Correction starting?

It was a pretty grim week for the stock markets, especially in the US, with the Nasdaq selling off almost 4%.  My portfolio did relatively well, with larger positions in Amazon and On the Beach and a number of positive trading updates acting as buoyancy against the sell off. I’m more concerned about what’s coming up next. The fact that most of the US fall came late on Friday doesn’t bode well for next week.

There were quite a few trading updates for my portfolio this week. I also made a couple of new purchases earlier in the week. 

I think some sort of short term correction has been on the cards, given the way in which the US markets having been rising without volatility for some time. The catalyst has nominally been signs of rising interest rates and a fall in the bond markets. While rising interest rates are not good for stock valuations, economic conditions beyond this are very positive for corporate profit growth at the moment and businesses are continuing to beat expectations at an exceptional rate. I still don’t think that valuations seem excessive.

Overall, this means I’m still bullish about the stock market and not overly concerned in the medium to long term. However, more immediately I think it is looking possible that we will experience a significant market correction, particularly for US stocks. It could equally well be that the current sell-off is short lived. I’m going to stick to my game plan, only selling shares that hit stop losses, but holding the resulting cash until the clouds clear rather than immediately reinvesting.

I had a few trading updates this week and most were very good. Cranswick, Amazon, Mastercard and Estée Lauder all had very positive updates – on a different week I might have done very well. Alphabet’s trading update was more of a curate’s egg with better than expected top line growth offset by continued growth in traffic acquisition costs and earnings that came in marginally below expectations. Nothing that I think should really be of much concern in the long term, but the market is tough to please at the moment.

I bought two new positions early in the week: I reinvested into long-term favourite Burford Capital and took a new position in Moody’s. I’ve written about Burford before and have held it a number of times so I won’t write about it again. My main reason for buying again is that the news flow has continued to be relentlessly positive and the share price has broken out to new highs after a long period of consolidation for most of the year.

Moody's

Moody’s

Moody’s likely needs little introduction, particularly after gaining notoriety from its role in inadequately assessing credit risks in the run up to the financial crisis. Its business of course is to provide credit ratings and related products and services used by businesses for risk management.

Quality

  • Business economics: Moody’s is a relatively capital-light and profitable business. It has had consistently very high returns on capital and margins, though profitability has dropped substantially in the last couple of years. My understanding is that this is due to a large legal settlement relating to Moody’s role in the financial crisis and to a major acquisition of Bureau van Dijk. I’m happy that both of these are temporary factors and that high profitability should resume shortly.
  • Track record: Moody’s has a very solid track record of increasing revenues and profits since the financial crisis. The share price has steadily risen since about 2010.
  • Competitive advantage: Moody’s is one of a small oligopoly of businesses providing credit ratings. The information Moody’s has accumulated over the years and the need for a consistent credit rating standard gives Moody’s a very solid and enduring competitive advantage. It is the kind of sector that is hard to imagine being disrupted.
  • Growth prospects: Moody’s has good growth prospects as demand for its products and services should increase over time. It got hit pretty hard by the last financial crisis but more generally I would expect it to be fairly defensive.

Pricing

The valuation seems reasonable given the growth prospects and quality of the business. Momentum was excellent, though since my purchase on Monday Moody’s has dropped a bit, in line with the rest of the US markets.

 

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