Red Light, Green Light
Back in the summer, Peter Spiller - the founder of wealth preservation fund Capital Gearing Trust (CGT), was comparing the market to the game of ‘Grandma's Footsteps’ (an extreme version of which featured on the surprise hit show ‘Squid Game’, under its alternative name, ‘Red Light, Green Light’).
The idea of the game is that players advance when Granny isn’t looking, but lose if they are caught moving when Granny turns round. Peter had the cautionary message for investors that “Granny hasn't looked round for a very long time”.
Granny did indeed look round in 2022, catching out investors - particularly those invested in UK small cap and growth stocks which had a terrible year. The typical bear market pattern of a series of steep declines punctuated by short, sharp, rallies, like mini games of ‘Red Light, Green Light’ left the AIM All Share down by -31% for the year and the FTSE 250 down by -20%.
UK markets peaked back in September 2021 when inflation was still low, but beginning to rise, and expectations were that it would be short lived. It was only when markets started falling significantly at the start of 2022 that, in a spectacular feat of timing, this portfolio was launched.
In Here I Stand A Chance At Least, But Out There?
Navigating the macro environment was difficult. The strategy is to build a portfolio of quality growth companies selected by applying thresholds to scores in the MIA Share Rankings which are compiled using a number of underlying quality and growth metrics.
Staying out of the market in cash is not a particularly attractive option when it’s real value is being eroded by double digit inflation, but this was the main lever available to protect against the significantly falling share prices in growth stocks. The target cash level in the portfolio is determined by market sentiment measured with the MIA Sentiment Index. As sentiment falls, cash reserves are released, slowly initially, and then in increasing amounts as sentiment moves towards extreme fear.
When the portfolio launched at the start of the year, initially 100% in cash, falling sentiment released around half of the cash for deployment into the market. That was too much too soon. I’ve since tightened up the rules in this area, but too late to prevent the damage done by the initial stock purchases in Q1 which were generally the biggest detractors to the portfolio performance.
The portfolio maintained close to 50% in cash for most of the year before the negative sentiment around the market lows in late Q3 / early Q4, triggered a number of further acquisitions, shifting the portfolio weighting much more heavily towards equities and reducing the cash position to around 25%.
These were the portfolio holdings at the end of Q4:
A new position was opened in YouGov (YOU) in Q4 after the company’s full year results indicated that it had so far been resilient to the turbulent macro environment. There are reasons to be cautious though with the company noting that key contracts are shortly coming up for renewal:
“While we continue to see no material changes in client behaviour due to the current macroeconomic environment and outlook, we recognise that the upcoming months and key subscription contract renewal season will determine our ability to meet our stated targets.”
A new position was also opened in Calnex (CLX) as the markets reached their October lows. Calnex’s business of testing telecoms and technology infrastructure has so far proved to be extremely resilient. Interim results in November showed revenue up by 38% and profit before tax up by 34%. The share price finished the year up by 40%.
This Is Hell. What Are The Rules In Hell?
Despite holding close to 50% in cash for most of the year, the portfolio value experienced some significant declines reaching low points of -20% in June and again in October.
A strong rally from the October low gave the portfolio its best quarter so far with the value rising by 12% compared to the benchmark rise of 9%. The wider picture though is not so encouraging and the portfolio ended the year down by -9.8%. The rally in Q4 peaked in early December, but it’s too early to tell if it is now in another steep decline and heading towards a new lower low.
The chart below shows the full year portfolio performance compared to the SPDR FTSE UK All Share Accumulation ETF (FTAL) as a proxy for the FTSE All Share Total Return index.
The two asset management holdings, AJ Bell (AJB) and Impax Asset Management (IPX), were the biggest contributors to portfolio performance during Q4. AJ Bell in particular benefits from a higher interest rate environment, and also received a broker upgrade during the quarter.
Both YouGov and Calnex proved to be timely acquisitions, at prices very close to their October lows, and these are now the top 2 holdings in the portfolio.
Alpha FX had a change of name and ticker to become Alpha Group International with ticker ALPH. The company released another positive trading update in October:
“Profit is expected to be materially ahead of expectations as a result of the interest rate environment generating additional income from Alternative Banking's overnight cash balances.”
All holdings with the exception of Allianz Technology Trust (ATT) contributed to the positive 12% performance in Q4 as shown below:
The biggest detractor by some margin to the full year performance of -9.8% was Molten Ventures (GROW) followed by Allianz Technology Trust, and Smithson (SSON). All of these were acquired in Q1. Molten Ventures was disposed of in Q2.
Good Rain Knows The Best Time To Fall
I began this review with some cautionary words on the current state of the markets from Peter Spiller of the Capital Gearing Trust. There were no words of comfort in Peter’s longer term outlook either:
“the expected return [from our modelling] on the S&P 500 is roughly zero over the next 10 years and it could be significantly worse than that...”
Jonathan Ruffer of the Ruffer Investment Company (RICA), another popular wealth preservation fund, has been equally pessimistic. He said in October:
“In the forty-five years I have been an investor, I cannot recall a more dangerous period than today.”
On a more positive note, we may now be at or near peak inflation. The Bank of England’s current projections show inflation falling sharply in 2023 and dropping below their 2% target in 2024.
However, if you believe, as Russell Napier does, that we are entering an era of financial repression, then in the longer term inflation is likely to settle well above the BoE’s target - perhaps, as Russell suggests, at a level of 4 - 6%.
Making money in the markets may well continue to be more difficult in the near future than it has been in the recent past. At some point though the markets will turn upwards again and the good rain will fall.
Wishing you all a very happy New Year and successful investing in 2023.
This article is intended for informational purposes only. It is not a recommendation to buy or sell shares or other investments. Always do your own research before buying or selling any investment or seek professional financial advice.