Come on Santa!

While I’m not too worried about the impact that the Brexit outcome might have on my portfolio, it is making my job more ‘interesting’. The result is that I haven’t had much time for blogging and now have two trades to update on: two weeks ago I bought back into Keywords Studios and this week I bought some shares in Diploma.

I was excited last Monday on discovering that both of the catalysts I’d been hoping might trigger a stock market rally had come to fruition. On Wednesday 28 November Fed Chairman Jerome Powell indicated that the Fed may stop hiking interest rates sooner than anticipated. Over that weekend followed news that the US would delay its China tariff increase. Of course, this was not a complete resolution of the trade war, but it did suggest some progress in negotiations was being made and a favourable outcome may be more likely. It looked at the time that this would be enough to get the traditional Santa Rally going.

However, the stock market has remained volatile since then. Those catalysts were insufficient to allay the fears that seem to be building of an impending US (or global) slowdown. On top of that the dreaded ‘inverted yield curve’ has reared its ugly head, souring sentiment further. The yield curve has flattened and temporarily partially inverted on the 4th December. Many investors will be worried as inversion in the yield curve has historically been a fairly reliable indicator of an upcoming recession in the next few years.

Should the yield curve be a cause of concern at the moment? Perhaps, but while I’m not sure I understand it fully, the logic seems a little convoluted and indirect. The main point in my mind is that historic yield curve inversions seem to have largely arisen in periods where the central bank has raised interest rates to deal with an overheating economy and anticipated inflation. This has consequently been accompanied by expectations that a slowdown and lowering of interest rates would occur in the not too distant future. The combination of high interest rates now but expectations that they would fall again in the future can lead to the unusual situation where it is rational to price longer term bonds higher (so with lower yield) than short term bonds. This doesn’t seem to fit well with the current situation where interest rates are being normalised from historically low levels. The Fed is already signalling that it is likely to pause interest rate hikes, inflation doesn’t seem a major concern and otherwise the US economy seems to be in decent health, so the inference that a recession is impending seems less strong. Aswath Damodaran has written an interesting recent post taking an empirical perspective on how well the yield curve predicts recessions.

While the volatility feels pretty gut-wrenching, the markets haven’t really fallen that far (yet). My portfolio has yo-yo’d up and down since its initial steep decline at the beginning of October, but is still at roughly the same level. It feels like we are now at a crossroads with a wide range of short term outcomes possible. Sentiment is currently exceptionally bearish and funds are being taken out of the stock market at a rapid rate. This could be a bullish sign that we are nearing a point of capitulation from which the market will rebound. Alternatively we could be gearing up for another next leg down of more panicked selling. I’m still hoping for a last minute Santa rally but not counting on it.

On to my trades…

I bought a position in Keywords Studios two weeks ago. I’ve held Keywords previously and written on it here. I made the fairly unusual decision to buy it despite very weak momentum – the share price has fallen by almost 50% from its highs. Given the current volatility I’m trying to mix up my approach a bit. Keywords seems to be trading well with no obvious concerns so the discounted valuation seemed too compelling to ignore. Sentiment to the computer games sector as a whole is poor at the moment. Shares of big US developers such as Take-Two Interactive and Activision Blizzard have also fallen a lot. The precise reasons for this elude me but it seems likely that it is overdone.

This week I bought shares in Diploma. I have held before and written about it previously here. Diploma owns a broad group of businesses supplying various specialised technical industrial products. One of the things I like about it is that an explicit part of its strategy is to focus on supplying defensive markets with consumable products (so purchased are repeated). Its long term track record is excellent and supports that it has these defensive characteristics. Momentum here is relatively good. Diploma issued some good results in November and while the share price has dropped back since then the long term uptrend is intact.


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