FCA Views of the Financial Landscape

The Financial Conduct Authority (FCA) have published a document entitled “Sector Views” giving their annual analysis of the UK financial landscape and how the financial system is working – see https://tinyurl.com/yc492lkt . For retail investors there is a chapter on “Retail Investments” which is particularly worth reading.

But we also learn that the “FCA continues to plan for a range of scenarios regarding Brexit” which is good to hear. I somehow doubt it will be settled tomorrow in Parliament – I continue to forecast March 28th. We otherwise learn that cash is still king as a payment method with 40% of payment transactions, albeit falling; that 44% of consumers say nothing would encourage them to share their financial data (that has been encouraged by recent regulatory changes); that car insurance premiums are rising even though mine just fell which very much surprised me; that the ageing population presents a considerable challenge for pension savings and that mortgage borrowers are getting older (39% will have mortgages maturing when they are older than 65).

Cash ISA subscriptions continue to exceed Stock/Share ISAs by a wide margin, although the number of new cash ISA subscriptions fell last year. But only one third of the UK population hold any form of investment product. It looks like the rest are replying on pensions, state support or housing wealth to keep them in retirement.

They claim the investment platforms market is working well “in many respects” despite the fact that their use of nominee accounts for investors has disenfranchised retail investors. You can send them some comments on that via an email to sectorviews@fca.org.uk . But they do at least highlight the difficulty of switching platforms and they note that comparing pricing is also difficult.

Assets under management by the investment management sector grew to £9.1 trillion in 2017 with 20% managed for retail investors. The proportion of passively managed assets rose to 25% which continues the past trend.

Overall this review shows the size and complexity of the UK financial sector. At 36% of European Assets Under Management, it is much larger than any other European country. The next largest is France at 18% and Germany is only 9%. Let us hope it stays that way after Brexit.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Market Bouncing Up or Down – Sophos, Greggs, Apple and Fundsmith

 

After a dire market performance before Xmas, we seem to be back to the good times in the last 3 days. Is it time to get back into the market for those who moved into cash as the market fell down and down and down in the autumn? Rather early to generalise I suggest although I have been picking up some shares recently.

One which I purchased a small holding in was Softcat (SCT). Yesterday it issued a trading update simply saying that trading was strong and they are materially ahead of where they expected to be at this stage in the year. The share price promptly jumped by 20%. I no doubt should have bought more. But there was a wider rise, no doubt driven by a rise in US markets and effectively ignoring the political turmoil in the UK.

Another company issuing a trading update yesterday was Greggs (GRG). They reported total sales up by 7.2% in the year and like-for-like sales up by 4.2% in the second half. The share price rose over 6% yesterday and it rose again this morning. CEO Roger Whiteside has done a remarkable job of turning around this company from being a rather old-fashioned bakery chain to a fast “food-on-the-go” business. New products have been introduced and new locations opened. The latest product initiative which got a lot of media coverage was vegan sausage rolls, now combined with “vegan-friendly” soup in a meal deal for just £2.25! A good example of how new management with new ideas can turn a boring and financially under-performing one into a growth story. But this comment of Lex in the FT is worth noting: “The positives, like the mycoprotein, are baked in. At almost 20 times forward earnings, the stock rating is well above the long-term average. Investors should wait for this dish to cool before taking a bite”. I remain a holder.

There have been lots of media comment on the profit warning from Apple with questions about whether we have hit “peak i-Phone”. Sales in China are slowing it seems and folks everywhere are not upgrading as frequently as before. Apple phone users may be loyal but they are now tending to upgrade after 3 years rather than 2.

Having just recently upgraded from a Model 6 to an 8, I can see why. The new phone is slightly faster but battery life has not significantly changed. Phone prices have gone up and I could not justify the even higher priced models. Software functionality is of course identical anyway.

Apple is the sort of company I do not invest directly in for two reasons. Firstly it’s very dependent on one product – iPhones are more than 50% of sales revenue. Secondly, all electronic hardware is vulnerable to being leapfrogged by competitors with newer, better products. With growing price competition in smartphones, particularly from low-cost Chinese producers, the world is surely going to get tougher for Apple.

