Why are many investment portfolios not making profits recently?

18th Nov '21 by WarrantStar

57 comments 3094 reads

I'm mostly interested in growth companies, and I am finding it difficult to make any money recently, despite considerable success in recent years. I think that the main problem at the moment is that high inflation in the UK is leading to worries about imminent interest rate rises, and cut backs or reversals to quantitative easing. These worries are causing market sentiment to turn negative. Do you agree with my assessment? If you think that I have got this wrong, then what is the real problem? I like to think that I am quite good at stock picking, so I don't think that I have selected a load of duff shares recently. Also I am fairly well diversified by sector & industry, and style, but with perhaps a bit of over-reliance on growth companies. I do try to ensure that I hold quite a range of Value ranks, so it's not that I only hold expensive shares.

So how is your folio performing over the last few months, what big themes are helping you or hindering you? It would help if you told us a little about your investment style.

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Philip999

29th Nov '21

I think Logical David has hit the nail on the head, low rates, good growth (admittedly from a low "covid" level). Looking ahead what's the catalyst to get small caps moving?

I think theres a little too much hysteria about inflation at the minute, I myself am firmly in the inflation camp over the next decade as things stand, but it's hard to see big numbers giving the debt levels held by governments. 4% interest rates is often quoted as the line in the sand which stifles growth, I expect this is closer to 2.5% nowadays. I expect a continuation of financial repression with real rates being negative over the next 3-6 months at least as supply chains adjust post covid. Clearly this could be longer if lockdowns happen once again!

My take is supply chains will right themselves unless we have further lockdowns, so perhaps q2(ish) next year we'll start to see more supply and probably a little less demand as post Covid growth splurge dissipates, this is actually disinflationary and does to some extent prove the Fed right. It's hard not to come to the conclusion inflation has been a supply side shock. However, I do think inflation will be sticky and trend higher as it can be difficult to drop prices, particularly with labour costs rising and a stronger US dollar.

So... supply chain worries ease, growth moderates and rate hikes are probably kicked a little further down the road I'd suggest. This could lead to stagflation or low growth and low rates for longer. I'd suggest small caps suffer most in these instances and the TINA trade has further legs (there is no alternative), particularly with bonds offering very little yield.

As always they'll be something else that comes out of the woodwork I guess. Perhaps a one size fits all covid pill, new Covid variant turns out to be a softer mutation and a sign of things to come maybe?

Phil

DaviStoVest

Hi Phil,

"So... supply chain worries ease, growth moderates and rate hikes are
probably kicked a little further down the road I'd suggest. This could
lead to stagflation or low growth and low rates for longer. I'd suggest
small caps suffer most in these instances and the TINA trade has further
legs (there is no alternative), particularly with bonds offering very
little yield."

Good post ... but I don't altogether follow this. Stagflation is rising prices without rising output ... money spinning round the system faster and faster but without any stimulus to actual demand or production. It's running faster but staying stuck absolutley to the spot. Maybe you could expand?

Thinking about this I had a vehicle once* ... perhaps 12 years ago ... with a really dodgy automatic transmission. After you had run a few hard miles and the transmission fluid had got a little 'warm' and lost viscosity it was suicide o'clock. Try to overtake a lorry on a gradient and while the revs go up the torq goes down. I have never been in greater fear for my life.

Stagflation is much like that feeling ... without the immediate horror of meeting a truck coming the other way with brakes on the cusp of failing.

I live in Africa ... the trucks, the failing brakes, the crap transmission oil ... just in a day's work. Stagflation is not my main worry.

For reference*: Hyundai Tucson - but I am sure they are better now.

Dave83

30th Nov '21

Thanks Ed - I think market breadth has been generally poor since Q2 2021, very natural to have choppy quarters after super quarters like we had in 2020... May i ask where you backtest your portfolios?

The Phoenix

Great post Dave its incredible really a bear market in March 2020 lasting weeks stage 1-4 of the business which should normally last years going passing by in eighteen months all be it with Omicron its debatable whether they can now raise rates.

It looks like central banks have given up trying to control inflation partly due to being trapped with galactic sized debts that if they raise rates north of 2% would collapse the entire system.

I was listening to a podcast last friday that mentioned the ECB has raised the level of bonds it can buy to 50% of the total supply which can't be good for the system standing on its own too feet.

timarr

Well, possibly. The other theory is that they're engaging in financial repression - keep interest rates low and let inflation roll and see the debt inflate away. It's exactly what countries did post WW2 and led to a near two decade bull market for equities. The best analogy for current times looks more like the go-go '50s rather than the inflationary '70s.

