One Golden Rule To Heed Before Investing In A High Risk Venture

Before you decide to invest in a company, start-up or venture that is highly risky, there is one very important rule that all investors should heed. We are all aware of the obvious rules such as doing sufficient due diligence and only investing what we can truly afford to lose. However, a less obvious rule, and the one which I am talking about in this article, is focused on having Skin In The Game.

The origin of this phrase is debatable although a quick Wikipedia search tells me that it originates from derby races whereby the owners of the horses taking part in these races have ‘skin’ in ‘the game’. More recently, it has been written about extensively in the works of Nassim Nicholas Taleb. Put simply, it refers to how much ‘skin’ a person has in something or how much personal risk they are willing to take on. For example, in the case of entrepreneurs or founders of businesses, an entrepreneur who has the vast majority of their net wealth tied up in their business has considerable Skin In The Game. Even though they will be handsomely rewarded if the company is successful, they will also go down with the ship and face financial ruin if the company goes belly up. This latter point is crucial.

When I analyse high risk ventures, one thing that is a huge red flag for me is a genuine absence of Skin In The Game. A founder or director of such a company needs to have the majority of their own capital invested. ‘Share options’ do not count. However, ‘director buys’ do.

Another red flag is when founders and directors draw huge salaries, especially if the company is not currently generating any revenues. If a company is not yet making money, a company will be raising money via debt or equity placings (issuing more shares) to keep it a going concern. This is precious cash and should not be eaten up in the form of generous remuneration packages. Alarm bells should be ringing if this is the case.

Founders and directors who have a considerable amount of Skin In The Game in a venture is an indication not only that they truly believe in what they are working on and executing, but also that they are motivated and kept under a considerable amount of pressure to ensure that the company succeeds. They believe in the company so much that they are more than willing to match their considerable belief via taking on a considerable amount of personal monetary risk. If the company doesn’t succeed they will be financially ruined. There will be no government or organisation ready to bail them out if they fail.

I have seen so many high risk ventures collapse where the founders and directors have come out of the wreckage mostly unharmed. They always drew big salaries and their equity stakes were mostly in the form of options rather than purchased with their own money. Founders and directors with little to no Skin In The Game are not under any acute pressure to contribute in the best ways they can. They don’t believe in the company they are working for nor is their heart really in it. It is merely a gravy train.

Thus, before deciding to invest in a company, start-up, venture or anything that is highly risky, one should always ask, ‘How much Skin In The Game do the founders and directors have?’

 

By Nicholas Peart

(c)All Rights Reserved

 

Image: valueresearchonline.com

THE FOLLY OF MARKET TIMING: Focusing On Percentages Not Prices

It is natural to get in the habit of trying to buy or sell shares at a particular price. Sometimes we may get lucky and reach our desired entry or exit point. Other times, we may not always get what we want in this respect. I fall into this trap myself a lot of the time, yet, perhaps unwittingly, am I playing a mugs game?

The future is uncertain. Nobody can predict the future and don’t believe anyone who tells you otherwise. I have written articles where I have talked about where I think certain things may be going, but the truth is anything can happen. I know nothing. Even if we have deep and unmatched levels of foresight we can so very easily, in the words of Nassim Nicholas Taleb, be fooled by randomness. We can be knocked off our perch by completely random and unforeseen events way out of our control. This is one reason why it is important to have a diversified and balanced investment portfolio. If one sector or stock is particularly badly hit by some unexpected event, at least your other investments in other stocks and sectors are not affected. That old chestnut of ‘not keeping all your eggs in one basket’, whilst it may sound hackneyed, still rings true.

Whilst we may or may not be able to get our desired buy or sell price for a particular stock, one thing we do have complete control over is how we weigh and structure our investment portfolios. There may be a company you highly rate and want to invest in, but you want to invest in it at the right price. Right now, you consider the current price too high and have lower price in mind that you hope will arrive. But what happens if that price never comes and instead the share price of the company just continues to climb in value? Instead of hoping to get the right price, or worse, the lowest price, why not say to yourself, ‘What percentage of my total investment portfolio do I want this company or security to represent?’. I think dealing in percentages rather than prices can not only help you to be a better investor, as it can take away a lot of the unnecessary stress and anxiety associated with trying to buy or sell a security at ‘the right price’. It can also help you overcome deeply ingrained cognitive biases.

When you focus more on what percentage of your investment portfolio you want a security to represent, rather than chasing a price, that can give you more control and balance. If the investment goes down in value, the percentage weighting it represents in your portfolio also goes down. If the investment goes up in value, it’s percentage weighting also goes up. By this you can then decide whether you want to be more overweight or underweight in the percentage weight of this particular security. If you want to be more overweight, you buy more. If you want to be more underweight, you sell a portion.

The percentage of what a security represents of your total portfolio is in many ways more important than the price you pay for it. Even if you end up overpaying for a stock or security, if it represents a percentage of your portfolio that is not too detrimental to the overall performance than it is not so bad.

 

By Nicholas Peart

(c)All Rights Reserved 

 

Image: datanami.com

 

Money Cannot Buy Happiness, But…

Money can buy you freedom. That’s it. Not as a means for conspicuous consumption, gaining status or power, or indulging in an eternal cornucopia of mindless, decadent pleasure and self-indulgence.