Hargreaves Lansdown have reduced their recommended fund list down from 85 funds to 61 and it’s now called the Wealth 50, but Fundsmith Equity Fund is still not included even though it was one of the best performing funds last year. But they have kept faith in the Woodford Equity Income Fund which is most peculiar given its recent performance. It seems they think the big bets that Neil Woodford has been making on companies and sectors will come good in the long term, as they have in the past. We will see in due course no doubt.

But their reluctance to recommend Fundsmith seems to be more about the discounts on charges that some fund managers give them, which they do pass onto customers of course. It’s worth pointing out that the lowest cost way to invest in the Fundsmith Equity Fund can be to do it directly with Fundsmith rather than via a stockbroker or platform. That’s in the “T” class with an on-going charge of 1.05% which achieved an accumulated total return of 2.2% last year, beating most global indices and my own portfolio performance.

Indeed one commentator on my fund performance reported in a previous blog post suggested that an alternative to individual stock picking was just to pick the best performing fund. Certainly if all of my portfolio had been in Fundsmith last year rather than just a part then I would have done better. But that ignores the fact that my prior year performance was comparable and having a mix of smaller UK companies helped to diversify while Fundsmith is subject to currency risk as it is mainly invested in large US stocks. Backing one horse, or one fund manager, is almost as bad as buying only one share. Fund managers can lose their touch, or have poor short-term performance, as we have seen with Neil Woodford. Incidentally the Fundsmith Annual Meeting for investors is on the 26th February if you wish to learn more. Terry Smith is always an interesting speaker.

Stockopedia have just published an interesting analysis of how their “Guru” screens performed last year. Very mixed results with an overall figure worse than my portfolio. For example “Quality Composite” was down 19.7% and Income Composite was down 13.9%, with only “Bargain” screens doing well. It seems to me that screens can be helpful but relying on them alone to pick a few winning stocks which you hold on for months is not a recipe for assured success. It ignores the need to do some short-term trading as news flow appears, or to manage cash and market exposure based on market trends. As ever it’s worth reiterating that there is no one simplistic solution to achieve good long-term investment performance without too much risk taking.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Review of the Year – I’ve Seen Worse

It’s that time of year when I review my overall share portfolio performance. My main objective is to outperform the FTSE All-Share every year using a balanced and diverse portfolio which I did manage to achieve again last year. But I showed an overall loss, including dividends, of minus 5.0%. The FTSE All-Share capital value index was down 12.6% on the year and taking into account dividends that suggests a total return of minus 8.3%.

When I say a balanced portfolio, there are few traditionally defensive stocks in there, and no index tracking funds. The emphasis is on small to mid-cap stocks with hardly any FTSE-100 shares.

The first half year was good, but the last few months of 2018 were particularly bad for many shares that were technology focused or had any pretense of aiming for growth. That’s not to say that there were not a few gainers, but with a large portfolio the numerous losers offset the few shares that rose. You might say that “growth” shares have gone ex-growth as investors put bigger discounts on a gloomier future in general.

Small cap stocks of all kinds were depressed – for example the share prices of two small cap investment trusts (Standard Life UK Smaller Companies and Blackrock Smaller Companies Trust) were down by 18.2% and 7.5%. They both have good long-term track records with well respected managers but an emphasis on UK stocks did not help.

Would it have helped to skew my portfolio to overseas markets? No. That was in fact done by purchasing a number of investment trust holdings but they were some of the worst holdings in the portfolio in the second half.

I did sell down a number of shares in the portfolio as I manage the exposure dynamically to follow overall trends. That means I am now over 20% in cash which is unusual for me as I tend to prefer to be fully invested in shares. But am I looking to rush back into the market? No simply because I am wary that UK share prices will not recover until the Brexit issue is settled and the US market, which we tend to follow, may not recover quickly either. I never act based on economic predictions anyway – I just follow the trends.