Whether this is by design or is an unintended consequence of other things is another question, but it means that risky assets are far less risky than non-risky ones. Which is upside down and inside out but who wants to have their money in cash or government bonds right now?

Thanks for the reply Tim you are one of the sharpest posters on here and i always look out for your posts and agree with much of what you post day to day.

I do still think the central banks are trapped as far as raising rates goes but equally don't disagree with you that they won't be entirely unhappy with higher inflation helping reduce the longer term monetary value of the current debts.

I do wonder if at some point there will be a part or full global reset where by the trillions will all be wiped off and they will all start from zero again and be back in the same situation ten - twenty years later.

I also concur until the latest variant reared its ugly head long dated bonds were probably higher risk than equities with minimal yields of 1-4% depending on what you hold government bonds or high yield with downsides of 5-15% depending on redemption term and bond quality.

What I do still find strange is that despite printing money on a scale that makes us look fourth grade the Japanese still can't get the desired inflation they want any thoughts on this is it down to an ageing population not being as willing to spend ?

Regards Andy

Even if Omincron is a problem it will be a short-term one (well, no worse than next summer). We're no longer in the situation we were a year ago when we weren't certain if or when we were going to get treatments. I don't see that equities in general are any more risky now than they were a week or so ago, as long as your horizon is more than a few weeks.

Debt levels, however, are a long term issue. The traditional way of getting them down (given that no major economy has defaulted in a long time) is to inflate the debt away. If that's the case then real assets are the only place to be.

Japan - well, I've no more idea than anyone else. It seems that a deflationary mindset is as hard to shift as an inflationary one - although at some point if the cost of inputs goes up then so must prices. But it seems that it's very hard to artifically generate inflation, which is what they've been trying to do for years - if people expect that prices won't change then they're not under any pressure to buy sooner than they need.

But who knows really? Far better minds than mine have tried to solve that particular problem.

timarr

1st Dec '21

Hi Davi, I should have really added further info. Supply chain worries ease but I still see energy costs higher for longer, i.e cost of goods remain elevated as the west continues to offshore dirty energy and on-shores critical supply chains which are more expensive, whilst global growth levels reduce to pre covid levels.

Thanks, Phil

HHR

4th Dec '21

This is just my view for what it’s worth – I’m not an economist or expert.

In theory governments/central banks “shouldn’t” be able to hold interest rates low and allow inflation to reduce the monetary value of debt.

In theory bond investors “should” be thinking ‘Hang on, you’re asking me to buy a bond which is going to be worth substantially less when it gets redeemed. And you’re offering me a derisory interest rate! I’m out!’.

In theory bond investors voting with their feet “should” force central banks to raise interest rates in order to incentivise investors to take the risk of trying to guess and defeat inflation.

Medium to long term inflation rates are a matter of speculation but we know current inflation rates are way above interest rates. And yet the reality is bond investors are queuing up to buy government bonds with negative real interest rates.

Why is the bond market behaving in this apparently irrational way?

Well, that is obviously the $64 trillion dollar question!

My view is that bond markets have ceased to look at the long, medium, or even short term. All they are looking at is the very short term; QE gives them a one way bet on short term bond prices, thus guaranteeing paper capital gains on bond investments, which in turn guarantees high salaries and bonuses for bond investors.

I don’t think bond investors care a fig if the bonds they are buying will ultimately lose money as long as they make their cut. After all, they aren’t lending their own money. As individuals they will have enough money to hand over the mess to some one else to sort out, if and when the music stops.

I think this apparently irrational behaviour by the bond market is analogous to the apparently irrational behaviour of the banks in the 2008 financial crisis. The theoretical economic assumption was that banks wouldn’t lend money to bad risk borrowers, but the reality turned out to be that they did precisely that in the interests of paper profits and bonuses.

Why aren’t there any dissenting voices in the bond market? Maybe there are, I don’t know as I am not on twitter. May be there are some big players out there who share my analysis. But they know not to “fight the fed”. That means they can only speak out when they have a chance to shift market opinion and defeat the fed. By then it will be too late. I agree with clarea that a ‘global reset’ could be an eventual end game but that could be decades away and it would be a horribly painful and drawn out process.

Many organisations have no choice but to buy government bonds - banks, pension funds, etc:

https://www.nytimes.com/2021/0...

