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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A Bad Day in the Market, but Good News from Unilever and BEIS

It was a bad day in the market yesterday, with the FTSE All-Share falling over 1%. This seems to have been driven by a sell off in bonds. Equity prices are usually linked to bond prices simply because as bond yields rise from a fall in bond prices, it becomes more attractive to hold bonds relative to equities. That particularly applies to shares that are “bond proxies”, i.e. ones bought because of their high yields for income seeking investors.

These changes have been driven by the realisation that the US economy is booming. The Federal Reserve has already raised US interest rates and is therefore likely to do so again if the US economy continues to race ahead. But a booming US economy is of course good news for many companies. Higher interest rates may mean that some companies pay more on their debt but that it a longer-term impact and many “new economy” companies do not have any debt.

When markets are falling in general, there is no place to hide. My over-diversified portfolio, mainly in UK small cap stocks, fell about 1%. Not every share declined but the majority did. It affected particularly highly rated, go-go stocks such as Fevertree (FEVR) which was down 8% yesterday. I am glad I now only have a nominal holding in the company. But also affected were many investment trusts which I hold as their typical low liquidity compounded by a few private investors panicking drove down the prices. Some fell more than the underlying shares they hold.

Property companies have also been affected as interest rates have an impact on their business model, despite the fact many have locked in low rates on long-term debt. Safestore (SAFE) for example was down 3.9% yesterday (I hold it).

The share price declines spread like a contagion to many other stocks who should be positively affected by a booming US economy and not impacted by higher interest rates. The rise in interest rates is hardly a surprise though it has been well signaled in advance in both the US and UK. It was unrealistic to expect the historically exceptional low interest rates to continue forever.

My reaction when there is carnage in the stock market is to stand back and wait to see whether it develops into a trend or is simply a short-term blip. There can be buying opportunities if the reaction to economic news is too severe. But interest rates are nowhere near low enough yet to cause me to abandon the stock market and move into bonds. I feel there is more destruction to come in the latter. 

Unilever and Enfranchising Nominee Shareholders

Today we have some good news from Unilever. They have backed down on their proposal to merge their dual legal structure. The announcement said “We have had an extensive period of engagement with shareholders and have received widespread support for the principle behind simplification. However, we recognise that the proposal has not received support from a significant group of shareholders and therefore consider it appropriate to withdraw”.

There was opposition from both individual shareholders and institutions in the UK and there was a risk that they might fail on the Court hearing vote to gain enough support. It’s always good when shareholders make their voice heard, although it still leaves the issue that shareholders in nominee accounts were likely to be disenfranchised.

The good news in that regard is that I have received a letter today from the BEIS Department which says “BEIS is sponsoring a project by the Law Commission to examine the UK system of intermediated securities”. I will try and find out more, but don’t get too excited – it might not report before 2020!

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

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Interest Rates and the Gig Economy

You probably don’t need to be told that interest rates are at their lowest for several centuries, if not in recorded history. The fact that the Bank of England is making noises about possibly raising base rate could just be a way to try and rein back inflation (a higher base rate, or prospect of it, causes the pound to rise and that makes imports cheaper – and import costs have been one of the factors in inflation rising). But unemployment is also at its lowest level for 40 years which usually indicates a booming economy and the prospect of higher inflation to come.

Inflation is now at 2.9% measured by the C.P.I., or 3.9% based on R.P.I. which a lot of us like to use instead. Now to me the really astonishing item of news last week was that the large City of London Investment Trust managed to borrow £50 million at a fixed rate of 2.94% for 32 years (I do hold some of their shares). That’s must be one of the best deals ever surely, and shows how investment trusts have the advantage of being able to gear up by borrowing money – and why not when interest rates are so low?

In reality, the lender is not even getting a real positive rate of interest at current inflation rates, and is also betting that it won’t get any worse for the next 32 years. Astonishing, and just shows how the world economy is awash with cash.

Another couple of interesting items of news last week were that Deliveroo lost £129 million in 2016 according to accounts filed at Companies House, on revenue of £129 million. In other words, for every pound paid by customers, they lost a pound. It’s raised $472 million from investors to achieve this wonderful business model (source: FT).

Deliveroo use “self-employed” bike couriers to deliver restaurant meals. Another exponent of this “gig-economy” model is Uber who received the bad news last week that Transport for London were terminating their license to operate in London. More information on that in this blog post I wrote for the ABD: https://abdlondon.wordpress.com/2017/09/23/uber-kicked-out-of-london/ . In there I praised the merits of the service and suggested people sign the petition against it (which is rapidly heading for a million signatures).

But one reason that it is so low cost is because like Deliveroo, Uber loses money in a big way at present. To quote from one report on its financials, “Uber is cheap because the company is heavily subsidising each trip” where it was suggested that Uber’s losses as a percentage of revenue were 129% in the last quarter of 2016. Like Deliveroo, revenue is rising rapidly though.

Do we mind if these companies lose money hand over fist? If they are fool enough to do so in the race to dominate a new market why not let them. But the long term viability of both when there are obviously lots of competitors providing similar services does raise doubts about these businesses, even if London Mayor Sadiq Khan relents over Uber’s license.

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

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