Market Wrap
With the risk of repeating myself, the month of March saw the market push up, get nervous and then push lower again. One would never like to get ahead of themselves and say that this market is becoming predictable but the simple fact is we can’t seem to find a catalyst to push higher or lower.
This isn’t a problem but the simple fact is, that after enduring a terrible year on equity markets in 2015 we still haven’t bounced back and continue to trade in the lower end of the trading range. With every major pullback since the GFC we have had a V shape recovery but the market seems content to play the waiting game, mind you an erratic one.
The Growth Portfolio
We continue to focus our growth components of the portfolio away from the major stocks.
Our core holdings of A2M, MTS, TNE, SCG and GEM have all performed well throughout the quarter and we continue to monitor these positions with our trailing stops.
We also added a short Dow Jones position as the U.S market has now rallied a massive 14.85% on very low volumes which can indicate a change in trend is near. This coupled with, the index is now technically overbought signalling a shorting opportunity to us so we have taken advantage of this through the use of a warrant.
A2M continues to be strong. We have traded this stock a number of times with extremely good success over the past few months and we still like their business model and growth prospects especially with in the Asian region.
MTS has started to gain some solid traction from brokers as rumours of a merger between Home Timber and Hardware and Mitre 10 start to heat up. The stock has been holding up well in what has otherwise been a relatively weak market so we have no reason to change anything here at present. We have our trailing stop in place and will let the position run its course.
TNE has been a standout market darling over the past couple of years and continues to march to its own beat. The company is debt free and continues to invest in R&D which has been heavily contributing to growth for the organisation.
We have picked up dividends on both SCG and GEM and both stocks have moved back up to our purchase price which so far is a very good result given the volatility we have experienced in recent months.
As we employ strict risk management and exit strategies to all our positions, we are comfortable with how each position is running at present will be looking to add to our portfolio with other standout opportunities in the coming weeks.
Growth Portfolio returns
Income Protected Portfolio
The month of March ended relatively flat after a strong start and a weak finish driven primarily by banking stocks after ANZ released an announcement saying their bad debts were likely to increase by $100 million due to having more exposure to the underperforming resource space than they’d like.
There were no new additions to our income protected portfolio during March so at present we still currently hold CSR, TLS, SYD and CBA, all of which have performed well in what has otherwise been a volatile and relatively shaky market.
We purchased CSR at approx. $2.85 – $2.92 and sold a June dated $3.20 call option to help pay for the put protection at $2.70.
The stock has reached our maximum profit target of $3.20 and is currently trading around the $3.25 level. This is a great start to the trade and ideally from here we will see CSR maintain its value heading into June when the ex-div date arrives.
We’ll be looking to book in an 11% net return on this 4 month trade should CSR be trading at our maximum profit target level of $3.20 come June expiry.
TLS has recovered from paying its dividend in February and is back to our purchase price of around $5.30. We have September dated call and put options on TLS at $6.01 and $5.00 so we want TLS to be trading as close to that $6.01 level as possible.
SYD continues to be strong and outperform the market and technically looks set to break through resistance around $6.75 and move towards new all-time highs. SYD has been a star performer within the ASX200 and has consistently payed out a healthy dividend to shareholders over the past several years making it a very good candidate for the IPS strategy.
CBA paid an increased dividend in February along with TLS and has been one of the better performing bank stocks of late. We have put protection on the stock and call options sold out to September as this ensures we pick up not only the February dividend but also the August dividend as well. CBA has come well off the high it reached last year in March representing far better value around current levels so we are happy to have some exposure to the biggest of the big four around the $75.00 level.
The Options Portfolio
For clients who are trading our options we have seen this add significant value to the portfolio over the last 3 months. Today we are going to focus on the component of volatility and how we use it when we are considering the structure of an option trade.
