2022 – Half Year Review

Six months into 2022 and like most private investors I’m finding the markets increasingly challenging to handle. After 2021’s fantastic returns of 24% my portfolio is currently down around 10% year-to-date. That gives me a truly wonderful feeling considering inflation is running at 10% – meaning that I’ve effectively lost all my gains from last year. Unlike 2020’s sudden market collapse and rally, this year’s bear market feels much more like death by a thousand cuts.

I’ve had dozens of days where my portfolio has been down 2, 3, or even 4% in a single drop, which is usually gradually reversed over a week or so, only for the process to repeat all over again the following week. Any positive momentum has usually lasted a matter of days before reversing.

My overriding feeling has been one of sheer frustration; prices are skyrocketing around the world and central banks seem to be doing pretty much nothing beyond nudging interest rates up at a glacial pace. Supply chains continue to be stretched thin by the war in Ukraine, we have the hangover from COVID, and now a rising tide of strikes here in the UK as overworked, underpaid workers finally snap from the pressures being heaped on them by an increasingly dysfunctional economy.

Looking forward, I fear the only way to get the inflation genie back in the bottle will be to tip economies into a recession. Collapse demand significantly enough and companies will be forced to reign in price rises to attract a shrinking pool of customers. The risk then, of course, becomes something called deflation where prices persistently fall as customers hold off making purchases on the expectation that they will be asked to pay less in the future for the same thing. Established economic theory is that this is a terrible thing for the economy;

  1. Businesses have less revenue and less profit, so lay off staff to compensate.
  2. The unemployed staff then reduce expenditure to compensate for their loss of income, further reducing demand.
  3. Businesses then have even less demand for their goods and services, need even less staff to provide those, and so lay off even more staff in response.

Although I understand the principle of this fear, many of the people espousing it are the same ones that tried to tell me that globalisation was an indisputably wonderful thing, that endlessly printed money was never going to cause inflation and that outsourcing more and more of the UK’s manufacturing, farming and engineering was good for us. Needless to say, I’m not so convinced.

My concern is more that productivity is the UK is so weak and actually declining as the decades tick by. It’s all fine that we’re all using Microsoft software, buying Apple and Samsung phones, being driven around in Ubers…but where are the UK powerhouse success stories?

Business investment has flatlined since the Brexit vote six years ago. Businesses seem to be struggling to export and are facing significant skills shortages and logistical challenges to boot. We’ve got inflation through the roof, a political infrastructure that seems to be predominantly interested in squabbles and name-calling over intellectual rigour, and yet another PM that seems to be barely hanging onto power.

I can’t pretend to know what the solution is. It’s easy to throw stones and complain but I simply have a feeling that the UK economy is struggling to gain meaningful traction when faced with a sea of challenges to overcome. With that in mind, let’s turn to my own performance, which is hardly much better!

H1 2022

I entered 2022 with real concerns about my performance having struggled with a lacklustre end to 2021 that took the shine off an unexpected momentum-driven bounce from the COVID crash. By the time we entered March I was beginning to feel real concerns as multiple positions went into reverse and I started giving gains back to the market.

This feeling intensified as interest rates began to creep up and markets really started to panic. By the time April rolled in, the initial trails of smoke from my portfolio had become full-blown fires with multiple positions underwater 20% or more and little positive momentum across the board.

My strategy during these periods is to hold tight and be cautious. I’ve spent the first six months of the year arguing with bullish investors telling me that I’m an idiot for not ‘buying the dip’ as they point out company after company that have, without exception, all been available cheaper after they were flagged. At one point, I was even told that markets had ‘priced in’ future interest rises and that I really ought to get buying before the market took off without me. I’m thrilled that some people are feeling so confident; feel free to come back and tell me how you’re doing with some of those picks!

This caution doesn’t mean I haven’t also been active though. I’ve picked up a few new positions (Darktrace, Michelmersh Brick Holdings, Hargreaves Lansdown, NCC Group, Poolbeg Pharma, Vistry, and S4 Capital) and sold out of others (Augmentum Fintech, Aquila Energy Efficiency Trust, SDCL Energy Efficiency Income Trust, Pan African Finance, Supermarket REIT, and Begbies Traynor).

The decision to sell Begbies wasn’t the easiest – when I bought the company, it was sat squarely at the ‘value’ end of the market, with a low P/E and high yield but as the months went by and the share price ticked up. Unfortunately, their underlying performance didn’t keep up and the company became more and more highly valued but with poor fundamentals including extremely weak ROE (sub 1%), slim operating margins (single digits) and a propensity for share issuance (around 5% per annum).