The Twitter account Orange Book (@orangebook_) recently posted the following tweet…

Things money can buy:

-freedom to think
-freedom to travel
-freedom from jerks
-freedom to learn slowly
-freedom from an alarm clock
-freedom from work you dislike
-freedom from financial anxiety
-freedom from low-cost nutrition
-freedom to pursue a creative purpose

I could add more things to this list…

-freedom to create and invest in ventures that make the world a better place
-freedom to be time rich
-freedom to afford better healthcare
-freedom to help others

All of this is very positive, however there are downsides too. For example, I would include the following…

-freedom to run away from problems
-freedom to avoid the unsavoury aspects of life
-freedom to not live in the real world
-freedom not to grow

As much as having money shields us from the unpleasant aspects of life; from jerks, from jobs we hate etc ; if we never have to deal with these unsavoury aspects of life, this can put us in a very vulnerable and fragile situation if, by some random stroke of misfortune, we ended up in a no money situation. The freedom that money provided in the past is gone at the drop of a stone. When previously, money offered a means to be cocooned from the real world, not having any money now throws us back into it.

It is much better to have money, but at the same time, know how to deal with the real world, how to deal with challenging situations, how to deal with difficult people. This is because, if we ever find ourselves back to a situation without money, then life is not a constant struggle.

 

By Nicholas Peart

(c)All Rights Reserved 

 

Image: Patheos

The Dangers Of Story Stock Investing

Investing successfully requires a lot of boring fundamental analysis and often the best stocks to invest in are in boring overlooked, but undervalued companies with strong fundamentals and a decent margin of safety. These companies are not prone to hype.

On the other hand you have story stocks. Investing in a story stock does not mean that your investment will go down in value. On the contrary, a stock with a powerful story could make you very rich. Look at Amazon. Then again look at the multitude of other stocks, which had a powerful story behind them, but that was it. Fundamentally they were houses made of cards, which soon collapsed. The Dot.com crash from twenty years ago is littered with such casualties. More recently, the whole WeWork disaster is a prime example of company with an enticing and exciting story (as well as a charismatic and convincing leader), yet with very shaky and fragile financial fundamentals.

The problem with story stocks is that the stock valuation gets to a point where it is propped up much more by the goodwill of the story alone than by the company’s fundamentals. This is very treacherous territory as even a mild downtown or modest bit of bad news can send the share price crashing back down to Earth.

A stock with a unique story behind it is psychologically very alluring. Doing some solid due diligence such as analysing company reports and financial statements requires effort and if you dont have much experience on that front it can seem very daunting. However, with practice and learning you can become better at analysing and understanding all this nitty-gritty stuff, which also enables you to make better investment decisions with a cool head. Knowing exactly what you are investing in and having even just a modest understanding of the full financial health of a company is a very reassuring thing.

I suppose we prefer stories to analysis, because stories have much more of an instant cognitive resonance. Our minds can be lazy and it’s so much easier and more soothing to be swayed by a good story or glowing article in the media on a stock. More succinctly, sometimes a powerful mantra alone is enough to sway us. Software is eating the world or It’s the wave of the future or You are investing in a slice of history or Nobody else is doing what this company is doing are a handful of mantras that can make us overly bullish on a particular stock without questioning it further or taking it apart via some deep research.

The problem with such stories and mantras is that they activate and play to our emotions and making investment decisions based on emotions is never smart. We always have to have a healthy, balanced, critical and analytical mindset to investing without allowing our emotions to hijack and influence our decision making. A cool head always wins.

 

By Nicholas Peart

(c)All Rights Reserved

 

Image: 4.bp.blogspot.com

VALUE OR GROWTH? A Tale Of Two Scottish Funds

There are two Scottish funds listed on the London Stock Exchange, which I would like to focus on in this article. They both have similar names, yet their investment strategies differ considerably. The first of these two funds, The Scottish Investment Trust, is a contrarian value fund. Whilst the second fund, the Scottish Mortgage Investment Trust, is a growth fund.

The Scottish Investment Trust (SCIN) is over 130 years old and was first established in Edinburgh in 1887. Since 2015, the fund has been managed by Alasdair McKinnon with a focus on blue chip dividend paying companies that are out of favour. McKinnon takes a contrarian view to investing avoiding sectors that are hot and investing in companies that are undervalued and where sentiment is poor. The rationale being that when sentiment turns, the value of the companies increase as investors begin to pile in. To be clear, contrarian and value investing don’t mean simply investing in any old company that is down and out and going through a turbulant period. It is important that the company has a margin of safety to ride out any difficult period thus protecting it from having to raise emergency cash and/or ceasing to remain a going concern. It is also equally important that the company has healthy cash flows and a decent track record of this. The amount of cash that a company generates from its operations is a crucial metric and sometimes overlooked. A low P/E (Price To Earnings) ratio is one thing and a significant metric in indicating whether or not a company is overvalued, yet it doesn’t tell the whole story. The level of cashflow generation indicates how much cash a company is generating and the more cash it generates, the more of a financial buffer it has, especially if it’s total operating margins are not very high. It is also important to monitor a company’s total liabilities and how manageable and sustainable they are.

As of 30th April 2020, the largest holdings in SCIN’s portfolio included large gold mining companies such as Barrick Gold and Newmont Mining, large pharmaceutical companies such as Roche, Pfizer and Gilead Sciences and other assorted value blue chips such as United Utilities, Japan Tobacco, BT and Chevron. The gold mining companies have been in the portfolio for sometime. Recently gold has performed very strongly and it’s likely to continue. McKinnon, like myself, is of the view that major fiat currencies run the risk of being debased. Since the last financial crisis in 2008, we have been living through a period of very low interest rates and easy money. The present COVID-19 crisis has only exacerbated this as central banks have reduced interest rates even more and printed unprecedented amounts of money to prop up national economies in the wake of this crisis. Add to this the staggering levels of global government, corporate and household debt and you have a rather fragile situation. McKinnon’s thesis for having exposure to gold is as a form of insurance against this extraordinary macro environment and the real future risks and consequences it carries. He is also no fool by investing only in the biggest and most geographically spread global mining companies with low production costs. Whilst it is true that gold may not currently be unloved, I would still consider it a contrarian investment as it represents, to a degree, a lack of faith and trust in central banks and governments. It is also considered unfashionable. I would argue that newer supply-capped digital cryptocurrencies such a Bitcoin are more fashionable and hotter than gold. Especially amongst younger investors who generally overlook gold and other precious metals as a store of value.

