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Hi, Smart Investors. In this article I explain the major market developments of recent months and their impact on our SIA-style portfolios and proceed with the end-of-month rebalancing for GLP. The PP portfolio rebalance is explained here.
Main trends of recent months
We’re now 5 months into the Covid-19 recession. Meanwhile we saw a 37% 1-month drop in equites and a stellar 50% comeback supported by the unprecedented monetary and fiscal support actions and the hopes connected with reopening of the global economy, which has so far been both uneven and unpredictable. As far as equities are concerned possibly the biggest story has been the outperformance of high-tech vs. the wide market. Covid-19 has caused some businesses to tumble, with sectors like dining, entertainment, airlines, travel, hospitality being the most hit. On the other hand people’s whole life went even more online, boosting profits of the new era names. This can be clearly seen in the FAANG 2Q20 numbers, which were all stellar. I wrote about it here in my latest Weekly. Here’s a very clear graphical confirmation of this trend year-to-date (YTD) showing normalized YTD gains of Nasdaq100 (NDX) vs. SP500:
As an effect Nasdaq Composite (CCMP) and Nasdaq100 (NDX) have both already made new all time highs (during a recession!) and SP500 is a notch away now. If that happens, it will be the second time only in history (after 1983) when equities surge to record levels during a recession period. To me it means two things:
1st – protecting the wealth effect (via high risky assets prices) during a recession is now the very most important target of both the monetary and fiscal authorities. Otherwise there would possibly be a total implosion of consumption and consumer sentiment, which (remember that always!) account for 70%+ of GDP. The authorities, so far, are succesfull in reaching this target. Old saying to cite here: “don’t fight the Fed”. Although more and more sounds of whislteblowers can be heard, saying that the monetary policy is having less and less of an effect in current zero-minus rates environment. These opinions have been here for a while now, since the QE programs have been laid out in 2009. Time will tell…
2nd – asset prices possibly also discount the fact that this recession is mostly exogenous (not triggered by any specific disfunction of the economy itself, but by an external factor) and once this factor subsides, the recovery will be quick and, with support of the Fed and the government, broad in its character. The recession is also expected to be relatively short. Again time will tell…
Gold on fire
Possibly one of the biggest winners of recent months has been the Gold bullion. In July only Gold surged as much as 11.5%. This week it made new all time highs and is now testing a round $2000/ounce level. I have already wrote a few times about the reasons for Gold strenght and why it is poised to stay strong in the coming months (and years possibly), but let’s again recall in short the main reasons:
* Gold is a safe haven, and even though equities are now at record highs, there’s still a lot of uncertainty in markets, which naturally bids assets like Gold,
* Monetary policy dovishness is now limitless,
* rates are zero to negative in most countries (even more so in real terms),
* fiscal support is monstrous around the world to fight Covid-19 effects and that surely causes that….
* …long-term inflation expectations are starting to surge (which can be depicted by the comeback of the yield curve to its normal shape – see here for details) – Gold is an inflation hedge asset,
* geopolitical scene is still hot and possibly to get even hotter (US-China relations main theme).
Our SIA portfolios have now a substantial portion of assets invested in Gold via GLD ETF (27-30%) and continue to gain nice alpha here :).
It’s expensive now
There’s many market participant sounding alarms that markets are now extremely expensive on valuations. And that’s mostly true. Here is a table with aggregate P/E estimations for 2020-2021 for the major US indices:
| current trailing | 2020 est | 2021 est | |
| SP500 | 24,3 | 25,5 | 19,8 |
| Dow Jones | 20,7 | 23,7 | 17,9 |
| Nasdaq Composite | 56,8 | 38,2 | 27,7 |
| Nasdaq100 | 34,2 | 31,1 | 25,5 |
| Russell 200 | 98,8 | 121,7 | 28,4 |
Woooh! It is expensive. Especially the mid-caps (Russell 2000) are now (on trailling and end 2020 basis) at absurd levels. But, remember one pretty basic thing. P/E is a ratio. There’s a nominator and a denominator. So P/E can be driven up by a rise in the P or a fall in the E (or a simultaneous move of both with diverging dynamics) and the opposite is true for a fall in the P/E. On trailing basis the P/Es have skyrocketed mostly because of the fall in earnings (as prices right now are pretty much where they were before the virus came). This factor is now known and already mostly ignored by the market (it’s priced-in). Trailing P/Es are calculated using given data. Forward P/Es on the other hand are put together given current prices and expected earnings in the future. And here we’re coming to another issue. forward P/Es are now so high, because the market’s expectations as to future earnings have been unprecedently dumped.
Now whether current equity prices hold or not will depend on the EARNINGS SURPRISES and REVISIONS going forward. Surprises (and revisions) to analysts’ expectations are possibly the biggest driver that moves equities. Many institutions have developed very useful tools to measure them. Among the most widely used is the Citigroup Earnings Revision Index. Other enterpreneurs have built whole businesses around this phenomenon. Take www.zacks.com for instance, who have built a system of stock-picking based on earnings estimates revisions. To cut the long story short: going forward either the earnings turn out out better than expected and P/Es go down (with prices here or higher) or prices go down as surprises will still be negative and revisions keep skewing to the downside. We’ll see how it develops, but given the fact that expectations are now super-duper low, i’d give the first option a little higher probability. All will also of course depend on how the recession unwinds and how the world tackles the virus trends.
OK let’s move on to the portfolio rebalance…
The rebalance
The GLP is now perfectly positioned for the recession phase of economic cycle. It is supported by (a) gains in the Gold bullion (GLD) (b) continously lower bond yields (higher bond prices) (TLT) (c) good stock picking (SIAScore). Our Portfolio gained 6.7% month-on-month. GLD was the biggest contributor and added 3% alone, TLT rose 4.4% and added 1.6% to the GLP’s performance in July. Rest of gains came from the equities part.
As a result not much action was needed this month during the rebalancing. I only cut 10 shares (30%) of the AMD position. That was done to adjust the aggregate equity weight back to under 20% as per our SIA investing strategy (max 20% in equities during recession).
Portfolio holdings are traded at the closing price on the rebalancing day presented by www.morningstar.com (which may differ from official closing prices given by appropriate stock exchanges).
Current structure of the GLP can be found on Portfolios page.
Total Personal Return since inception (TPR) of GLP as of close 31st July 2020: +17.3%.
Next update in a month.
Yours,
PC
Disclaimers: None of the ideas, views and thoughts presented here shall ever be taken as a recommendation to buy or sell stocks,bonds,FX,commodities or any other financial instruments as stated in REGULATION (EU) No 596/2014 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC or the Regulation of the Polish Minister of Finance of 19 October 2005 on information constituting recommendations regarding financial instruments, their issuers or exhibitors (Journal of Laws of 2005, No. 206, item 1715) or the Polish Act of 10 February 2017 amending the act on trading in financial instruments and some other acts. The article is for educational reasons and purely presents private views of the author, thus the author shall not be claimed eligibile for any losses of a third party resulting from trading activities based upon this article. The author uses his best knowledge and data from sources believed to be reliable, but makes no representations as to the accuracy of the data.Full Disclaimers&Liability Limitations page.