It might feel that we have been through a bear market of late but really it’s only been a relatively small correction to date, driven by investor confidence that has been undermined by political events and trade wars.

Looking back a minus 5% return might be considered disappointing but I had minus 17% in 2008, after which there was unbroken series of positive returns with a very good one in 2017. Most of the 2017 high fliers fell back to earth in 2018 though.

One question that investors should always ask themselves is “should I forget stock-picking of individual shares and just buy an index-tracking fund?”. That would save a lot of effort in researching individual companies and monitoring them. The answer is clear in my case. Looking at the last ten years I only underperformed the FTSE All-Share in one year and in some years was way ahead. So I would be a lot poorer if I just relied on an index-tracker.

I am not convinced that stock picking, particularly among small to medium cap shares by someone with a little experience, cannot produce positive returns. In other words, it is not a perfect market in reality. No doubt there are also some investors who have done better than me with more focused portfolios but all I know is that diversity does protect against disasters that are unfortunately all too common in the investment world.

Two things I should probably have paid more attention to were a) running a trailing stop-loss (one that is adjusted to take account of share price rises; and b) being more aggressive in dumping my losers. The latter is something I consistently fail to do but some small cap stocks are very illiquid so getting out of a biggish holding at a reasonable price when the spreads widen can be both difficult and expensive.

Were there any major disasters in my portfolio this year? There are frequently one or two in every year. This year the only big one was Patisserie but only relatively so as it was not one of my bigger holdings. I avoided most of the really big crashes in “hot” shares such as Fevertree by avoiding buying them at their peaks.

Overall a disappointing year so like most stock market investors are probably feeling, “I must try harder”. But don’t we say that to ourselves every year?

As a born optimist, and with buoyant economies in the UK and USA, I am looking forward to the future with some confidence as ever.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Market Trends, Interest Rates, and Yu Group Accounts

Yesterday was another dismal day in the markets. The US fell significantly allegedly caused by the rise in interest rates announced by the Federal Reserve and the UK market followed it down this morning. The US rate rise was widely expected although perhaps slightly lower estimates for US economic growth had an impact. But when the markets are in a bear mood, excuses for selling abound. Meanwhile the Bank of England has announced today that their base rate will remain at 0.75%. The UK market recovered somewhat after it’s early fall, even before that announcement at 12.00 am. Did it leak one wonders, or is it those city high fliers with big bonuses stimulating the market before it closes for Xmas? Or was it the news from GlaxoSmithKline (GSK) that a de-merger was to take place? Many market trends are unexplainable so I won’t say any more on that subject.

The general state of markets was highlighted in a recent press release from the Association of Investment Companies (AIC). They represent investment trusts and reported that the industry’s assets hit an all-time high of £189 billion in September but pulled back subsequently. At the end of November the average investment company returned 1.3% over the prior year they said, but that suggests that when the year ends most will be lucky to show any return at all. Investors who manage to beat zero for 2018 should consider themselves either lucky or wise.

But the good news the AIC reported was that many investment trusts, 37 of them, have reduced fees in 2018. Even better news was that 9 of them abolished performance fees which I believe is a good move for investors. There is no evidence that performance fees improve investment managers’ performance and they just lead to higher fees. Needless to point out that the lack of returns in 2018 might have encouraged the trend to cut performance fees!

Not only that but the average return of 1.3% by investment companies beat that of the average of open funds who showed a loss of 2.6% and the FTSE All-Share with a loss of 6%. Perhaps this is because there are more specialist or stock-picking investment trusts as opposed to the many open-ended index trackers and heavy weighting in a few large cap dominated sectors in the FTSE. That shows the merits of investment trusts (I hold a number but very few open-ended funds).

Coming up to Xmas and the New Year, it’s worth warning investors about share trading in small cap stocks and investment trusts though. Both often have low liquidity and this is exacerbated over the holiday season as active investors take a break. The result is that such stocks can spike or decline on just a few trades. Might be a good time to take a holiday from following the markets even for us enthusiastic trend followers.

