As February Ends

Rebalance

As promised, albeit a little later than hoped, here’s a little commentary behind the recent rebalances of our main portfolios held on the Transact platform.

Inflation

As investors, our world changed at the beginning of 2022 as the rate of inflation ran rampant and central banks endeavoured to control inflation with aggressive interest rate rises. Equity markets plummeted. It seems like the easy yards have now been gained with inflation in the UK back from 11% to 4% now. Getting the rate of inflation down from here and back to the 2% per annum target will be a stickier proposition. More importantly other nations, including the US now have inflation in the low 3’s, so the UK should fall back in line within the next month or two.

As interest rates rose a safe cash return seemed like a much less risky proposition than shares. However change is finally afoot.

Opportunities & Risks

The eyes of investors are focused on five main opportunities and risks

1. When will the reduction in bank base rates begin? This will be positive for companies and hence equity valuations especially those of smaller companies. The first reductions in base rate will also force a revaluation of how useful cash remains as an asset in portfolios. There has to be a reduction in the return individuals can obtain risk free from cash, to tempt many (me included) into accepting fully the risk that accompanies equity investment. In times like these a 4.88% cash return obtained without locking it away for years feels good.
2. The Inverted Yield Curve. A full explanation can be found here. When a lender can get a higher return over the short term than they can over a longer term it suggests we are on the brink of a problem. Usually the longer the period you lend your cash, the greater the chances of default, so the higher the return you should demand. Unfortunately at the moment you can earn more by lending over shorter terms. This anomaly is called an inverted yield curve and it usually foretells of a full blown recession in the making. A looming recession isn’t necessarily bad for investors, often markets climb dramatically beforehand. Markets can continue to rise until the interest rate curve becomes normal once again. It is at that point where volatility cranks up in investment markets. The situation isn’t peculiar to the UK, it is true in most major economies. So we can still dance, but we need to keep our eyes on the exit. That will be when short term interest rates drop below long term rates once again, perhaps later on this year.
   • The UK 3 Month Bill Yield is currently 5.25%
   • The UK 2Y Gilt Bond Yield is currently 4.33%
   • The UK 10Y Gilt Bond Yield is currently 4.18%
3. Artificial Intelligence. It’s everywhere, but again it’s nowhere. For many of the “Magnificent Seven” stocks that are carrying the S&P 500 and the NASDAQ, AI is an arms race. Together they will spend $100’s billions each to win the prize. Without the returns of these 7 shares, most of the US market participants are still doing OK, but they could not drive the markets up to new all time highs. In total 10 shares make up 40% of the S&P index. If AI doesn’t deliver ever higher profits, what then? I believe the benefits of AI have been oversold, to me it looks like a mania, but I’m happy to commit a little to the potential beneficiaries of AI, but I won’t be betting the farm like many other investment managers are. Like the inverted yield curve, something has got to give eventually. Dance I will for now, but again I will keep my eye on the door.
4. Global Elections. There are so many this year, not just in the US and the UK. The markets never like political uncertainty, so the US Presidential race will likely upset the markets as it will be close run once again, decided by a tiny percentage of the voters probably a few weeks after the votes have been cast. Meanwhile in the UK, the result should be an over-whelming victory for Labour; but what happens if they embark on heavy spending and run up further debt? We can probably expect Sterling to be down-valued. November could signal the beginning of a currency decline. Better holding global assets rather than UK ones perhaps towards the end of the year. In juxtaposition, in many European countries socialism is on the retreat. The US Presidential election is scheduled for November 5th and the latest I have seen is the UK General Election will be held on the 14th November.
5. War? Whether that is aggression from Russia, Iran or China, there are bad actors in the world currently that threaten world peace and prosperity. Escalations in many theatres are possible which weighs on investor sentiment. Meanwhile defence shares are doing well from the increased spending. Internally Iran seems unstable, even former allies like Pakistan are becoming increasingly assertive. What if Israel decides to finish the job off of securing its close borders by launching an all out strike against the Iranian proxy warlords and quartermasters? Frighteningly where would that leave the UK with the mass demonstrations already on our streets?