McKinnon deliberately stays away from sectors that are hot and fashionable such as the technology sector. SCIN has absolutely no exposure to FANG (Facebook, Amazon, Netflix, Google) stocks or any other hot tech/startup stocks. The closest thing to tech in the portfolio are it’s holdings in boring and undervalued blue chip communication service companies such as BT, China Mobile, Verizon and Deutsche Telekom. McKinnon believes that the tide will turn regarding the high valuation of many technology companies, as unlikely as this may currently seem, and that value stocks, for a long time overlooked and underperforming compared with their growth counterparts, will prevail in due course.

The Scottish Mortgage Investment Trust (SMT) is currently the most valuable investment trust by market capitalization listed on the London Stock Exchange. As of today, it has a total market cap in excess of £10bn and over the last decade has performed extremely well. The primary reason for its impressive performance has been it’s exposure to all the FANG companies plus a number of other tech investments that have recently done exceptionally well. For example, the fund has a substantial holding in Tesla, whose share price has more than doubled since the beginning of this year. Generally speaking, tech shares have done very well since the COVID-19 induced lockdown measures were put in place over the last few months and the share price of SMT is trading at all time highs.

SMT, like SCIN, is also a very old investment trust with a hundred year plus history having first been established in 1909. It is currently jointly managed by James Anderson and Tom Slater. Anderson has been managing the trust for 20 years with Slater joining him in 2010. Their focus is purely on growth and investing in companies of the future. SMT is everything that SCIN is not. SCIN adopts a Benjamin Graham style value investing strategy. SMT does not embrace this type of strategy and even questions it. This is highlighted in a series of interesting essays written by Anderson and published on the fund’s parent Ballie Gifford website entitled Graham Or Growth?. I highly recommend giving them a read as it provides one with unique insights into Anderson’s way of thinking and by extension the investment philosophy and strategies of SMT.

It is true that growth investing has greatly outperformed value investing since the last financial crisis more than a decade ago. At the very start of 2009 the Russell 1000 Growth Index (RLG) was around 360 points. Today it is almost 1820 points. In this time the RLG index has grown more than 500%. That is highly impressive. By comparison the Russell 1000 Value Index (RLV) was around 446 points on 1st January 2009. Back then the RLV index was higher than the RLG index. The same cannot be said today with the RLV index almost 1,105 points. The RLV index has grown less than 250% during this period. Whilst this is certainly not a poor return, it doesn’t hold a candle to the RLG index’s 500% plus return.

Regardless of which side of the fence I am on regarding value or growth investing, it cannot be denied that both Anderson and Slater are highly skilled and visionary managers with a highly impressive track record for picking winners. It is much harder to quantify growth stocks than value stocks via traditional metrics and methods of fundamental analysis. If one were to just use just those methods when investing, one would have passed on investing in Amazon, Alphabet or Tesla in the early stages of their listings in the public markets. It takes more than just the tried and tested strategies of the past to value these companies and Anderson’s essays make this very clear.

However, it is just simply not the case that all new and exciting tech companies are ‘crushing it’. There have already been some casualties. The one that springs most to my mind has been the downfall of workspace company WeWork. Before the issues of the company came to the fore, it had a valuation of $47bn even though it had vast amounts of debt. Today, it’s worth far less at around $3-4bn. One of the largest investors in the company is SoftBank whose Vision Fund took a massive hit. Fortunately, SMT and its parent company Baillie Gifford, never built up a stake in WeWork over the years, but it could have easily happened here.

The recent WeWork debacle is one of a number reasons that make me nervous about having too much exposure to SMT right now irrespective of its stellar performance. As much as I respect the vision and foresight of Anderson and Slater, I worry that their fund could come a cropper some time down the line if a number of the holdings in the SMT portfolio underwent similar write-offs in value like WeWork. One of the fund’s holdings, Tesla, is probably the most polarised and hyped publicly traded stock in the world today. I have a great respect for its founder Elon Musk, who is a highly driven and exponentially thinking visionary. There is no doubt in my mind that he is special. However, the company could very easily experience a similar WeWork style crisis. No matter how highly I rate Elon, the financial fundamentals of Tesla are fragile and the share price could dive spectacularly in the event of a major existential crisis. This would create a huge dent in the value of SMT, as its Tesla holding currently represents a chunky 10% of the entire portfolio. Together with Amazon (which also represents 10% of the total holdings), it is one of the largest holdings in the SMT portfolio.

McKinnon is very wary of the present high valuations of tech companies and has citied the WeWork situation as a clear and present danger. In a post from December 2019 entitled Peak Unicorn?, he refers to the overvaluation of these exciting multi-billion dollar valued unicorn story stocks as a ‘disruption’ bubble, which has been propped up by an environment of cheap money and will not end well.

The last ten years have been very good for growth and technology stocks, yet it remains to be seen whether the next ten years will be equally magnanimous.

By Nicholas Peart 

Published on 27th May 2020

(c)All Rights Reserved

CITED ARTICLES:

https://resoluteoptimism.bailliegifford.com/will-the-mean-revert/

Peak Unicorn?

Image: tripsavvy.com

Don’t Fight The Trend…

the trend

But don’t be off your guard either.

A lot of the time, stocks are priced at a value quite debased from their fundamentals. Thus they are either overvalued or undervalued. This is true since markets are, for the most part, driven by sentiment. In the most extreme circumstances, total greed or fear takes over.