Yu Group (YU.) is the latest AIM company to report fictitious financial accounts. Yu Group is a utility supplier to businesses and only listed on AIM in March 2016, reached a share price peak of 1345p in March 2018 and is now 68p at the time of writing, i.e down 95% – ouch!

An announcement by the company yesterday, following a “forensic investigation” of its past accounts, reported more bad news including serious deficiencies in the finance function. They are now forecasting an adjusted loss before tax of between £7.35 million and £7.85 million for the year ending December 2018, but that excludes lots of exceptional costs including possible restatement of prior year accounts. Future cash flow is also called into question. In summary it’s yet another dire tale of incompetent if not downright fraudulent management in AIM companies which it seems likely the auditors did not spot. The FCA and FRC should be investigating events at this company with urgency. The AIM Regulatory and NOMAD system has also again failed to stop a listing or what clearly has turned out to be a real dog of a business.

Let us hope that the mooted changes to financial regulation in the UK bear some fruit to stop these kinds of disasters in future years. Risks of business strategy failures and general management incompetence we accept as investors. Likewise general economic trends, even Brexit risks, and investor emotions driving markets to extremes we accept as risks. But we should not need to accept basic accounting failures.

On that note, let me wish all my readers a Happy Christmas and a prosperous New Year.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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It’s Not Just Blood on the High Street – ASOS et al

The trading statement this morning (17/12/2018) from ASOS (ASC) has caused the share price to fall by 40% at the time of writing. Other internet retailers such as Boohoo (BOO) fell in sympathy.

ASOS reported that revenue was up by 14% over the previous year, but warned that they “experienced a significant deterioration in the important trading month of November and conditions remain challenging. As a result, we have reduced our expectations for the current financial year”.

In effect the previous forecast sales growth for the year of 20 to 25 percent has been reduced to circa 15% (last year it was 25%). In addition margins are down which they blame on a “high level of discounting and promotional activity across the market” which they have reacted to by increasing their own level of promotional activity with more discounting and clearance sales.

They blame the weakening in consumer confidence driven by economic uncertainty plus unseasonably warm weather in the last three months. Weather is normally blamed by retailers for poor footfall in their shops so why should it affect internet retailers? It’s because it allegedly has reduced the average selling price of items purchased. But the really interesting aspect is that it is not just the UK that has suffered. Trading in France and Germany has also become “more challenging” with more promotional activity therefore required.

Note that I do not hold either ASOS or Boohoo although I have done in the past. Before this profit warning, ASOS was on a prospective p/e of 36 for the current financial year according to Stockopedia which I considered rather fanciful even given the high growth rates. Estimates will now be revised down substantially, the company is cutting capital expenditure which is always a negative sign, and they “continue to anticipate returning to a free cash flow positive position in FY20”. In other words they are still burning cash.

So it would seem that the dire stories about trading on the High Street is not just caused by the move to internet shopping. Both High Street and internet traders have been hit by declining consumer confidence, with the former also damaged by high business rates and increased staff costs.

There has been no Santa Claus rally in share prices as normally expected this year. It may be too soon to judge the outcome of all retail sales over the Xmas period but this news does suggest that there will be no Santa Claus effect there either. One has to question whether internet retailers such as ASOS will ever return to the heady 25% annual growth rates. There are too many companies getting in that game because there are no significant barriers to entry. Internet retail start-ups are spending money on marketing on the basis that they will make money sooner or later, but will they? Competition to the likes of ASOS and Boohoo can only increase.

A similar trend is being seen in the on-line estate agent market (Purplebricks et al) where competition is growing, some are giving up after running up losses, and nobody is making money due to high levels of marketing expenditure so as to grab market share.

These are markets where I have no urge to dabble in the shares of such companies at present.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Political Turmoil, Investor Confidence and Brexit

With the latest news that Theresa May faces a leadership challenge and recent events in Parliament, it’s worth commenting on the impact on the stock market. These gyrations have generated an enormous amount of uncertainty among investors. The result is that few investors are buying even after share prices have fallen substantially.

