Sometimes It Pays To Do Nothing

Since my last blog, I’ve kept quiet, because for the last few weeks, my view has barely changed. I’ve been banging on for months now about buying cheap, unloved equities and this has been a trade that has paid off beautifully, with many doubling or even tripling in value. You can check back to previous posts to have a look at what I bought and how they’ve done since I went in. My methog has been to trade like a value investor - look for opportunities to go long on stocks which I think have been mispriced and where there’s considerable potential for upside. I like trading low priced stocks ‘cos you can get plenty of bang for your buck, and you can judge how far they can fall more easily - hence some excellent winners such as Pendragon (PDG.L) (from 2.9p to 24p - 700%), Rightmove (RMV.L) (from 150p to 340p), and Ferrexpo (FXPO.L) (from under 50p to 140p).

So rather than doing loads of in and out day trades, I’ve been letting my positions run, and adding to them as the trend becomes more apparent. And I’ve just been moving stops up to protect profits and not worrying too much about if and when they get triggered. It’s been good to do as little as possible and let those longs run.

Riding The Dash For Trash

There’s been a sharp rebound in debt-laden equities like Taylor Wimpey (TW.L), Barratt Developments (BDEV.L), Debenhams (DED.L) and JJB Sports (JJB.L) - classic ‘cyclical’ stocks. Buying stocks like this has been rather unkindly labeled by some commentators as a dash for trash. Previously they were ‘priced to fail’. Now it looks like they’ll survive in some form or other, either by restructuring their borrowing or by issuing new shares to raise capital - rights issues and debt-for-equity swaps. They can bounce back quickly because of ’short squeezes’ where hedgies and big corporates who were short get forced to buy back stock to cover their position. Hence the violent upswings that we’ve seen in some of the banks and retailers. So I’ve ridden those out reasonably well and am still holding a bit of Taylor Wimpey and some REITs.

My two favourites are Workspace Group (WKP.L) and Quintain Estates and Development, partly ‘cos they’re involved in lots of public-private partnerships and urban regeneration schemes, which to some extent are protected from the ravages of the recession by government subsidy. They’re also Olympics-friendly stocks, with a concentration of properties in East London and around Wembley. So I’m sticking with them for now and I’ve stuck a few retailers and an airline into my ISA - Marks and Spencer (MKS.L), Game, Sainsburys (SBRY.L), Morrison (MRWA.L), Kingfisher (KGF.L) and BA. I’m planning to hold them for the longer term because I think if and when recovery comes they’ll rebound further and faster. But I’ve sold out of Debenhams - again, perhaps too soon.

To get these sort of winners you need to be patient, and be prepared to sit out the inevitable volatility. So be disciplined with stops.

But Now It Gets Tricky…

However, for the last week I’ve been a lot more cautious, such has been the scale of the rally in a lot of the stocks I bought into. I’m reviewing my approach from being out-and-out bullish to more neutral, although I’ve haven’t taken profits on all of the long trades I’ve been accumulating. I’ve kept some of those ‘value stocks’ in play, but I’m also been looking for opportunties to go short, particularly in financial stocks which look overbought. I’ve had some fun shorting Lloyds (LLOY.L), American Express (NYSE:AXP) and Capital One (NYSE:COF) over the last couple of days.

Now I’m looking ahead to try to anticipate what is to come over the next month or two. There’s a basic choice to be made: long some sort of recovery or look for the next leg down. The indicators are mixed. That’s why the market is wavering. We’ll need a proper trigger for a substantial selloff, it seems.

Perhaps I’m oversimplifying. Its certainly paid off to trade long in the past month, but I’m now having some doubts, especially with indicators like the number of idle ships and trains suggesting that trade is still deeply depressed across the planet.

Themes To Think About

The Government momentum trade, elequently described by Meredith Whitney, seems to have driven the banks up. I fitfully rode Bank of America (NYSE:BAC), Citigroup (NYSE:C) and even the near-bust bond insurer Ambac up, but I’m out of them for now. I’ll probably go back in if the rally resumes. She’s saying that the banks are benefiting massively from cheap money, without which, most of them would be bust. This means that it’s almost impossible to value them fairly.

Another hot topic is rights issues. How long will investors tolerate endless cash calls and equity dilution? The flipside of investing in dodgy ‘value’ plays is that they tend to get somewhat diluted. I’m wondering how long it will be before Pendragon, my out and out success story in the ‘trash stocks’ stakes decides it wants a rights issue too, and so, I’m considering selling out of that position.

Another long standing issue is inflation. I’m finding it hard to be an inflation bull although there are some signs that a weaker dollar is pushing up the price of oil and gold. But oil inventories are still at all time highs and demand is muted. The only place I can see inflationary pressure coming from is quantitative easing. How much of this ‘new’ cash is working through to the real economy? Mervyn King seems to think that not enough is. Here’s an interesting chart which shows the ratio of liabilities to income faced by the U.S. consumer. As unemployment bites, consumers will look to pay down debts. The pool of individuals and businesses that banks are willing to lend to will shrink as they tighten their attitude to lending risk. That in turn takes more cash out of circulation. We could be seeing the temporary effect of ‘fiscal stimulus’ - temporary tax cuts and household income top-ups - but that’ll wear off pretty fast.

Combine that with the increase in household savings rates in the US and the UK and it’s hard to see where the inflationary pressure is coming from. I’m pretty persuaded by the Accrued Interest blog argument, and that’s why I can’t really explain why gold is going up, except that there is still uncertainty and anxiety about inflation and whether the equity rally will hold.

On the other hand, folk seem to be going out and spending the money they’re saving on their mortgages. There could be a bit of inflationary pressure there. But not much in my view. Wages are going to be pretty stagnant, especially with rising taxation. Jobs are still scarce. Property prices aren’t really rising. So there’s a real squeeze on available cash. Deleveraging isn’t over.

Is This A Real Recovery?

Well, what is a real recovery anyway? The market works on nods, winks, whispers and rumours - a hint of recovery, signs that even if the data isn’t great, it’s not getting worse. If Meredith is right, we could yet get the mother of all selloffs which we have to be prepared for. Other commentators are happy to concede that at least a temporary bottom is in, but it’s easier to imagine a sideways market than a full blown bullrun at this stage. I don’t mind either way so long as more often than not I’m on the right side of the trade. Judging that is tricky.

Sometimes it pays to do nothing - other times it pays to be very fast to cut and run. Right now, I’m preparing for a pullback in equities which could easily accelerate further. So I’m keeping some speculative long positions open but keep trying to add FTSE shorts (none of which, incidentally, have worked very well), mainly on the view that commodity prices have risen too fast and the banks look overvalued. I’m also looking to go back in on a short gold and long USD trade when the moment comes. But it doesn’t seem to be quite yet. My favourite leading indicators, the yen crosses (EURJPY and AUDJPY in particular), have fallen off in the last 24 hours and that could be a sign of further weakness in equities.

Subscribe by RSS Subscribe by Email