Most weeks I try and bring readers some potential warning signs of over-exuberance. For the record, I don’t expect a big correction in the next six months, but I do think it’s going to become progressively harder to make money in this market. Some contrarian bets may pay off, but the headwinds are growing and I’m quietly taking some profits, so I can have a bit more cash to play with at the right moment. Today, for instance, I sold down half my holding in Syncona, which has doubled in price since I bought it. I still think it is a great success story and I am very happy to be a long-term holder of the other 50% of my holding – it’s just that I think I might want a bit more cash. My plan is to get to 25% cash by the end of the calendar year.

I’m cautious because more and more signals are flashing amber, if not red. Take corporate debt. Andrew Lapthorne over at SocGen has been banging on for an age about fast-rising US corporate debt levels. And, of course, US investors have taken no notice. Share prices have headed onwards and upwards.

I’d presumed that UK corporates were more immune to this debt binge but a report out today from Link Asset Services suggests otherwise. Their UK plc Debt Monitor report reveals that:

  • UK plc debts hit an all-time high of £390.7bn
  • This is up 69% since the debt low point in 2010/11, an increase of £159.6bn
  • Most of this increase (£122.6bn) has been in the last three years, helping fund dividends of £263bn at a time of low profitability for UK plc
  • Oil borrowings have risen fastest, though the debt burden of oil companies is relatively low
  • BAT is the UK’s most indebted company; Persimmon has the most cash
  • A high value of debt need not mean the debt burden is high – the debt/equity ratio helps solve the puzzle
  • UK plc’s debt burden is in decline after a post-crisis peak in 2015/16

Here’s Link’s summary – “after years of rock-bottom interest rates, the debts of the UK’s listed companies have soared to a record high of £390.7bn, easily surpassing pre-crisis levels, according to the new annual Link Asset Services UK plc Debt Monitor. In the vice of the credit crunch, companies had cut their borrowings by a fifth in just two years. But since the low point in 2010/11 net debt has jumped by a staggering £159.6bn. Moreover, most of this increase (£122.6bn) has been in the last three years alone. Over the same three-year period UK companies have paid their shareholders £263bn in dividends, despite profitability being squeezed and dividend cover levels (the relationship between profits and dividends) falling to record lows in 2016/17, before recovering this year. Faced with the demand from shareholders to continue their payouts and needing also to invest in new assets and acquisitions, companies had to increase their borrowings significantly.”

Who said that share buybacks were a positive idea? drowning in debt, corporates are taking on more loans to increase dividend payouts. What could possibly go wrong?

Factor Olympics

Moving on to smart beta and factor investing, the latest roundup of first half 2018 numbers have just come through from the Nicolas Rabener at FactorResearch.

You can see the full report online at-

The bottom line? The first half of 2018 is pretty much following directly in the path of 2017.  The Size factor has 2taken the lead, likely reflecting the threat of global trade wars” whereas “value has generated the most negative returns across regions”.  The chart below shows the performance of seven well-known factors on an annual basis for the last 10 years and the first half of 2018. The global series is comprised of all developed markets in Asia, Europe and the US. 

According to Rabiner “the first half of 2018 shows largely a continuation of 2017, i.e. Growth, Momentum and Quality generated positive returns while Value and Dividend Yield were negative. The Size factor generated the strongest returns in Q2 as the performance was flat in Q1 and has taken performance leadership since then. The strong performance of small caps can likely be explained by the threat of global trade wars, which are based on policy changes of the US government. Investors anticipate that smaller companies will be less negatively impacted by trade tariffs than larger companies.”

CHART showing varying returns for different factors, globally – source Factor Research

As for methodology, Factor Research observes that “The factors are created by constructing long-short beta-neutral portfolios of the top and bottom 10% of stocks in the US, Europe and Japan and 20% in smaller markets. Only stocks with a minimum market capitalisation of $1 billion are included. Portfolios rebalance monthly and transactions incur 10 basis points of costs.”