call options on the US market moved to extreme levels. The theory being, that when there are more people buying puts than calls, it means market participants are generally bearish. History shows that at the top of the market investors tend to be bullish and not surprisingly at the bottom, bearish. Chart 1 published by @charliebilello demonstrates it had moved to an extreme on 17 March, higher than in the great financial crisis of 2007-09. A year later, the markets were considerably higher. More recently, the spike up in December 2019 proved an excellent buying opportunity.

Sentimentrader.com also publishes analysis measuring the market mood. Its strap line is “Analysis over Emotion”. Chart 2 shows what happened to the S&P 500 over various time horizons after it had a more than 4.0 per cent up day, combined with fewer than 70.0 per cent of the stocks participating (going up). Uninformed comment might suggest that the rally being so narrowly led was not good news, but the evidence suggests otherwise. Going back to 1962, Sentiment Trader looks at the five previous times that the S&P 500 recorded a 4.0 per cent up day combined with only 30 per cent of stocks going up. In all cases the market was higher a year later, with the worst return being 16.4 per cent and the best 38.3 per cent.

On 17 March, sentimenttrader published chart 3, measuring the degree of panic in the market. Its 'Panic' indicator incorporates measures such as the TED spread (difference between three-month treasury bills and interest rate on interbank loans), junk bond spreads, and measures of volatility.  “All spike higher when uncertainty about the economy, corporate outlooks and stock prices are high, and reach extreme high levels only during times of outright panic.” Sentimentrader considers any reading above 3.0 as panic. On 16 March it hit a record high of 7.7.

Going back to 1954, there have been 52 daily occasions when this measure has closed above 5.0. On 83 per cent of the occasions, the S&P 500 was higher three months later, with a median return of 4.9 per cent. A year later it was higher 92 per cent of the time, with a median return of 25.4 per cent. So, while many are panicking and raising cash, the evidence shows that the correct course of action is to do the opposite.

Apart from these and other sentiment indicators, the vast monetary and fiscal stimulus in the US, UK and other western economies was an important factor behind my decision to go fully invested. What was impressive was not just the magnitude of the intervention, but the speed it was announced together with the commitment to do whatever it takes. Lastly, for many stocks, the valuations – so long as they had the financial strength to get through this lockdown – were looking attractive.

Trades:

The worst trade was adding to RockRose at 1,375p on 6 March. I bought back Anglo Pacific (APF) on 6 March at 127p, 25 per cent below the price I sold in early February. Likewise, I bought back Strix (KETL) at 139p, having traded out at 181p in February. I added to Games Workshop at £39 (reduced in January at £66), to Baillie Gifford Shin Nippon (BGS) at 120p, (reduced in February at 161p) and to L&G Global Robotics & Automation ETF (ROBG) at 1,075p, (reduced at 1,311p in February). New positions were introduced in PayPoint (PAY) at 717p, Watkin Jones (WJG) at 196p and 180p, Schroder Mid Cap UK Fund (SCP) at 439p, 364p and 334p. Schroder Mid Cap had moved to a 20 per cent discount to net asset value (NAV), which looked like a good entry point, especially as I like most of its most significant positions. A few months ago, the discount was less than 5.0 per cent.

I also added Moneysupermarket (MONY) on 18 March at 225p. A few days could make a huge difference. For example, my first purchase of Watkin Jones was on 16 March. If I had waited three more days, I could have got it 30 per cent cheaper. My timing with Moneysupermarket was much better, with the share price now 35 per cent higher. The important thing to me is where the share prices of all these stocks are in a year. I think they will all survive and that by April 2021 business activity will have recovered somewhat, and the outlook will be somewhat clearer. With many companies suspending their dividends, I have tried to focus on companies that can and most likely will maintain their payout, such as Bioventix (BVXP). Where payouts are put on hold, I need to be confident that they will resume in the next year.

I trimmed my exposure to gold through small sales of the physical gold and mining ETFs. At 31 March, my exposure to gold and gold miners was 16 per cent. Given the scale of fiscal and monetary stimulus, there must be a good chance of higher inflation. I intend, therefore, to hold on to the 16 per cent exposure to gold and miners for the time being. With the current government’s mandate to “even out the regions” of the UK, I do not see there being any appetite for austerity. Boris will want to be re-elected in 2024, so my guess is the aim of bringing down the deficit will be extended long into the future.

I have increased the number of positions from 24 to 28 and am likely to go up to my maximum of 30. This is a deliberate policy of reducing my stock-specific risk. Adding Schroder UK Mid Cap and building up Baillie Gifford Shin Nippon and L&G ROBO Global Robotics & Automation was part of this process. To help reduce individual stock risk, I reduced my standard unit size from 2.5 per cent to 2.0 per cent. So, High Risk/High Reward is now 2.0 per cent (from 2.5 per cent), Medium Risk/Medium Reward is 4.0 per cent (from 5.0 per cent) and Low Risk/High Reward is 6.0 per cent (from 7.5 per cent).

Outlook:

Whether we have seen the bottom for this cycle remains to be seen, and I think much will depend on how quickly the current severe lockdown is lifted. It seems obvious that it will be a gradual process. Any easing will be welcome and should contribute to a recovery in economic activity. Economic news will be grim, with what looks like a double-figure drop in GDP in the second quarter. However, the worse it is, the higher the stimulus. It is likely that most corporate news will be dire, but that should not be a surprise. I also think that the economic recovery could be quite robust. Although there will be lasting damage in some sectors, other areas will benefit from pent-up demand and restocking. I rather like this quote from Black Cullin Investment: “The foundations of a bull market are laid in diminishing bad news, not the start of good news.”

We have had a tremendous bounce from the lows, (the FTSE All-Share TR Index is up 20 per cent from the low and the S&P 500 is up 25 per cent). It would be incredible if markets did not pull back. However, most of the 'sentiment indicators' suggest a balance of people are still bearish and distrusting of the recovery. I am likely to use this rally to trim the odd position and let cash move up a little, say towards 10 per cent. This will give me some flexibility going forward and allow me to shift the balance of the Portfolio towards stocks that should ultimately benefit from this momentous period in history.

Stop Press: I normally report trades during the calendar month, but due to the volatile markets I have decided this month to update as of Tuesday. In April, I have reduced to Strix to 2.0 per cent (177.2p), and RockRose Energy to 5.0 per cent (at 905p) and sold Schroder UK Mid Cap completely (471p) for a tidy profit. One of my principal reasons for buying Schroder UK Mid Cap was its near 20 per cent discount to NAV. When I sold at 471p, the discount had all but disappeared. Cash on Tuesday 14 April stood at 6.8 per cent.