Bad News for the Housing Market and On-Line Retailers

The news in the housing sector is all bad. Banks have stopped providing mortgages and builders have stopped building houses (Redrow announced it was closing all its sites this morning). Estate agents are also giving up as nobody wants to have strangers wandering around their house and there are few new buyers. Who would look to buy a house given the economic uncertainty and with everyone’s jobs under threat? Rightmove previously announced it was discounting all its bills to agents but they have now announced that the proposed final share dividend is being cancelled.

Did you think on-line retailers might be able to continue operating? Think again. Next has announced it is temporarily closing its on-line operations including warehousing and distribution. Apparently “colleagues” feel they need to be at home. This mirrors what I have seen from a couple of smaller on-line clothing suppliers I use. They both announced closure in the last few days. Will Boohoo, ASOS and Amazon be able to continue to operate? Only supermarkets seem reasonably sure to be able to stay in business over the next few weeks.

This gloom over the country’s business status was echoed in the comments of Paul Scott on Stockopedia. He said this morning: “Hundreds of £billions in economic activity is being killed off, with ruinously expensive compensation schemes being dreamed up. For what benefit? We’re likely to end up with millions of unemployed, many thousands of destroyed businesses, all of which might have slowed down the spread of the virus a little”. He has lost confidence in the recent stock market bounce and thinks losses will be ruinously high in many companies. I agree with his comments. Certainly in many sectors it’s a question of which companies will survive the year, not whether they will make any profits or pay any dividends.

The only positive glimmer is that Anthony Bolton, who ran Fidelity’s Special Situations fund until 2007 very successfully, is apparently moving back into the market to purchase selected stocks according to an article in the Financial Times. He says “at these prices there are really interesting opportunities”. Certainly the key is to be very selective even if you believe the crisis will be over by the end of the year.

Meanwhile I am sat in the bomb shelter otherwise known as isolating at home. These are such momentous times that I decided to start writing a diary just as my father did during the second world war. It may interest my offspring in due course as reading my father’s diary did after it came to light 37 years after he died. My diary may be a much shorter one though if I catch the virus.

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

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A Cautionary Tale from Paul Scott

City AM published an educational story last week which is worth repeating. It covered the investment record of Paul Scott who is very well known in the small cap investment world. He writes very perceptive, and quick, analyses of announcements by smaller companies for Stockopedia with a strong emphasis on the financial accounts. He trained as an accountant and worked for a retailing company as finance director for some years. He then became a professional investor – one might say living off his wits – and reportedly turned £50,000 into more than £5m in a few years. Then the financial crisis hit in 2008/9.

This is what he said in the City AM interview: ““I lost the lot and had to start all over again in the financial crisis. It was horrendous, it ruined my life at the time. I had to sell my house, I lost all my savings, I ended up £2m in debt. It was a catastrophe.”

The article suggests Scott made two mistakes: “One was investing in stocks with low liquidity. The other was gearing up on them through spread-betting. When the crisis hit, he couldn’t get out.”

Now with speculative small-cap stocks again riding high, with valuations not based on current fundamentals such as profits and cash flow, but on their future prospects and for their ability to dominate their markets, it is surely again a time to be wary.

Markets are driven by emotions and once a panic sets in then small cap stocks in particular could become very illiquid. Having a major proportion of your portfolio in such stocks may have done wonders for your investment performance in the last couple of years but it is high risk. That is particularly so if you also gear up, and have an undiversified group of holdings – a portfolio of less than a dozen holdings of such companies is positively dangerous.

So the moral is surely never to hold a company on the premise that you can get out if the market turns sour for shares in that company, or in general. Unless you are sure you want to hold a company for the long term, and can afford to do so (i.e. you have not borrowed money to buy it), you should not buy it in the first place.

In addition never let a few holdings dominate your portfolio. And in particular be very wary of companies where there is little trading (i.e. low liquidity). If your own holding is a multiple of the daily trading volume, you’ll never be able to get out at a fair price if there is a crash.

This is what Paul had to say recently in an interview for Stockopedia: “I’ve learnt all my investing decisions the hard way. 2008 taught me that you need to keep an eye on the exit and you need to consider what will happen to liquidity if there is some sort of awful event. Not necessarily a minor event, but if the financial system starts to cave in again – which it might well do. So for that reason, this time my risk management is much better. I’m keeping the gearing lower than it was and I have a general rule that I want to be able to exit every position I hold within a maximum of two days in a bear market. So I position size accordingly. If something is very small and illiquid, I wouldn’t have more than £30,000 – 40,000 worth of it. If it’s nice and liquid then I’ll have £500,000 of it. I think liquidity is so important.”

I would only comment that when everyone wants to exit, shifting even a relatively small amount of stock in small caps can be damn difficult. Having solely small cap stocks in your portfolio can be a risky strategy when mid to large cap stocks will be much more liquid and less volatile. For example, private investors could easily sell their holdings in HBOS, RBS, Northern Rock and Bradford & Bingley even when they were in dire difficulties.

Diversity in individual holdings, and in company size, are both prudent.

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

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