Governments set the rules and large corporations have no choice but to follow them. So if governments decide to engage in financial repression - keeping interest rates low while inflation remains high - they can always legislate to force buying.

And you still have quantitative easing going on, although that will presumably start to taper off soon.

Of course, eventually there must be a reckoning - but that could be years or even decades off. None of this is new:

At the end of World War Two, U.S. short-term rates were pegged at below 1% and the yield on 10-year Treasuries at just over 2%. The Federal Reserve acquired bonds directly from the Department of Treasury. American public debt peaked at 120% of GDP. Deposit rates in the western economies remained negative in real terms for decades. Between 1945 and 1980, this form of financial repression reduced the size of U.S. and UK public debts by nearly 3% of GDP a year, according to Maria Belen Sbrancia, an economist at the International Monetary Fund.

https://www.reuters.com/breaki...

Hello timarr, it’s a good point you make about pensions being obliged to buy government bonds but basically that’s just another reason why the bond market is acting irrationally (in the sense that they are investing in an asset because they have to, rather than because they think it’s a good investment).

As for Maria Belen Sbrancia’s research, when debt to gdp ratio last hit 120% the US had just fought a long and expensive war (a necessity) – that’s not the case today, the debt has been accumulated in trying to avoid the pain of two recessions (a luxury that can, and arguably will be repeated up to the point of catastrophe i.e. I think debt to GDP ratio will continue to grow even when a ‘new normal’ is established).

At the end of WW2 the US faced decades of high GDP growth fueled by population growth and technology. I think it was economic growth, rather than interest rate policy, that enabled taxation and inflation to reduce debt to GDP ratio to manageable levels. This time around I don’t think anyone’s models are predicting high long term growth in GDP for the US.

But that's just my opinion..... always good to test it in public discussion.

gmtrader

Well, that is obviously the $64 trillion dollar question.

Well, that makes me think of the £6 million dollar man from the 70’s. Now that has to be the power of compounding!

5th Dec '21

There were lots of factors involved but I don't think any reputable economist would disagree that financial repression was a significant factor. Even a non-economist such as myself can see that if people or corporations are guaranteed to lose money by investing in the risk free asset then they're likely to seek higher returns elsewhere - or spend their money. That investment then drives future growth.

As for the future - well, who knows what we face? But it's not impossible to imagine another economic boom led by the US. Carlota Perez makes a very good case for this, drawing out the similarities, both economic and political, between current times and those of the mid twentieth century:

https://www.bailliegifford.com...

We'll know in twenty years or so,

timarr

interesting video. Thanks for posting it.

illiswilgig

6th Dec '21

Timarr,

thank you for posting the link - fascinating video. Much better than I expected and gives me plenty to think about. It is not, of course, a prediction of the future - but an intriguing look at the way we tend to evolve our futures through our choices.

cheers

Mark

I'm guessing one of the important things to consider for a lot of investors who use Stockopedia is when will small caps pick up and what will the catalyst be.

Maybe a quick end to Covid, a super pill or something along those lines. Otherwise I'm looking further out to next year, once supply chains ease and thus inflation starts to drop. It'll reach a point where we potentially move back into a deflationary period (granted from a higher water mark), I also think the labour market will start to remobilise, thus lowering wages and increasing unemployment. It's hard to see the FED and other central banks raising rates significantly in this environment. And if they do 2022 will likely be a terrible year for equities.

So we move back into a deflationary environment with lower inflation (but more sticky than the last decade, think on-shoring etc), we'll reach a point where we reenter a low growth environment and things even out. Funds will move out of the TINA trade into the wider market.

Who the heck really knows, right!?

Logical David

"And if they do 2022 will likely be a terrible year for equities".

Hi Philip, the general consensus and prediction amongst the various city bankers & brokers is that the stock market performance next year will range anywhere from -3.7% to +11.7%.

That means, in my simple eyes, there is roughly a 25% chance the market may move downwards next year but there is a 75% chance that the stock market will finish 2022 higher. Either way, it is a big spread which suggests that nobody really knows how the market will perform next year.

David.

lemming1

29th Dec '21

For many wealthy bond investors the most important thing is the avoidance of a large sudden loss like we saw in Feb/Mar 2020 sell off.

I think Brexit may be part of the explanation - it has not been fully implemented yet and its mostly negative economic consequences will be a drag on UK equity valuations for years to come.

Why are many investment portfolios not making profits recently?

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WarrantStar

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