I’m writing this portfolio review off the back of a pretty horrendous week for my portfolio. The markets have been weak all round and I’m sure many investors will have suffered losses, but with my focus on high quality growth stocks I’ve been hit particularly hard. It’s the worse week I’ve had in quite a few years. At times like these I think it’s important to accept your losses rather than regret them and to look forward to the opportunities and risks ahead. This review gives me the opportunity to take a step back from the carnage and focus on ensuring my portfolio and strategy are well-equipped for what might be coming next.    

A strategy like mine that focuses on quality growth businesses has the weakness that when valuations are high and panic sets in you can get hit particularly hard. Fear can make investors very reluctant to pay up for uncertain growth. Most of the time this sort of panic and ensuing volatility proves to be fairly short lived. This has been the case during the course of the current bull market we have enjoyed since the Financial Crisis. Most recently, recovery from the correction in February this year was relatively swift and many of the quality stocks on my watchlist went on to make new highs since then. More severe and prolonged market crashes are pretty rare as I discussed in this post. However, when they do occur ideally you don’t want to be fully invested in growth stocks if you can help it! The bursting of the dot.com bubble is a good case in point where from the peak it took stock markets about three years to recover.

So what is behind the current panic? It would be overly simplistic to try to attribute it to a single factor but the main underlying story is that US interest rates are rising and look set to continue to rise in the context of a tight labour market and in anticipation of future inflation. This triggered a sell off in the US government bond market last week and has raised concerns that equity valuations may be too expensive given we may be nearing the end of the economic cycle. To some extent I think these are legitimate concerns, in that these are the basic elements of a story that could lead to the next major bear market. However, given current valuations and interest rates do not seem excessively high to me, the concerns feel a little premature.

That said, the recent market action suggests that we could continue to experience more weakness, particularly for growth stocks. This has the potential to become pretty unpleasant. I expect that it will not take very long to recover from, but really it’s anybody’s guess what will happen over the next few months. I’ve resolved to ride out the volatility rather than attempt to take cash out or time the market.

Performance

The performance of my portfolio (QSS) is shown against its benchmarks in the table below (all the figures below exclude dividends). My benchmarks as the FTSE 100 and a portfolio of the top decile of UK shares according to their Stockranks.

Ouch! As you can see, performance over the last month has been pretty horrible with my portfolio falling significantly further than the FTSE100 and Stockranks benchmarks. I’m pretty much back to where I was a year ago, which is not great but then not a disaster either. Over the longer term, I’m still well ahead of the benchmarks.

I also run a ‘buy and hold’ benchmark portfolio which holds all the shares on my watchlist with equal weighting and several mechanical momentum benchmark portfolios described in more detail here. Unfortunately, I’m still having technical issues with these portfolios that mean while I can see their total value, I am unable to track their performance over time – at least not without a lot of effort reformatting data that I don’t have the inclination to do at the moment. These benchmarks have actually done marginally worse than my portfolio recently, confirming that it is my strategy rather than stock-picking that is currently being punished.

Given my shift to periodic rotation rather than stop losses, the ‘trading stats’ I’ve done in previous portfolios reviews no longer match how I’m thinking about my strategy. So I’ve decided to stop presenting them.

Strategy review

Prior to last week, I was feeling pretty happy that my strategy was becoming more clear and settled after I decided to limit my activity to trading only once every couple of weeks, rather than worrying about when to apply stop losses. It’s Sod’s Law that this epiphany seems to have come at pretty much exactly the wrong time, as stop losses could have saved me quite a bit of money this week. However, apart from the timing I don’t actually regret this decision. Had I been using stop losses I would have either ended up selling pretty much my whole portfolio or would have had some tricky decisions about what to keep. I would only have saved myself from some of the losses and would now face the very material risk of missing out on any bounce that occurs. While the short term losses are painful, I think riding out volatility rather than agonising over when and what to sell seems like a safer and less stressful option. The one thing I need is confidence that my strategy will work over the long run and thankfully I still have this.

As an aside, I think I should point out here that I think my strategy does carry a significant risk that I suffer a prolonged period of underperformance. By focusing on great businesses I’m unlikely to permanently lose much capital. However, valuations can sometimes get ahead of themselves and then spend a long time reverting (as in the dot.com crash). I am comfortable with this risk as I am fairly young and have a reasonably well paid permanent job. If I didn’t I would probably be more diversified into different types of investment.

In the immediate future, when choosing what to buy I think it makes sense to focus a bit less on price momentum and a bit more on valuation, recent positive newsflow and my conviction in long term quality. While I don’t think a short term correction is necessarily a reason for momentum to stop working, the higher momentum shares could be at greater risk of falling further if market weakness continues. As I am resolved to remain fully invested through the volatility, I want to be holding stocks where I have the most confidence that any weakness would be temporary. As most stocks on my watchlist seem to have been hit fairly indiscriminately, there are also some opportunities to rotate into some relatively higher conviction investments at temporarily discounted prices. Given the circumstances seem fairly exceptional, I decided to make an exceptional decision on Friday to carry out a couple of additional trades to take advantage of these opportunities. I’ll update on them next week.