I have been rather baffled by the stock market rally over the last few weeks after having witnessed some of the most spectacular series of crashes over the brief one month period from the end of February towards the end of March. This rally far from reflects the economic reality on the ground. Many people have lost their jobs and are struggling financially. Yes, there have been huge stimulus packages to soften the blow, but these are artificial and only increase an already substantial debt load.

Yet markets can behave irrationally for a very long period of time. Far longer than one can stay solvent, to quote the economist John Maynard Keynes. Instead of trying to be right, sometimes it can pay to just go with the trend. That often quoted adage, the trend is your friend, is very true. Rather than fighting it, it can be less painful to simply ride with it in whichever direction it may blow.

But don’t get carried away. Always be on your guard. As the tide can abruptly change without warning.

By Nicholas Peart

(c)All Rights Reserved 

 

Image: Peggy_Marco

Fishing For Bargains In The Market Carnage (UK MARKETS)

deep sea fish

Disclaimer: All financial recommendations in the article are those of the author and should not be taken as financial advice. It is best to do your own research before investing in any security or to speak with a financial advisor. 

The market crash since February has been painful for all long term investors. Yet at the same time it has presented opportunities to buy several good quality stocks and securities at a lower price than normal. In this article I will focus on some of those, which I think may be worth a look at.

Travel Industry

Lots of the big multi billion pound FTSE 100 blue chip companies are currently trading at much lower valuations than before the crash. One of the industries most affected by the current coronavirus pandemic has been the travel industry, which includes airline and cruise ship stocks.

On the FTSE 100, three companies springs to mind; International Airlines (IAG), EasyJet (EZJ) and Carnival (CCL). The share prices of all three companies have been heavily impacted and currently look very cheap. However, as cheap as they may be, they now carry a lot of risk as there’s no guarantee that, despite their size, they will have enough cash to see them through this difficult period before they are back to operating at normal capacity again.

International Airlines group owns multiple airlines in its portfolio including British Airways, Iberia, Aer Lingus and the low cost airline Vueling. Out of the three companies, this one is in my view the safest bet if I had to chose, which one I would invest in. The principle reason for this is, because of the fact that it owns multiple airlines rather than just one. Furthermore, it also employs the greatest number of people (over 60,000) and it is likely, although not guaranteed, that it would be at the receiving end of a government bailout should it really struggle to remain a going concern in the coming weeks and months. Allowing the firm to go bust, would result in a lot of people out of work.

Easyjet carries more risk than International Airlines. Although it has decent cash reserves, it has entered into an agreement with Airbus for £4.5bn to purchase 107 aircrafts. Considering that Easyjet’s current market cap is less than half that amount, such a transaction puts the company in a very difficult situation at a time when precious cash reserves are king. Unless the company scraps the Airbus deal and temporarily suspends it’s dividend, it runs the risk of becoming insolvent in no time and is unlikely to be bailed out either.

But Easyjet is not the riskiest of the three. That prize would go to cruise ship company Carnival. In the wake of all the well publicized coronavirus cases occurring on cruise ships, I cannot see that industry recovering for at least several months. Unlike flights, which are a necessity, it is not a necessity to take a cruise. It’s share price has reacted accordingly falling from a 52 week high of £41.75 in May 2019 to a 52 week low of just £6.06 earlier this month. The share price is currently £8.69. If the company wants to ride out this crisis, it will need to embark on some pretty substantial cost cutting measures going beyond simply cutting the dividend. Earlier this month, the company increased it’s borrowings to give it more financial flexibility, but the consequence of this is that the company has got itself into debt even more.

Personally, I would think very carefully about investing in either company as cheap as the shares may be. The trick is to find high quality blue chip stocks that are beaten down, but fundamentally have a robust enough margin of safety that will see it through the worst of a crisis without having to resort to options such as taking on more debt or any kind of dilutive rights issue.

Oil and Gas Industry

The other industry that has taken a hammering is the oil and gas (o&g) industry. As the market crash began to develop steam, the price of oil fell a whopping 30% in just one day. Towards the end of March, the two largest UK listed oil and gas companies, Royal Dutch Shell (RDSB) and BP (BP.), were both trading at discounts of more than 50% of their share prices at the start of the year. As I write this, their share prices have recovered a bit off their recent lows, yet they still have a way to go to reach their previous levels from the beginning of the year.

I think o&g prices will be incredibly volatile over the new few years and long after the worst of this current coronavirus pandemic is over. Even though o&g prices may currently be at very low levels, it doesn’t take much for prices to suddenly spike again in very little time. In the coming weeks and possibly months, o&g prices may continue to stay low or go even lower to lows that are unthinkable. When investing in o&g companies, especially when prices are low, it is always important to invest in companies that have very low production costs and/or a large downstream business. Such companies are able to weather lower o&g prices better than those that are either producers with high production costs or worse o&g exploration companies.  The latter are much more vulnerable to lower o&g prices and a prolonged slump in these prices can have a very real existential impact on these businesses as their operations become economically unviable.

For those reasons, I am attracted to the more solid players in this industry who will be able to get through this challenging period the best. I already mentioned the two main players, Shell and BP. Their share price erosion has now meant that both companies now pay even higher dividends. Yet there is always the very real possibility that these dividends get temporarily cut, which I actually think is a good thing in the short run if only to boost essential cash reserves. There is currently a lot of negative sentiment in the o&g industry and its not a popular industry. I have a contrarian mindset towards this industry and believe that in due course there will come a time when o&g prices will be much higher than their current levels.

Consumer brands companies

There are some consumer brands companies that are presently very under-priced. A neglected industry that immediately springs to mind is the tobacco industry. Like the oil and gas industry, it is a very unpopular industry and sentiment continues to be poor. What I find interesting is that whilst sentiment has been poor for some years now, there was a period not so long ago where there was a lot of hype in the nascent cannabis industry. I recall the share prices of exotic hot Canadian pot players such as Tilray ascend to ridiculous valuations that were very debased from their fundamentals. I fortunately stayed well clear of all the hype and I am glad that I did as today the current share price of Tilray is a mere fraction of what it was at the apex of the hype.

