Reweighting our portfolio
12th March 2018 |
I received this email from a new subscriber and since there are thousands more like him, I thought now was a good time to answer these questions which I believe will be of general interest to everyone who has subscribed.
I joined your newsletter on Monday of this week, and I have been avidly reading as many of the old, as well as current issues and updates as time around work and family will allow. I love your writing style and the personal touch in the issues.
Naturally I can’t wait to tap into your expertise, start investing and making some money, as my history with investing has been very poor to date. I wish I had signed up last year!
I have a few questions if I may, as I want to seek some additional clarification before I put my savings into the markets. Apologies if the questions are stating the obvious, but I don’t want to get off to a bad start.
1. This first question, is a broad question. As you succinctly highlight in your recent video post, the VIX/volatility has increased markedly, and US markets are around all-time highs roughly, and many are reducing equity positions (including Charlie Morris in his whiskey and soda portfolios). Thus, do you think I should invest at this juncture in only the most recent recommendations of yours Agios Pharma, PureTech health, or follow through with the entire portfolio? Or maybe hold off US market shares, and follow through with the UK shares? I am mindful that the months of May to September as some of the worse for shares also.
2. In the portfolio to date. Based on the current share price being below the “buy-up-to” price, the only companies as of now worth investing in are the following is this correct, do you agree?
IBM; Advanced micro devices; Northrup; Science apps; Ormat technologies; Haydale; Smart metering; Zynerba pharma; Terra Tech; Puretech
Even though the momentum is strongly down in Ormat technologies, and smart metering and Zynerba Pharm are trending down, would you suggest being patient and wait for either a holding pattern or upward momentum? Don’t want to catch a falling knife! Or is this a great time to buy at discount? I am happy to be patient, which I have learnt to my cost is important in investing.
3. Northrop has no “buy-up-to” price. Should this be bought as of this now?
4. On your video, you highlight a number of companies in the portfolio as being the “better performers” many of which are now above the buy zone. Would you consider these companies good buys if the markets go into a correction and they fall below your “buy-up-to” price? You were very positive on your video about the future of (e.g. CISCO, Garmin, Microsoft) for example. I guess some of these shares may be held for years maybe….?
5. In terms of portfolio allocation. Can you provide any guidance on a % weight in a portfolio? For example, might “Moonshot” shares being higher risk, buy in the order of 1% of portfolio weight vs. 2-3 % for the others?
I am largely inexperienced in investing and would be very grateful for any clarifications on the above. Many thanks in advance for your time and expertise.
First off, thank you for your kind words. It is enormously gratifying that you enjoy my writing style because I certainly enjoy writing the monthly issue of Frontier Tech Investor.
Let me take your questions in order.
Volatility has indeed been high and I expect it to stay at higher levels than those which prevailed for the last two years. However, since those levels were abnormally low, the condition couldn’t have persisted indefinitely and the ranging environment now present on global stockmarkets is reflecting a digestive period where investors are taking stock.
In fact, that is an object lesson for all of us. We all tend to feel self-reflective after a period of heightened volatility. Our own personal psychology is often a good barometer for what everyone else is feeling. If we feel trepidatious there is a good chance everyone else does too. When a large part of the market feels anxious they are usually not buying and that contributes to a ranging environment.
Likewise, when we occasionally feel like we can do no wrong and everything is going our way, it is a good time to reflect that everyone else feels like that too and has been buying, has big positions and therefore there are fewer people left who do not have positions and want to own some.
A very important point to remember about volatility is that it is calculated as a rolling average of the price of calls and puts on the S&P500 Index. When there is very little volatility, the average price declines so that when you get a big move in the price it has an outsized effect on volatility. The spike to 50 on the VIX Index was a reflection of that explosive effect but a move back to that level is unlikely in the near term.
The video I sent out to subscribers on 5 February, the day that the VIX was surging to new highs, was recorded with the express intention of calming nerves. That was because the kinds of shares that were being most keenly affected by the stockmarket correction are not the kind of shares we hold. That point has been borne out subsequently with a significant minority of shares in the portfolio rallying to new highs.
