It has been rather refreshing to take a break from the markets for much of August. In between family time, days out void of connectivity (yes, it is still possible to escape the modern world, if only for a few hours) and too many pub lunches, I have been doing a lot of reading and much thinking. In particular, I have been focused on the risks in the market, the exposure to those risks in my folio and what I could/should be doing to mitigate those risks.
My overriding investment thesis for 2018 has been to avoid UK focused businesses. My rationale for this was simple, Brexit uncertainty. This has not gone away and if anything, the risk of a “no deal” or “hard” Brexit seems greater than ever. For good measure, I believe there is the very real prospect of a leadership challenge this autumn. The pound is pretty weak against the dollar and there is every chance this could worsen.
Fortunately, my top ten holdings are all net dollar earners and therefore, largely unaffected by Brexit uncertainty and beneficiaries of the weak pound/strong dollar situation (albeit H1 comparatives have been tough). All well and good BUT…
There are a plethora of other risks and indicators that are evident in the US and globally such as trade wars, Iran sanctions, yield inversion, US corporate share buybacks, Italian bonds, Turkey, Venezuela, Argentina, emerging market contagion, US mid-terms and the ever present threat of “what will Trump do or say next?”. Risks abound and yet, the US economy and corporate earnings are both strong with their main indices extending all-time highs and continued dollar strength against virtually all currencies, including gold.
How long that dollar strength persists remains to be seen but for now at least, I am happy to retain significant exposure to gold via Anglo Asian Mining (AAZ) as they are a low-cost producer and I believe, significantly undervalued. There is every chance that value will begin to out during September (resource upgrade, first half results and details of the maiden dividend) and October (Q3 production update – the first quarter with their second crusher fully operational). Given that such a high portion of my folio are net dollar earners, AAZ, while comfortably profitable with gold at $1200, also offers a currency hedge should the dollar weaken significantly, as gold should move in the opposite direction.
I have absolutely no idea what is going to trip the US market up nor how far it is going to fall nor of course, when it is going to happen. My hunch is that it will be something simple such as wage inflation that triggers the initial sell-off but whatever it is, the chances are it is already hiding in plain sight. As we all know, when the US sneezes, the rest of the world usually catches a cold. My overall sense is that we are getting towards a market top in the US. Maybe this bull market can carry on for another 6, 12, 18 months. Perhaps. But right now, I see more downside risk than upside risk.
Throughout 2018 I have been happy to be fully invested but I think the time has come to increase the cash weighting and reduce risk. The last time I did this was leading up to the Brexit vote and while that did cause a dip in dividend income, it ultimately enabled me to pivot and re-position my folio to make good returns in the subsequent 18 months. Therefore, my plan as we go through September’s results season is to top slice some of my larger or more speculative holdings, hopefully into share price strength. While these mostly remain core holdings, I’d like to have some ammunition available to capitalise on market volatility and/or shifts in the market landscape. Indeed, I have already begun this process by top slicing Games Workshop (GAW), Bioventix (BVXP), Apple (AAPL), Victrex (VCT) and XP Power (XPP) last week. Anyone following my weekly Tweets or Share Watch column should expect to see more of the same as we go through September.
The other thing I will be doing is topping up some of my high yielders. Mostly, these have been out of favour in 2018 and therefore, offer increasingly attractive yields. I suppose they count as value plays but I am more interested in the sustainability of dividends. Indeed, I might even add a couple of new high yielders to the folio once I am comfortable with my cash levels.
While I acknowledge (and usually adhere to) the familiar adage that one should focus on “time in the market” rather than “timing the market”, sometimes the risks become too high a probability to ignore. Ultimately, the success of a compounding strategy hinges as much on minimising drawdowns as it does on making consistent gains. And right now, I believe there are so many risks in the UK and globally that at least one of them is likely to trigger a significant sell-off as we go through autumn. If I am wrong, so be it. I will miss out on some gains and some dividend income but I will continue to sleep well at night whereas if I am right, there will be some bargains to be had.
My regular Share Watch column will resume shortly, perhaps even as soon as this Friday. Until then…
Disclosure – At the time of writing, I own shares in AAZ, AAPL, BVXP, GAW, VCT and XPP which were all mentioned in this article