Rather than chase these hot pot plays, there was and is far more value to be had investing in some of the large public tobacco companies such as British American Tobacco (BATS) or Imperial Brands (IMB). Both companies have been depressed for some time and currently pay very large dividends. In the case of Imperial, it’s dividend is now more than 10%. In the current economic turmoil we are all experiencing, there is no guarantee that these dividends will not be cut, yet I remain certain that the share price of these companies will recover. Whilst it is true that less people are smoking traditional cigarettes than before, these companies will increasingly become entities where they do not have all their eggs in one basket. Going back to the much hyped cannabis industry; who’s to say that once cannabis becomes increasingly legalised in a growing number of jurisdictions across the world and there is more robust consolidation in this industry, those large players don’t also get a piece of the action?

I am also interested in those large consumer brands companies of essential products. The two biggest ones on the FTSE 100 are Unilever (ULVR) and Reckitt Benckiser (RB.). Both are global, robust and defensive non cyclical companies. Yet there is one smaller company, which I think offers a lot of upside to long term investors. This company is called PZ Cussons (PZC). It has been undervalued for a while now and currently has a total market cap of less than £1bn, which I think is very cheap. What’s more, it is well exposed to emerging markets with high growth potential. It is best known for owning the Imperial Leather soap brand and also the Carex brand too. This is important to know since as this current coronavirus pandemic has escalated there has been an acute shortage of hand sanitiser products. Carex is one of the leading producers of hand sanitisers in the world and whilst it may not have a monopoly, I expect record sales for PZ Cussons’ Carex brand when their next financial report covering the last few months is published.

Index Funds and Investment Trusts

Rather than focus on picking individual company stocks, I also like looking at index funds that track entire stock markets and also well run investment trusts. Investing in index funds is ideal for those who don’t want to invest in individual companies and undertake all the fundamental analysis that goes with it. What’s more, by investing in a small select number of index funds rather than lots of individual stocks, you are also cutting down on your dealing costs, which can eat into precious cash.

In the UK, the two principle stock markets are the FTSE 100 and the FTSE 250. The FTSE 100 contains the largest 100 UK companies by market capitalisation and the FTSE 250 the next round of large UK companies, which are not part of the FTSE 100. The FTSE 250 companies, although smaller than the FTSE 100 ones, have generally more growth potential. Yet what the FTSE 100 companies may lack in the growth potential of the FTSE 250 ones, they make up for by paying generally larger dividends. Both indexes are trading at vast discounts to their levels befor the start of the crash. If you are a long term investor, buying some units in both a FTSE 100 and FTSE 250 index fund at current levels could be a very smart move. One could also slowly drip feed money on a weekly or monthly basis. This may also be a good move if these markets continue to fall before they recover.

I have selected a few LSE listed investment trusts, which I consider sound and well managed. One investment trust which I recommend more for income than growth and is currently trading at quite a discount is the City Of London Investment Trust (CTY). It consists mainly of large multi billion pound FTSE 100 companies paying good dividends and thus the trust pays a decent dividend. Some of these companies have temporarily halted their dividend payouts and that is I feel reflected in their current share prices. I expect this trust though to recover strongly when the markets recover and for the companies in the trust that have cut their dividends to reinstate them. The trust also has one of the lowest fees in the industry.

Another LSE listed investment trust I like which is focused more on smaller FTSE 250 companies is the Henderson Smaller Companies Investment Trust (HSL). This trust also pays a dividend although its smaller than what CTY pays and the trust’s fees are also higher. However it has much more potential for growth, without it being reckless.

Both CTY and HSL are currently trading at discounts of more than 30% of their January highs.

The Templeton Emerging Markets Investment Trust (TEM) is also trading at a large discount and is one of the best trusts invested in some of the largest emerging markets comapnies in the world. I prefer this trust over ones focused on just single emerging market countries and I recommend drip buying on any dips in this current downturn.

Finally, I am always keeping an eye on the largest LSE listed investment trust by market cap, the Scottish Mortgage Investment Trust (SMT). This trust contains many high growth companies in its portfolio from holdings in some of the largest tech companies in the world to several promising unlisted companies. NASDAQ listed tech stocks have been some of the best performing stocks during the ten year plus bull market. However it remains to be seen whether the next ten years will be equally generous to these companies. Like other stocks, SMT has also suffered during the current downturn although its held up better than others. I have included this trust as although I still think it is rather richly valued, it may wobble more over the coming months and could present a very good buying opportunity for the long term.

Precious Metals

I continue to remain very bullish on precious metals. In particular, gold and silver. Rather than typical investments to make money, precious metals for me are a form of insurance in a world simply awash in debt, cheap money and uber low interest rates. One of my biggest fears is the effect all this accumulated debt will eventually have on the world’s major currencies, especially the US dollar. Several economists are predicting many years of deflation and sustained low or even negative interest rates, but I beg to differ and think that all this debt and enormous current stimulus packages to soften the blows inflicted by the current coronavirus pandemic could likely lead to inflation rearing its ugly head. As I explained in my previous articles, this will lead to central banks raising interest rates and all this outstanding global debt becoming more expensive to service.

All these factors considered I think gold will do very well over the coming years and even from its current high levels, I don’t think the price is expensive. Silver, on the other hand, is very cheap compared to gold and perhaps for value investors, there is more upside and an even stronger case for silver. I like silver very much for those reasons and think it could rally much harder than gold.