The general trend in the UK market is down, the pound is falling and overseas investor confidence (which is key to prices of large cap stocks) must have been damaged by the headlines that they see. Will the UK face a “hard” and damaging Brexit, or even a change to a Labour Government? Overseas investors will have even less of a handle on those risks than UK investors so are running scared.

The fall in the pound should help the profits of many UK listed companies. But even the shares prices of those companies who might benefit have been falling. That applies particularly to small cap companies. Many small cap stocks have limited liquidity and the liquidity provided by private shareholders has been disappearing as those with limited stock market experience have suddenly realised that the markets are not a one-way system where you consistently make money after ten years of positive market trends. They are taking their profits and sitting on their hands.

We are in a “negative momentum” situation where falling share prices drive further falls as trend followers ignore fundamental valuations and sell regardless. This will not change until share values start to look very cheap. The decline in US markets has also undermined investor confidence generally, and has a big influence on the UK market.

There could be a sharp recovery in share prices if confidence returns – after all the UK and worldwide economies are doing well. But confidence will not return until there is some sight as to how the Brexit problem will be resolved.

Theresa May has certainly got herself and her party into a very difficult situation. She signed up to an agreement with the EU over withdrawal that many in her party, and in the DUP who she relies upon for votes, do not like at all. Instead of simply telling the EU that the deal has to be renegotiated, as any firm leader would have done, all she has been doing is going around Europe asking for “reassurances” on the back-stop. The EU bureaucrats (Juncker et al) might have said that they won’t renegotiate it – so would I knowing that Mrs May does not have enough support to take a firm position and time is rapidly running out. But the EU needs a deal to protect its economic interests. They might hope that Britain will reconsider and stop the Brexit process altogether but that is not consistent with the views of the majority of the UK population so is unlikely to happen. Even if a general election was called over the issue, it is not clear that Labour would run on a manifesto committing to rejoin the EU as a lot of their traditional supporters do not like the EU and are affected by the unlimited immigration that has resulted from free movement of people.

The answer therefore is to replace Mrs May with someone who can provide firmer leadership including taking a risk on a “hard” Brexit with no withdrawal agreement if necessary. The latter would not nearly be so damaging as some predict and would put the UK in a very strong position to negotiate a trade deal that is in our interests (and with no complications over Northern Ireland as that issue could then be simplified to avoid a hard border).

My view is all deals are renegotiable if either party no longer supports it. Therefore we need to “withdraw from the withdrawal agreement”, i.e. repudiate it and start again. There are many aspects of the EU Withdrawal Agreement and the proposed future relationship that make sense, but some aspects of the former need changing.

Well those are my views on the political situation. Others might disagree. But so far as investors are concerned, improving confidence in the future economic and political landscape is the key to improved share prices. That seems unlikely to happen under Mrs May’s leadership however much one recognises that she has been trying her best in difficult circumstances.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Bioventix AGM, Babcock Attack and FCA Measures on CFDs

On Thursday (6/12/2018) I attended the Annual General Meeting of Bioventix Plc (BVXP) at Farnham Castle. There were about a dozen ordinary shareholders present. Bioventix develop antibodies for use in blood tests. Their Annual Report contains a very good explanation of the business.

This AIM company had revenue of £7.9 million last year and post-tax profits of £5.6 million. They did that with only 15 staff. Total director pay was £362,000 even though CEO Peter Harrison’s pay went up by 54% – but no shareholders even mentioned that. With consistent growth, good dividends and high return on capital, there’s not much to complain about here.

There is a copy of the last presentation the company gave to investors here: https://www.bioventix.com/investors/overview/ which gives you more information on the company.