New to our portfolios

In this rebalance I have added some new faces along with the return of some old faces. I was happy with most of the shares we already owned. However I was finally ready to lose the comfort blanket afforded by holding all that cash. So the cash we held was reduced in the expectation of higher returns from additional shares. There is still room to reduce cash further in the future.

The final two weeks in February are historically the poorest 2 weeks for investment returns, so I needed to be happy this year wasn’t going to be a re-run of previous years. I was ready to make the trades only once I was assured that Nvidia wasn’t going to miss the projected earning estimates and single handedly crash the market last Tuesday.

Here are the new shares added

• Advanced Micro Devices – beneficiary of the AI Gold Rush.
• Airbus – War. A probable beneficiary of increased European defence spending and also the recent commercial airline woes at Boeing.
• Cameco – Environmental. Uranium. The gradual understanding that the transition to sustainable energy must include Nuclear power.
• Costco – Recession Proof Our portfolios had become too top heavy in Walmart, so some shares were sold and re-invested here.
• Intuit – As “tax goes digital” every business needs an on-line accountancy package. A sticky recurring income model.
• L’Oreal – Recession Proof “Because you are worth it”. Recessions can come and go but cosmetic spend continues to climb. 94% of everyday purchases are made by women.
• Microsoft – AI Gold Rush Our portfolios had become too top heavy in Apple, so some shares were sold and re-invested here. Strong in data centres too.
• Novo Nordisk – (GLP – 1) Previously only in our Go For Growth portfolio. A dominant player in diabetes and fat reduction treatments. The stickiest business model ever.
• Nvidia – AI Gold Rush. Should have held it earlier but always seemed to be too expensive to buy. Maybe still is.
• Rolls Royce – War and Environmental. Jet engines and nuclear power stations.
• Segro – Warehousing. Previous long term hold, out of favour as interest rates climbed, should benefit as rates return to normal. Earner of rent
• Toyota – Sensible everyday car manufacturing. Largest in the world. They have not been involved in the excessive costs of all electric fleets.

And the existing shares still held, some reduced in volume

• Apple – AI Gold Rush. Sticky technology ecosystem. Reduced to make way for Microsoft and Nvidia.
• Ashtead – Plant hire. Adding rental income to the portfolio
• BAe Systems – War Missiles, Warplanes, Shells
• Berkshire Hathaway – Global conglomerate under the direction of Warren Buffett.
• Centrica – Energy provider, been a great performer since Putin invaded Ukraine but now much less impressive.
• Conva Tec – Necessary “icky” repeat healthcare products
• Indivior – Fighting Opioid use disorder
• LVMH – Champagne, Whisky, Cognac, Handbags & Fashion
• Merck & Co – (GLP – 1) Vaccines and Oncology
• Premier Foods – Recession Proof basic brands
• RELX – Information and analytics provider
• Stryker – Medical devices and equipment
• Walmart – Recession Proof reduced only to make way for Costco.

Shares waiting to be sold.

• Savannah Energy – Energy provider. Currently suspended from trading until 2nd April pending an acquisition of an energy business from Petronas. Whether the deal goes through or not I will be selling the share.

Investment Themes

From the shares above it is possible to see the themes that run through the portfolios.

• An aging developed world population requiring ever more pharmaceutical products.
• An increasingly hostile split in nations with an axis comprising Russia, Iran and China which demands a commitment from the West to increase defence spending.
• Recession proof goods and retailers which will continue to survive even through harsh times.
• An environmental requirement to transition to sustainable energy only afforded by the increased use of nuclear power to provide a carbon free base load.
• Technological innovation, which is ever changing.

Tablets and Tablets

In 2013, in the early years of my blogs I wrote about the themes that drove my investment decisions. These themes have served us well over the decade and remain relevant today. For a little bit of nostalgia here is a link to that early blog. Times have moved on since then. We now live in a more uncertain hostile world, laden with debt, on the cusp of a globally uncertain economic period ahead of us.

In the 36th year of my investment career it would be nice to imagine a time in the future where the world becomes economically more stable. I know that just isn’t going to happen. For now my job of walking the tightrope between FOMO – Fear of Missing Out and FOLO – Fear of Losing Out must continue.

As always I’m a phone call, an email or a visit away. Better still, ask questions in the comments section below. My answers to your questions then not only benefit you, but all clients.