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Why are Markets so Volatile?

An excellent article today in the Wall Street Journal ‘Why Are Markets So Volatile? It’s Not Just the Coronavirus’ commented how the stock market is now dominated by computer-driven investors that rely on signals such as volatility and momentum

Since the mid-February market peak, the Dow Industrials have closed more than 1,000 points lower on six trading days and rebounded at least 1,000 points four times, not seen since 1929. Adding to those moves, and potentially hastening them, are technical factors that have little to do with how investors feel about the outlook for companies, earnings and the economy.

In a dramatic shift since the financial crisis, the market today is dominated by computer-driven investors whose machines react to a series of technical and other factors, as well as by more-traditional investors who rely on reams of fast-flowing data. On many days, forces such as the market’s volatility and momentum, derivatives activity and the market’s liquidity—how easy or difficult it is to get in and out of trades—can help drive trading.

As long -term investors, we invest in companies based on their fundamental attractions and have little interest in apparent short-term trading opportunities, which only serve to enrich the brokers.

The clue is in our name!


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Our current thinking on the ‘Corona Crash’

This week’s stock market sell-off has been indiscriminate and, with a few rare exceptions, has materially affected the share prices of all companies, large and small.

The Financial Times has highlighted how the S&P500 index, dominated by some fantastic cash rich companies, experienced its quickest fall into a bear market on record, taking just 16 sessions. While the coronavirus, oil price and recessionary fears were the catalyst for the sell-off, the speed and severity of the fall was primarily due to the proliferation of automated computer trading systems which now dominate the trading of large company shares around the world.

In this regard it is noticeable that, at the time of writing, the FTSE AIM index has fallen 23% year to date which is marginally better than the 29% fall experienced by the FTSE All share and broadly in-line with the 22% fall of the S&P500 index respectively. Where smaller less-liquid companies generally bear the brunt of any market sell-off, this is a surprising outcome and very different to what we experienced during the Financial Crisis of 2008-9. It could also reflect the prevalence of many investors in AIM holding shares for Inheritance Tax planning purposes, who are obliged to display more patience.

The impact of the coronavirus is clearly going to be more meaningful for world economies than originally anticipated. Certain sectors are going to experience a challenging period over the next few months as expensive assets remain under-utilised and staff need paying.

Thankfully, Fundamental portfolios have no exposure to oil and gas and resources companies, where even the blue chip names have seen their share prices fall significantly more than the overall market. Shares in Royal Dutch Shell are currently down 41% year to date pushing the forecast yield to 12%, if those forecasts are to be believed!

With recessionary fears now uppermost in the minds of many we are adopting a cautious stance to bargain hunting on the stock market. While some shares appear oversold, this is often for good reason given the questionable short-term outlook and need to support a hefty debt load and interest bill.

We are long-term investors (not short-term traders) and remain focused on investing in businesses whose balance sheets and cash flows offer the desired support in the short term and where there is no immediate risk of debt and interest burdens causing financial distress.

Many of our portfolio companies have the comfort of being in a strong net cash position, whose cash flows are reasonably predictable and continue to support meaningful dividend payments. From our perspective any bargains will therefore need to meet the key criteria of a strong balance sheet and reliable cash flow.

There is no modern precedent for the ‘Corona Crash’ which has the potential to materially disrupt our way of life over what will hopefully be a relatively short period. As the virus spreads, nobody is sure of how or when it will end. Markets dislike uncertainty and therefore the current volatility could continue for some time yet.

We remain confident in the long-term prospects of our investee companies and the markets will inevitably rebound. As we have communicated previously, at some point this can create opportunities to buy companies at irrationally low prices.

As the end of the tax year approaches please don’t forget to use your ISA allowance. There is no requirement to invest cash immediately, which can simply be held on the account to invest at a later time.

If you would like to discuss potential opportunities please email or call Chris or Stephen on 01923 713890.


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Coronavirus encourages stock markets to take a breather

The indiscriminate sell-off in global equities due to the spread of the coronavirus has, not surprisingly, resulted in material weakness across Fundamental portfolios in the current quarter.

As is usual in these circumstances, the selling has been indiscriminate and even companies considered traditional safe havens have seen their share prices fall. Smaller companies as always have felt the brunt of the sell-off, as have those businesses most directly affected by the impact of the virus.

Diageo, the global drinks group and a constituent of our Ultimate Stocks portfolio, has warned how the virus is affecting its business with global sales now expected to be between £225m and £325m lower than they would have been otherwise. Though meaningful, that’s relatively small in the context of a business which generated sales of £12.8bn last year.

Apple, a long term portfolio holding, previously warned that it would fail to meet its quarterly revenue target of $63-67bn due to temporarily constrained supply of iPhones and a dramatic drop in Chinese shoppers.

Airline, hotel and leisure sectors have been hardest hit with the share prices of portfolio holdings easyJet, Dart Group, Hostelworld Group and Booking Holdings suffering material falls over the past few days. The proposed IPO on AIM of Meininger Hotels, a European hotel and hostel operator, could certainly prove challenging in the current climate.

Portfolio holding Walt Disney Co has also seen its shares slide as its theme parks in Hong Kong and Shanghai have been temporarily shut down. News that Bob Iger, its highly-regarded CEO of the past fourteen years, is also retiring sooner than expected (although he had already extended his stay) also came as a surprise.

Long term holding Microsoft is dealing with the outbreak by donating generously to the recovery efforts in China. That includes RMB 40m worth of products, services and solutions to equip frontline hospitals and medical workers, as well as providing free cloud services to mitigate the impact of the outbreak for businesses and students.

In the gloom of the stock market rout it was pleasing to see price comparison group Moneysupermarket.com report excellent results with a 9% increase in revenue and 10% increase in profits as it reaped the rewards of a diverse product offering. This business continues to display many of the characteristic we look for in an exceptional company.

At the smaller end of the scale, the share price of Ramsdens has also been particularly weak. This company has been enjoying strong growth from its foreign exchange offering which will clearly suffer in the short term as fewer people travel from UK. However, it will also be a beneficiary of the soaring gold price which has climbed to its highest level in seven years.

If there is one positive from the outbreak of the coronavirus, it is that global healthcare systems have been alerted to the need for better contamination control. It’s hardly surprising therefore, that the share price of legacy AIM portfolio holding Tristel, a specialist manufacturer of infection prevention and contamination control products, has climbed to new highs over recent weeks. While it could be a big long-term winner from greater investment in global infection prevention, the share price appears to have become a little over-heated. You can read a full commentary on Tristel’s progress from our associates Investor’s Champion here.

We remain happy with our selection of excellent companies, which will continue to generate growing profits and cash for many years to come. Contrary to what is implied by the current sell-off, they certainly haven’t all turned into bad businesses overnight.

With the US stock market having recently scaled all time highs, a pause in our opinion was long overdue and we view a correction at this point as beneficial to the long-term health of stock markets.

Equity investment should be viewed as a long-term exercise and, unless investors have a near term requirement for cash, see no reason to run for cover at the first sign of short-term difficulties.

We anticipate further weakness in global equities over the coming weeks as the coronavirus spreads inexorably around the world, as unfortunately seems likely. However, human nature is such that, when things ultimately settle down, people will be keen to get out and enjoy life once more. Where applicable, we will therefore look to buy and add to selective holdings as opportunities arise.