Regarding investment opportunities for exposure to both metals, I think the best mining companies are the biggest ones, Barrick Gold and Newmont Mining, which are both listed on the Toronto and New York stock exchanges. I am not so keen on the smaller mining companies with high production costs and too much exposure to politically unstable countries. One can of course buy physical gold and silver from a dealer and keep it in a vault. Bear in mind though that storing silver, especially in modest amounts, will be more costly than storing gold. I like very much gold and silver ETFs, which are backed by physical bullion in a vault. It is very important that each unit of such an ETF is directly backed to a portion of the physical metal in a vault. Two precious metal ETF securities I recommend are the Wisdom Tree Physical Gold ETF (PHGP) and the Wisdom Tree Physical Silver ETF (PHSP).

 

By Nicholas Peart

(c)All Rights Reserved 

 

Image: PublicDomainPictures

It’s Only When The Tide Goes Out That You Discover Who’s Been Swimming Naked

low tide

This is probably one of the wisest bits of advice related to the current market turmoil. And it was said by none other than one of the most successful investors of all time, the Sage of Omaha himself, Mr Warren Buffett.

What this present crisis has exposed are those companies that are worst prepared to handle a downtown. A company should always have sufficient emergency cash reserves or at least some margin of safety to protect it in the event of a slump such as the one we are currently experiencing.

The most prudent companies always have this margin of safety. On the other hand, the most ill prepared companies overleverage themselves and take on large piles of debt during the good times. Then when the bad times arrive and the tide goes out, they are the ones who are most vulnerable.

Right now boring old cash is king. Some of the most indebted companies are currently facing a genuine liquidity crisis and the very real possibility of going bust as their cashflows have virtually dried up. However, those companies who have set aside enough cash, have no or at least manageable levels of debt, and don’t have unsustainable overheads (or a low cash burn rate) will survive this downturn period the best and will bounce back the strongest when the markets do eventually recover.

I think this is something we can all learn when we make investment decisions, especially when we buy shares in companies during a bull market. It is always important when doing your own due diligence on a company to figure out how well it would fare when the tide changes. When the tide goes out, will it be sufficiently covered?

 

By Nicholas Peart

(c)All Rights Reserved 

 

Image: TimHill

The Present Risks Of Holding Government Bonds

BankNotes photo

For a long time it has often been assumed that government bonds of developed countries are a safe investment. Whenever there has been a stock market correction, one always benefited by holding government bonds. Especially if they had a decent yield and it was above the rate of inflation. The difference now is that before the current market crash towards the end of February, interest rates in most developed countries were already at very low levels. Yet as the crash unfolded both the Bank of England (BoE) and the Federal Reserve (Fed) reduced interest rates even more to stimulate the economy. As I write this article, the current BoE rate is just 0.1% and the Fed rate is at 0%. Since 2016, the European Central Bank (ECB) interest rate has remained unchanged at 0% and so far there has been no plan to drop it down further towards negative territory, yet that could easily change in the coming weeks or months if the current crisis exacerbated by the Coronavirus pandemic shows no signs of improving.

The current yields on ten year government bonds in the following countries are just 0.8% in the USA, 0.39% in the UK, 0.02% in Japan, and in some countries such as France and Germany they are already negative at -0.03% and -0.37% respectively. For those bonds to increase in value these already pitifully low yields would have to fall even further. By investing in bonds with negative yields, you are essentially paying for the privilege of holding the bonds. And I have always wondered what would make one invest in bonds with negative yields?

In the case of Germany, if one had a lot of cash which they didn’t want to invest in other securities or deposit in a bank account, they would invest it in those negative -0.37% yielding government bonds. They may be too scared to deposit it all in a bank, which is financially not in great shape and may even be faced with the very real risk of going under Lehman Brothers style. The two main German banks, Deutsche Bank and Commerzbank, are both currently not in great shape financially and may need a bailout to save them. If a bank goes under, your money in a bank is safe up to a certain threshold and if you have savings deposits, which exceed the threshold amount, you will likely lose the entire excess amount if the bank goes bust. In contrast to other Eurozone (EZ) countries, Germany is in better shape than many other EZ countries. Furthermore, it’s national central bank, the Bundesbank, is running a massive surplus against the national central banks of most of the other EZ countries.

Unlike Germany, the yields on the ten year government bonds for Italy and Greece are positive at 1.21% and 1.43% respectively. Yet both countries have enormous and unsustainable levels of debt and are thus at a much higher risk of default. As I explained in some of my previous articles, I continue to remain of the view that it is becoming increasingly likely that the Eurozone will not last and that all Eurozone countries will revert to their own currencies. If this were to happen, it is highly probable that within the EZ area, there will be a huge flight of money to those countries such as Germany who will be least affected by any great devaluations of their new currencies. For example, the New Mark is likely to strengthen in value whereas the New Lira or New Drachma is likely to fall in value quite sharply against the new currencies of other stronger former EZ countries. Thus within the framework of the entire EZ, negative yielding German bonds are probably one of the safest securities to invest your Euros into despite the fact they come with a price. If the EZ falls apart and most EZ banks go under, those negative yielding German bonds will immediately be denominated into strongly valued New Marks. By contrast, those positively yielding Italian and Greek bonds will be converted into new weaker currencies.

In spite of all this, I think government bonds are overall very expensive where their risks vastly outnumber their rewards. Of course, their low yields reflect the low interest rates of their countries. However, if one were to look at the chart of the yields of ten year UK and US bonds over a 40 year period, it is clear they’ve been in a huge bubble for the duration of this time frame. In September 1981, the yield on 10 year US treasury bonds was over 15% and in that same year in October, the yield on 10 year UK gilts was over 16%. Yet since that time, the yields on both bonds has been in a downward trend and currently they both yield less than 1%. Some are predicting that the interest rates of both countries will fall into negative territory and therefore the yields of both bonds will also be negative suggesting that if one were to buy such bonds even with their extremely low yield, the yield may get even lower.