I won’t cover the meeting in detail but there were a few points worth mentioning:

Peter explained that the Vitamin D antibody market is “plateauing”, i.e. unlikely to show the same growth as historically. The key product for future revenue growth is their new Troponin test for which there are high hopes, but take-off seems sluggish. This is a marker for heart attacks and is used to check when someone turns up in A&E with chest pains whether they are having a heart attack or some other problem, the former being much more serious of course and needing rapid treatment. The new Troponin test is faster and more accurate which helps speedy and more accurate diagnosis. However adoption of it to replace the older test is slow. This seems to be because hospitals are slow to change their “protocols”. There is also some competition but it is not clear how the company’s product stands against that in terms of sales. It would seem more education and promotion of the new product is required but Bioventix is reliant on the blood-testing machine partner (Siemens) to promote it and it seems there is little financial advantage in doing so to them – the new product is no more expensive than the old. That you might think makes it easy for customers to convert to the new, but also provides little motivation for the supplier to promote. However, NICE and others are promoting the new tests. That’s a summary of what Peter explained to the shareholders with my deductions.

It would certainly be of advantage to patients if the new test was adopted. Might have saved me hanging around in A&E for most of the night a few years back just awaiting confirmation I had not had a heart attack.

There are other antibodies in the R&D pipeline although it can take 5 years from R&D commencement to product sales, even if the product is adopted. All R&D is written off in the year incurred though.

There were questions on cash and special dividends which the company sometimes pays. The business is highly cash-generative but they like to keep about £5 million in cash on the balance sheet and no debt so that they can take up any acquisition or IP opportunities.

On Friday (7/12/2018), there was an interesting article in the Financial Times on the attack on Babcock International (BAB) by Boatman Capital Research – a typical type of attack by an anonymous blogger probably combined with shorting. The article quoted an investor as saying “Boatman made some valid points…..but there were whopping inaccuracies which seemed calculated to drive the share price down”. For example, the article mentioned claims about overruns on a contract to build a dry dock at Devonport – there is no such contract.

Babcock has been trying to find out who Boatman Capital are, but with no success at all. The organisation or its owners cannot be located, and their web site is anonymised. So Babcock cannot even sue the authors. They may well be located overseas in any case which would make it even more difficult. Babcock share price has been falling as a result and is down 20% since the Boatman report was published. See the FT report here: https://www.ft.com/content/c2780d6e-f942-11e8-af46-2022a0b02a6c

Comment (I do not hold Babcock shares): The Boatman report seems to be the usual mixture of a few probable facts, mixed with errors and innuendo as one sees in such shorting attacks. There have been a few examples where such reports did provide very important information but because of the approach the writers of such reports take it is very difficult to deduce whether the content is all true, partially true, or totally erroneous and misguided. The shorter does not care because they can do the damage regardless and turn a profit.

The basic problem is that with the internet it is easy to propagate “fake news” and get it circulated so rapidly that the company cannot respond fast enough, and regulators likewise – the latter typically take months or years to do anything, even if they have a channel they can use. We really need new legislation to stop this kind of market abuse which can just as easily involve going long on a stock as going short. Contracts for Difference (CFDs) are one way to take an interest in a share price without owning the underlying stock and hence are ideal for such market manipulations.

Which brings me on to the next topic. The Financial Conduct Authority (FCA) has announced proposals to restrict the sales of CFDs and Binary Options to retail investors. Most retail investors in CFDs lose money – see my previous comments here on this subject: https://roliscon.blog/2018/01/14/want-to-get-rich-quickly/ . The latest FCA proposals are covered here: https://www.fca.org.uk/news/press-releases/fca-proposes-permanent-measures-retail-cfds-and-binary-options

You will note it contains protections to ensure clients cannot lose all their money and positions will be closed out earlier. But leverage can still be up to 30 to 1. The new rules might substantially reduce losses incurred by retail investors, the FCA believes.

But it still looks like a half-baked compromise to me. If the FCA really wants to protect retail investors from their own foolishness, then an outright ban would surely be wiser. At best most CFD purchasers are speculating, not investing, and I cannot see why the FCA should be permitting what is essentially gambling on stock prices. It creates a dubious culture, and the promotion of these products is based on them being a quick way to riches when in reality it’s usually a quick way to become poorer.

You only have to look at the accounts of publicly listed CFD providers to see who is making the money – it’s the providers not the clients. Those companies seem to be mainly saying the new rules won’t have much impact on them. That is shame when they should do and shows how the FCA’s solution is a poor, half-baked compromise.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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