Volatility typically has an inverse relationship to the stock market in that when the market is falling we see an increase in volatility and when the market is rising we see a decrease in volatility. But the thing with volatility is that it can only go so low before it rises again and it can only go so high before it fall again – in sense it is easier to trade than the actual direction of the stock. Inherently the market has to move so there will always be some level of volatility.
Below is a chart showing the volatility (lower chart) and the XJO(top chart) over the last 18 months. There is one characteristic about this chart that stands out. It spikes before moving lower and repeats itself over and over again. To provide an example of how this effects the value of an option I have identified 4 different points in time where the XJO has the same value – around 5000 – but the XVI (volatility) is significantly different.
At point the market has had a sharp fall and volatility has spiked up above 30%. The price of a 5000 put with 3 months to expiry would be about 285 points. Six weeks later the market has settled down and is still trading at 5000, however the value of the option has fallen from 285 to 135. Of this fall about 30 points is due to time decay, but the majority of the fall 120 points, is due to the fall in volatility.
We see the same thing happen again in February with another spike in volatility up to 30% again, before halving over the space of 5 weeks. This saw the price of 3 month 5000 put fall from 270 to 130.
Budget Insights
There’s a few adages to live by in this game and ‘markets hate confusion’ is as good as any.
Mostly this applies to companies not clarifying their strategy or being inconsistent on message. Sometimes these same faults can be found in governments.
This government could be accused of similar faults, ranging from complex policy regarding clarity on tax reform to simple issues like the date of the Budget, there has been inconsistency of message and no clear policy direction.
However, in our time watching the political game we have always found the bookies the best source of accurate prediction.
Party supplying the next Prime Minister after the next Federal election:
Coalition- $1.20
Labor- $4.50
Keep in mind the above does take into account the effect of a Double Dissolution. It is our belief that with the recent changes to Senate Electoral rules the Double Dissolution is the preferred option, which explains why Parliament was recalled over a relatively unknown piece of legislation soon after the Voting Reform was passed. Should the Coalition wish to push for a ‘DD’ (predicted date July 2) they’d better have something good to take to the voters. Bookies or not, the Coalition are getting beaten on two fronts- the polls due to the reasons outlined above and on backlash from internal and external Liberal voters regarding the leadership spill. Internals are causing grief at pre-selections and externals will cause grief in marginal seats. Should it be re-elected, the Turnbull Government will most probably not carry a significant mandate going forward. Should this be the case expect more Parliamentary negotiation, ongoing Party backlash and the potential for a sixth PM in 10-13 years.
Markets hate confusion.
The Prime Minister doesn’t want to go to a DD. Everyone’s up for reelection including himself and that’s a hassle that could have waited a few months to later in the year. Liberal Senators with years to go before their next preselection would have to go around again and if you’re doing that to your own people you better have something good on the table.
So what will the coalition take to the voters that is so good they’re confident of going to a DD when tied at the polls?
There’s only a small number of people privy to that information but all we can say with any real confidence is this Budget will be a colossal grab for votes. It will be friendly, it will be lenient, it will hope to win an election convincingly. At least that will be the attempt- how the media and the public decide to accept it is a different matter altogether.
Without the ‘Grey Vote’ you can’t win an election so expect beneficial policy movement to aged care, health care and superannuation.
Your Team,
VFS Group
Disclaimer:
This Communication has been prepared by Vertical Capital Markets Pty Ltd (ABN 11 147 186 114 AFS Licence No. 418418) trading as VFS Group (VFS Group).
This Communication is for general information purposes only. It does not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of the information contained in this report, you should consider whether the information is appropriate in light of your particular investment objectives, financial situation or particular needs. You may wish to consult an appropriately qualified professional to advise you. Derivatives can be highly leveraged, carry a high level of risk and are not suitable for all investors. Investors should only invest in such products if they have experience in derivatives and understand the associated risks.
VFS Group and/or entities and persons connected with it may have an interest in the securities the subject of the recommendations set out in this report. In addition, VFS Group and/or its agents will receive brokerage on any transaction involving the relevant securities or derivatives.
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