An unpopular opinion I hold, which many don’t share, is the real risk of dramatic and unexpected inflation. Many are predicting a long period of negative interest rates and deflation, but I am not so sure. What concerns me greatly is the huge amount of debt in many countries. Much of this debt is a result of an unusually long period of low interest rates. Since the middle of the last financial crisis in 2008, total levels of global debt have increased over 50%. And now with the current new crisis triggered by the coronavirus pandemic, this already staggering level of global debt is only going to get bigger as national governments plan huge rescue packages to prop up vulnerable businesses and households. In the USA, the Trump government is planning a $2tn stimulus package. In the past years since the 2008 financial crisis, large rounds of Quantitative Easing (QE) haven’t had too much of an affect on inflation. However this time it could well be different as the amounts of money printing rounds that national central banks will embark on could easily result in a great spike in inflation. This is very worrying as not only will this lead to central banks massively raising interest rates to tame this inflation, it will also make all outstanding government, corporate and household debt much more expensive to service. It is for those reasons that I think buying so called safe government bonds at current yields is a much more risky exercise than many realise.  Furthermore, as all those big accumulated existing debts become more expensive to service with rising interest rates, there will be lots more defaults which in turn will weaken the purchasing power of the currencies of major economies including the USA.

All these concerns naturally make me more attracted to precious metals like gold and silver, which, as tangible forms of insurance, will increase in value as the purchasing power of major currencies like the dollar and the euro declines. As precious metals are commodities, it is hard to predict their price movements. Yet if like me, you believe that they are a viable hedge against a world that is increasingly becoming smothered in debt, you will realise that there is quite a compelling case to owning some precious metals as a form of insurance against these economic vulnerabilities. Precious metals are the new safe havens rather than government bonds.

 

By Nicholas Peart

30th March 2019

(c)All Rights Reserved

 

Image: NikolayFrolochkin

 

MARKETS UPDATE: Thoughts On The Current Market Crash

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The last two months have been an exceptionally volatile period for global stock markets. The current COVID-19 pandemic has taken many by surprise and its consequences have had a clear affect on the markets during this period. For a long time, I thought that markets were overvalued and due for an eventual correction. The roots of my worries were based on the increasing levels of global debt since the last financial crisis of 2008 that have been fuelled by an unusually long period of low interest rates. With low interest rates money is cheap and cheap money has been the cause of the high valuations of many stocks and other assets such as property. All this concerned me. I knew it wasn’t sustainable and that eventually something would have to give. Yet little did I know that the catalyst for this current market crash would be a virus, which is now affecting citizens and the economies of every country on the planet.

I wrote an article back in 2017 and another one last year stating my fear that markets were overheating. Throughout all of 2019, I almost became resigned to the fact that we were in a ten year plus long bull market that seemed to show now signs of slowing down. Save for a sharp but very brief correction in equity markets from October to December 2018, the markets duly recovered and subsequently continued to hit new highs. Earlier this year, the NASDAQ index hit over 9,000 points and by mid February it had hit a new record of over 9,700 points. Back then I decided to view a longer term chart of the NASDAQ index and had discovered that back in March 2009, in the wake of all the wreckage of the last financial crisis, the NASDAQ index had collapsed to just under 1,300 points. In almost 11 years, the index had increased over 7 times in value. In the UK, only the FTSE 250 index comes close to matching the NASDAQ’s performance, but even the FTSE 250 has been no match. During that same time frame, the index went from under 6,000 points in March 2009 to a record high of almost 22,000 points in January this year. That represents an almost four fold increase in value. Impressive but still falling short of the NASDAQ’s run.

The reason for the NASDAQ’s epic performance is quite simply the unbelievable success of many of the biggest technology companies in the world, which are all listed on it’s exchange. The following NASDAQ listed companies: Amazon, Apple, Facebook, Alphabet, Netflix and Microsoft: have all been quite simply ‘crushing it’ throughout the last decade.

In the UK, the two principle stock market indexes are the FTSE 100 and the FTSE 250. Even though the UK doesn’t have anywhere near the kinds of innovative and exponential tech companies that come out of the US, the UK has a lot of thriving successful growth businesses and lots of these are listed on the FTSE 250. The FTSE 100, on the other hand, is made up more of long established big businesses with multi billion pound market capitalizations. Examples of such companies include Royal Dutch Shell, BP, Rio Tinto, HSBC, Unilever, Vodafone and British American Tobacco. These are big behemoth companies, which may lack the growth prospects of the smaller businesses listed in the FTSE 250. Yet what they lack in growth potential, they make up for by paying quite large dividends to their shareholders as their businesses generate a lot of cash. The FTSE 100 overall has, by comparison, not been a great performer. Even though from March 2009 until the January 2020, it went from less than 3800 points to almost 7700 points. Even though the index more than doubled during this period, it’s also worth bearing in mind that just before the turn of the new millenium, on December 10th 1999, the index was over 6700 points.

What is noticeable about this particular market crash is just how dramatic it’s been. Before the very beginnings of this market crash, when the markets closed on Friday 21st February, the NASDAQ was trading at over 9500 points, the S&P 500 was over 3,300 points, the FTSE 100 was over 7,400 points and the FTSE 250 was just a few points short of 21,800 points. By the time the markets closed just a few days ago on Monday 23rd March, the NASDAQ was below 6,900 points, the S&P 500 was a little higher than 2,200 points, the FTSE 100 had gone below 5000 points, and the FTSE 250 was trading slightly north of 13,000 points. In fact, just a few days previously on March 19th, the FTSE 250 had hit almost 12,800 points.