This combination wasn’t one I was thrilled about, and so despite the company feeling like it was in a good spot, I just couldn’t justify continued holding and so gradually sold down my position. Whether I buy back in in the future remains to be seen, but for now I continue to debate the merits of holding it vs. its market price.

The remainder of my sales were generally well executed, allowing me to capture gains close to their all-time highs (or at least limit losses). One mistake I’ve been guilty of in the past is taking profits too early, watching the share price continue to climb as I sit on the side-line. This year, I feel much less ‘regret’ about the positions I’ve sold out of, with nearly 100% of my sales from the last 18 months being significantly lower today than when I sold them. Of course, that’s an easy shout in the middle of a market rout – again, I’m not against repurchasing some of these positions in future as by and large I think they’re reasonably solid companies.

What a time to be buying growth

Unusually for me, the purchases are all, with the exception of Michelmersh and Vistry, tilted more towards long-term growth potential; a decision which in hindsight I could have timed better in the market cycle but which I’m happy to hold for a few years in the ‘odds and ends’ section of my portfolio.

Buying companies such as Darktrace and S4 Capital earlier this year possibly hasn’t been among the shrewdest investing decisions I’ve ever made but I like the businesses and have sized my allocation towards the bottom quarter of my portfolio. This means that despite some truly eye-watering performance, the overall damage has been limited – if I’d oversized the positions I’m almost certain that I’d be feeling a lot less calm and collected.

Despite this sanguine outlook, I can confirm that without exception, absolutely every purchase I have made in the last six months is now well underwater on my initial price. One or two positions I could handle, but for every purchase within six months to go the wrong way has given me cause to really sit up and pay attention. This is no time to be phoning in the due diligence.

2022 – The Next Six Months

Looking forward to the second half of the year, I feel a cautious resignation that markets are likely to continue chopping and sliding for the foreseeable future. Unlike some investors, I feel as though the global economy could be facing a persistent and highly damaging period of structural decline as inflation fundamentally reshapes consumer habits and permanently collapses demand in some parts of the economy.

I question what the future looks like for cinemas and restaurants, high street shops and airlines when prices are sky-high and quality is, on average, extremely mediocre. What next for employment, as more and more sectors go on strike? Will employers finally give up funding offices and attempt to outsource more and more functions overseas?

I don’t know the answer to these questions; I’m not an economic or social forecaster but the uncertainty present in my own mind is making it increasingly difficult to have confidence in my portfolio management abilities. Of course, six months does not make a lifetime – my time horizon is decades, not years – but I wonder how I will grow my portfolio’s value if the current economic conditions persistent throughout the 2020s.

One thing I am more certain of is that I am incredibly grateful for my long-standing focus on income producing equities over growth equities. During this period of market turbulence, I have found it far easier to withstand market volatility knowing that my portfolio is generating an income independent of equity price movements. Despite capital volatility on paper, the underlying companies I hold have broadly continued to perform well and their regular payment of dividends has given me some benefit despite the wildly fluctuating valuations provided by the market.

By comparison, I am certain that I wouldn’t be so patient if I had a portfolio packed full of companies with sub 1% yields or that didn’t pay a dividend at all. This decision has been one that has raised eyebrows from more than one fellow investor over the last few years – after all, with decades to invest and a full-time job to pay the bills, why am I bothered about income?

The last six months have given me a cast-iron response to this question. I focus on the income generating potential of my portfolio for a variety of reasons but one of the main benefits is that when markets rout, my income remains, and that benefits gives me something positive to focus on even when the market feels like it’s on fire and applying every last ounce of pressure to make me sell things.

I think it’s also helpful at times like this to remind ourselves why we’re investing. If the goal is simply to amass an unspecified pot of money, by an unspecified date, to do an unspecified thing, then the last six months have probably made you wonder why you’re bothering.

Personally, I come back to the income aspect of my portfolio. I have multiple ‘pots’ of money; some for current expenditure, some for my retirement many decades away, some for short-term goals, and some, like my actively managed portfolio, to generate an income that supplements my lifestyle.

Investing for the long-term means exactly that; long-term. If you’ve found the last six months uncomfortable, I wouldn’t blame you for a second but instead would encourage you to take a step back and look at your long-term strategy and goals. Remember why you’re investing, take a deep breath, and step back up to the plate. You’ve got to be in the game to win it!

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