What caught my eye this week.

The granddaddy of peer-to-peer (P2P) lending, Zopa, has thrown in the towel on P2P altogether.

According to the company:

…over the last few years, customer trust in P2P investing has been damaged by a small number of businesses whose approach led to material losses for retail investors.

Linked to this, the changing regulation which followed raised the operational costs of running a P2P business, as well as the cost of attracting new investors to the Zopa platform.

To offset these increased costs and ensure we have a sustainable and profitable business, we’d need to reduce investor returns to a point where they’d no longer be attractive and commensurate with the risk that investors take on.

For these reasons, we have decided to fully focus our attention on our Bank.

I think the writing has been on the wall ever since Zopa became a bank in 2020.

If you’re trying to overthrow the established order, you don’t typically pursue all the conventional trappings to make progress.

Zopa had a good run. The bank says that over 16 years – and despite two financial crisis – the average return to its borrowers was 5%. Even through the pandemic it delivered an average of 3.9%.

Given the failures elsewhere in the sector, that’s not to be sniffed at.

I did it my way

Monevator and peer-to-peer lending both arrived around the same time. I was an early adopter on Zopa and so I wrote about things I noticed, such as on a surprising pattern of a particular cohort of my loans going bad.

The zoperati smirked at my concerns on their forum. They said I didn’t understand probability.

But it turned out Zopa did see defaults spike at a higher-than-expected rate in late 2008. My hunch was right.

Zopa subsequently tweaked its processes and that rise in bad loans proved to be a blip. Overall the platform did well in the recession.

I bring up this ancient history because it framed how I viewed P2P.  You really could have visibility into how your money was lent with P2P – and the risks and rewards – in a way that was novel for nearly all of us.

But arguably, what the P2P experiment proved is most of us aren’t very good at judging such metrics – even at the level of choosing a viable platform. Many people just chased the highest yields.

Zopa-vision

Originally, peer-to-peer was all about Bob lending directly to Joe.

Bob would read a bio of Joe, look at his photo, and think: “Yeah, Joe looks like a trustworthy sort who needs a new motorbike.”

You’d already have set your interest rate. That would attract a certain cohort of risky/rewarding borrowers, which Joe might fit into.

Even if Joe seemed a bit riskier than you’d prefer, you might still see a tiny sliver of your cash spliced into a loan to Joe – with your money earning a slightly higher rate than other money in that loan – at the cost of your lending going out more slowly.

There were lots of quirks like that, and Zopa hobbyists poured over them.

Many of these early and vocal Zopa investors were more mathematically adept than me. I felt though that some lacked a survival instinct. They understood odds, but perhaps not existential risk.

A few of them had all their investment money with Zopa. I thought that was crazy. I still do, even though history has okayed their decision.

As I’ve said many times, my suggested P2P limits were far more cautious. Perhaps 1-3% of net worth across all one’s chosen P2P platforms. Maybe 5% if you’re keen, rich, or stuck for options.

Widely diversified across each platform, too, of course.

Bang goes the business model

Prudence was wise, because far from gracefully transforming into a bank (not a sentence you’ll read every day) the worst P2P lenders went kaput.

A couple went into administration. Others were consolidated. A few were part of larger businesses that put their underwhelming P2P units into run-off.

Most of these P2P experiments in the UK never achieved any scale. The vast majority you’ll never have heard of.

But there were a couple of high-profile casualties.

The failure of property loan financier Lendy highlighted risks that went beyond borrowers simply not paying you back. Lendy investors found out in late 2019 that their money had not been properly ring-fenced. Thus it could have been used to pay the firm’s creditors.

Elsewhere P2P lender and pawnbroker Collateral was closed down in 2018 when its regulatory status was thrown into doubt. Hard to plan for that.

The Financial Conduct Authority (FCA) tightened up P2P regulations. This (rightly) led to delays in granting Innovative Finance ISA status. But it also exposed another risk. Even a seemingly viable platform could suffer from adverse regulation. This could put a business model in jeopardy at a stroke.

First among less than equals

For all these reasons I graced only two of the biggest platforms, Zopa and Ratesetter, with my money. They were also the only ones I featured on Monevator.

Both seemed to me to have had sufficient scale and profile to be a problem for the authorities if they failed – and thus I hoped got more scrutiny – as well as being more transparent themselves.

Many P2P fans would count a third member of the ‘Big Three’ triumvirate, Funding Circle, as among the safe options. But I was less convinced its business loans were amenable to P2P evaluation, at least in the early days.

True, Funding Circle is stock market listed. That affords extra reassurance, because analysts and fund managers should also be kicking the tyres.

But like all these firms, Funding Circle’s offering changed over time anyway and I didn’t fell like I was missing out.

Eventually there seemed to me no great difference between what it and the other big two platforms offered from a consumer’s perspective – fixed rates, basically – but rates everywhere had plunged, and P2P returns no longer seemed very juicy.

Tails you lose

Perhaps I was too timid. There are other widely-admired P2P sites out there – Assetz Capital and Lending Works for starters – and I am not saying that there’s anything intrinsically wrong with the best of them.