The technology laden Nasdaq-100 Index is the only major global index that is back at its all-time peak. It has been led higher by companies with a common set of characteristics; they have adopted subscription oriented-business models and/or are the kinds of companies that build machines which build machines.
Subscription business models have been growing in popularity among technology companies since Adobe first explored the concept about five years ago. Historically technology has been a highly cyclical business with each new iteration of the product or software resulting in a surge in sales which subsequently led to declines as sales growth tapered off while support costs rose. The cycle would be repeated with each new product offering and this also put a lot of pressure on companies to come up with a new iteration that was measurably better than the last to justify the additional outlay.
Subscriptions remove that pressure and turn lumpy cash flows into predictable income streams that are easy to model and are generally rewarded by higher multiples. Historically, utilities, cable companies and consumer companies have been valued for the reliability of their cash flows and less for their growth potential. In the technology sector, companies have historically been valued for growth rather than the reliability of their cash flows. Subscription models bridge that dichotomy for the technology sector and helps to explain why it these kinds of companies that have been the first to break higher following the February meltdown. Companies in the Frontier Tech Investor Portfolio that fall into this category are Autodesk, Cisco Systems and Microsoft. All of these shares are long-term holds in my opinion and are best bought when they occasionally pull back towards the trend mean, represented by the 200-day MA. They represent some of the leadership in what remains a powerful technology-led bull market.
The companies that were most susceptible to the pullback in February are those which occupied large weightings in ETFs. There is no doubt that the mega-cap technology shares like Amazon, Apple and Alphabet fall into that category but of these shares it is only Amazon and Microsoft which has surged to new highs since and both fall into the subscription business model category.
So next, how do you buy and how should you pick from the list of shares I have recommended?
I want you to make money and the best way to do that is by buying at the right time and by being disciplined. Choosing what to buy it half the job, making sure you manage the position responsibly will ensure you have the best chance of making consistent profits.
I strongly suggest starting slowly and only investing money you and your family are comfortable to have locked up for some time and that could fall as well as rise. Please take the time to think about how much you are willing to lose before you ever buy anything. That is the only way you will ensure you will not end up buying too much of something. If you buy too little, that can be corrected later but if you buy too much and things do not go as planned then you have a problem.
Next, I know that many people have limitations on what they can buy through whatever ISA they have so that may limit them to buying UK shares. However, I would not allow volatility on the US market deter me, not least because of what I call the Wall Street leash effect. The simple fact of the matter is the USA is by far the world’s largest capital market and what happens there seldom remains an isolated incident.
Next you mention seasonality. In one of my other services, Reflex Trader, I have specific strategies to trade on seasonality. In general terms, the fourth and first quarters are by far the most favourable for stockmarkets. The second and third are generally the worst performers because there is often a summer swoon and some of the worst drawdowns in history have tended to happen in September and early October. That latter point tends to skew the averages because the late in the third quarter weakness which often occurs tends to flatter the performance of the fourth quarter because there is more scope for a rebound.
With those considerations under our belts, then we have to think about what the risk of a drawdown is? I have updated all of the buy-up-to prices on the website so you will see at which point I believe it is inadvisable to either open or add to a position.
For example, I have raised the buy-up-to price on 2U Inc. which is our best performing position at a gain of 164% at the time of writing. However, that new price is still below where the share is trading today because it is due a consolidation. I placed the buy-up-to price at $80 because I think it is likely that we are about to see a pullback of approximately $10.
I’ve also raised the buy-up-to price on Editas but again it is below the current price. As anyone who has held the share since I recommended it in March 2017 will know, this is a volatile share. It is prone to sharp pullbacks each one of those reactions has been a favourable buying opportunity over the course of the last 12 months.
Agios Pharmaceuticals is my most recent recommendation and I believe it is a buy now.
PureTech is currently ranging in the region of its post IPO peak so and it could pull back by approximately 10p from the current level and that would be an ideal entry point, if in fact it does pull back.
I have raised the buy-up-to prices for Microsoft, Cisco Systems, Northrup Grumman, Orocobre, Abcam, Autodesk, Agios Pharmaceuticals, Garmin and Illumina because I believe they are all at favourable entry levels right now.