In the space of little over a month, the NASDAQ had fallen around 27%, the S&P 500 had lost around 33%, the FTSE 100 had shed 32% and the FTSE 250 had lost over 40% of it’s value. Since these lows from last Monday, markets have made some gains owing to stimulus from central banks, yet at the close on Friday yesterday, a good chunk of these gains were erased.

Going forward

The question now is, how will markets behave over the coming weeks and months? Will the lows hit last Monday be retested? It is always hard to predict the future, but I think they will be. The difference between this crisis and others is that this virus has been very disruptive. Since there is still currently no cure for the virus, the only measures to contain the virus have been for governments to impose lockdowns and restrict the movement of people. The most affected industries include the airline and travel industries. The airline industry in particular has been greatly affected as the number of flights have been severely diminished. It is likely that even the most established airline companies will struggle going forward without some form of a government bailout. With their cash flows from operations dramatically reduced, they will be drawing on their precious cash reserves to keep the lights on. But the truth is, with the restriction of movement, most industries will be affected. If a lot of the most affected companies struggle to remain a going concern they will go bust and as a consequence many people will lose their jobs. As an increasing number of people lose their jobs, they will have no income and likely also little to no cash savings to keep them going. There will be a frantic need to create liquidity to free up emergency cash. And this is why there has been a sell off of almost everything, even the most defensive of assets such as gold. When people are desperate for cash they will sell anything. This notion that cash is trash is a myth. In a difficult crisis such as this one, hard cash is king.

So going back to my earlier question; will markets continue to fall? I think they will as I don’t see lockdown measures easing any time soon. I also see an increasing number of people continue to lose their jobs and as a result an increasing need for emergency cash as more incomes dry up. In this situation, markets will continue to sell off. Shares that may seem like a bargain now will get even cheaper. I think the situation is serious enough to say that it is likely that some of the lows of the 2008-9 financial crisis will be tested. Yet do I think there are currently bargain shares to buy? Of course. But at the same time one should ask themselves the following; how much free cash do they currently have to invest? Not essential cash to survive, but cash they can either afford to lose or not have any need to draw upon for at least five years. If the latter than I would recommend periodically drip-buying a select number of quality companies (that are not over leveraged, that generate a lot of cash and have sufficient liquidity to be able to ride out this crisis and thus recover once its over), investment trusts or tracker funds over the coming weeks and months.

Cheap money 

It is likely that as the current crisis continues to bite, they will be a lot of government intervention to help citizens and business. One solution that has been doing the rounds is the idea of creating ‘helicopter money’ whereby central banks print money which is then given directly to households to help them and keep them solvent. In the USA, the current Trump government is planning on putting together a $2tn rescue package to aid businesses and households most affected. With interest rates at close to zero, the idea of printing staggering sums of money is a tempting one. As mentioned at the beginning of the article, since the 2008 financial crisis we have had a long period of low interest rates. And since the first shocks of the current crisis began to appear, both the Fed and Back of England reduced interest rates even further. As of now, the current Fed interest rate stands at 0% and the Back of England interest rate is 0.1%. With such rock bottom rates, the temptation to just keep printing money to infinity is very strong. As previous rounds of Quantitative Easing (QE) since the 2008 financial crisis have barely had an impact on triggering inflation, the current conventional wisdom is that even bigger rounds of money printing will also barely stoke inflation. Even the former head of the European Central Bank (ECB) Mario Draghi who back in 2012 vowed to do ‘whatever it takes’ to save the Euro, recently commented that interest rates will remain low for a very long time. Others also share this belief. But what if, out of nowhere, in the midst of all this money printing, a tsunami of inflation catches everybody off guard forcing central banks to abruptly increase interest rates to control it?

In gold and silver we trust

If you have read some of my other articles you will see that I have always been a big fan of precious metals. And this is especially true now in our current economic climate where uber-low interest rates and cheap money have been reigning supreme. A consequence of more than a decade of low interest rates has been that total levels of government, corporate and household debts have increased dramatically. To exacerbate an already fragile economic situation, the current crisis has triggered central banks of major economies to drop interest rates to zero. On top of this, humongous rescue packages are being created to aid affected households and businesses. Although this may create short term relief, it will further accelerate already staggering levels of global debt, which have already been allowed to get out of control for too long. Taking on debt is fine when interest rates are low, but what happens if all of a sudden interest rates increase? I say this, because as I previously mentioned, not many people are taking into account the very real threat of inflation, which may finally be awakened out of its slumber in a big way as a consequence of larger than normal levels of money printing. When interest rates increase to control this inflation, suddenly all this cheap money floating around will seize to be cheap and all this gigantic debt will become more expensive to service.

I can’t help but think that all this will be nothing but beneficial towards the prices of gold and silver. Over the last several months, gold has been slowly increasing in value. It recently hit $1,700 an ounce and is currently hovering in the $1,600s. In my view, I think any dips in the gold price should be taken advantage of. It is unavoidable that there will be dips in the gold price as households scramble to free up cash, but over the coming months and years I think gold will do very well.

I am equally keen on silver. It is less scarce than gold and is more sensitive to industrial demand, but compared to gold it is currently extremely under-priced. For many years the silver to gold ratio (SGR) oscillated between around 20 and 100, and it was an incredibly rare moment if it ever went above 100. Over the last two weeks, this ratio broke the 100 ceiling and spiked to over 125 at one point. As I type, the ratio is 112. A consequence of this further distancing between the gold and silver price has caused some to say that silver is done and has lost its appeal as a store of value. Yet I disagree strongly. If anything, I think this is an incredibly good buying opportunity to have exposure to silver as I can foresee it playing catch up to gold in an epic way.

 

By Nicholas Peart

29th March 2020

(c)All Rights Reserved   

 

Image: OpenClipart-Vectors