I did not change the buy-up-to levels on Cyberdyne, Alkane Resources, Advanced Micro Devices, Haydale, IBM, Sherritt International or SAIC so you can conclude that I continue to rate all of these shares a buy.
Smart Metering is back at testing the 700p level and this is a key area for it to demonstrate support. If you have a position already I’d be looking for the share to rally from here and if you are waiting to invest I would probably wait for at least some evidence that demand is returning in this area.
Haydale With Ormat Technologies, it has pulled back sharply over the course of the last two weeks on weaker than expected earnings as well as a somewhat less rosy outlook for the coming year. However, it is deeply oversold and there is the beginnings of evidence that support is being found but it is too early to say just yet if this is a meaningful low. I continue to think Ormat is a wonderful avenue to invest in the geothermal sector but right now the utility sector is under pressure because interest rates are rising and the sector is often considered a bond proxy which suffers in a such an environment, at least until its yield becomes more competitive with bonds.
As for both TerraTech and Zynerba, they are both suffering from the Trump administration’s antipathy towards the cannabis sector. Until that attitude changes they may have a difficult time fulfilling their potential so I would wait until I see evidence of support building before initiating a long position.
SolarWindow has been moved to a hold because the USA’s Securities Exchange Commission has moved it on to the Pink Sheets which is reserved for high risk companies. Hargreaves Lansdown is no longer making a market in the share and that is proving problematic for some subscribers.
That brings me to the question of how to weight investments. Charlie runs his portfolio as a weighted whole. My recommendations are based on how to access certain themes, all of which I believe in equally. However, with the moonshot positions we are very clearly taking bets on what the distant future could hold. They are inherently more high risk because the potential risk and reward is higher. They could literally hit the moon but there is also a risk they could fail completely. That is something you need to take into account when you size the position. Microsoft for example might decline but is would be highly unusual for the share to half. On the other hand, the risk of being down 50% on a moonshot. and the medium to long-term outlook still being fine, is to be expected. You need to size your position accordingly.
There are currently 22 positions in the portfolio. I will sell when I believe the theme has fulfilled its potential or the investment was clearly wrong. I am not willing to make that call on cannabis at this point in time because the reason PRTC and Zynerba are underperforming is for one specific political reason and that could all change by the stroke of a pen.
If you equally size your positions you are not leaving any room for additional new entries. Rather than put your full sum to work immediately, I believe a cost averaging basis is best. Start off with those I have identified above with small positions and add to your winners when they experience occasional consolidations, but do not pay above the buy up to price I have identified. As you gradually add to your positions, you will have a portfolio that has been accumulated at reasonably favourable levels and that should also help to contain your risk. Again, always think about the maximum drawdown you are willing to endure before you decide to increase a position.
There is nothing I enjoy more than meeting my subscribers and hearing first-hand what they think of my letters. It was a great pleasure to meet many of you at the War on You conference last year and I’m sure you remember that I promised I would reach out when I believe the time to move to cash arrives. I do not believe we are there yet. However, we are certainly in a maturing market environment. Bond yields and technology cannot rally concurrently indefinitely. At the same time there is also the real possibility that technology is entering a mania phase and if that does in fact occur, then this is definitely not the time to liquidate one’s portfolio. I have a list of indicators I monitor on a daily basis and when I see warning lights flash that is when I will take action on the macro front, but not before.
Technology is in a secular bull market which means very long-term. Any bull market will be punctuated by recessions along the way. Investors have been conditioned to expect crashes because that is what our experience has been since 2000. However, it is worth remembering that the pace of technological innovation is independent of the financial cycle and that when we next get a recession it will offer a once-in-a-decade buying opportunity. I am compiling a shopping list for that eventuality too which I will share when the time is right.
I apologise for the length of this reply which covered a lot of points, but I think it was necessary to answer these questions in a forthright manner because I believe they will be of value to all subscribers not least as we enter what is sure to be a very interesting period for markets and the technology sector in particular.
Regards,
Eoin Treacy
Investment Director, Frontier Tech Investor