But I also stuck with the big two for practical reasons. At one point it felt like I was being emailed by a new P2P outfit every week. Evaluating them all would have been a full-time job (there are people who do just that). Even as a blog owner let alone as a saver, I didn’t have the spare capacity.

What really concerned me was systemic risk. This might be something off in a platform’s business proposition or with its models, or it could even be fraud. In the worst outcome, you wouldn’t just see 8% of your loans going bad when you’d anticipated that 5% might default. With systemic risk you could potentially lose much more. Maybe everything.

Losing all your money is very unlikely with a High Street bank – even before you consider FSCS protection – or with big stockbrokers. Size, regulation, and reputation aren’t 100% guarantees. But they do help.

In contrast, most of the new P2P firms were loss-making shoestring start-ups. Some were backed by crowdfunding retail investors. One wondered how much experience of actual banking some of the bright founders had beyond using an ATM to withdraw cash on a Friday night.

Risks clearly abounded.

Banking on it

That was (mostly) then. This is now.

With Zopa throwing in the towel on P2P, the original vision of P2P is dead, at least among the big platforms.

Zopa is a bank. Ratesetter was acquired by Metro and has become a loans business. Funding Circle is shut to retail investors for the time being at least.

I suspect this retrenchment has happened because of a combination of risk aversion, market mismatches, regulation, the pandemic – and even success.

The ability of Zopa and Ratesetter for instance to deliver higher returns than cash in a bank without blowing up attracted more money to those platforms. This in itself had a depressive effect on returns. Yet the platforms had to pursue ever-greater scale for their own economic reasons. Regulation costs mounted, and the increasing vogue for insulating investors from the risk of losing any money further curbed returns.

Somewhere the P2P element went by the wayside. In the end you’d save via an aggregated marketplace in almost the same way as you’d put money into a savings account. You expected higher returns but got no FSCS protection. Ultimately you relied on the platform’s safeguards to protect you from loss.

They’d reinvented banking!

Better to be a real bank in that case, I suppose.

Are any readers using the smaller P2P lenders or mourning the loss of the big ones? Let us know in the comments below.

And have a great weekend everyone.

[continue reading…]

What caught my eye this week.

For the past few years, being an investor in disruptive growth companies has been easy.

There’s been the odd hiccup – a tantrum in late 2018, and of course March 2020 when everything not nailed-down was sold in a panic.

But mostly, you just got richer every week.

Perhaps the biggest challenge this cycle was seeing your go-go shares only rise 5% in a month, while some meme stock jumped 300% and a crypto asset you’d never heard of rose 10,000%.

Bull markets don’t just make everyone (seem like) a genius.

They make greedy geniuses, too.

But investing in shares on ever-higher valuations is a game of chicken.

Even if you’re a fundamentals-based investor (like me, la-di-da) who buys into businesses, not stock charts, the market will eventually call your bluff.

You may own firms with fabulous futures, but one day they’re going to look about as appetizing as chlorinated chicken sounds. They will be tossed overboard indiscriminately.

The greatest multi-bagging companies – Tesla, Amazon, Apple – saw their value plunge 50-90% on their way to trillion dollar valuations.

It’s a matter of when, not if.

Under pressure

Friday was one such day. Which was remarkable, because Thursday had already seemed like one such day.

I’d actually messaged The Accumulator a screenshot from my portfolio tracking spreadsheet on Thursday showing how much the growth portion of my sprawling portfolio had been roiled.

But then came Friday, which guffawed: hold my beer.

Not one but two of my shares fell more than 25% on Friday. The worst was down 40%. Many of the rest were down at least 5%.

And we’re not talking tiny fly-by-night stocks. My biggest plunger, Docusign, was worth more than $50 billion a month ago.

Here’s how a random selection of growth companies fared last week:

Of course all of these companies – with the arguable exception of Meta (nee Facebook – have looked super-pricey for the past couple of years.

And there’s a definite ‘de-digitalization’ theme among the companies that have been faring especially badly.

Even as Omicron has loomed, the so-called work from home stocks that were winners in the locked-down world have proven too pricey for some tastes. Especially with higher interest rates on the way.

I wrote last month about how inflation expectations have been getting stickier all year. That had suggested Central Banks will need to tighten financial conditions sooner or more severely – or both. And that’s potentially bad for growth stocks because of the impact on discounted cash flows that I flagged up a few years ago in discussing the problems with low interest rates.

Twelve months ago, fanciful commentators were opining that paying multiples of 50-times a company’s sales (that’s revenue, not profit) was the new normal.

And it was – in that everyone was doing it.

Until they weren’t.

Another one bites the dust

Obviously I can’t sound too smug. As I say, a good part of my portfolio was pummeled this week.

I’ve been trimming growth exposure for much of 2021 on the back of re-openings and scary multiples.

But clearly in hindsight I kept too much and – hilariously – I’d even bought back some fallen high-flyers because they had begun to look tempting.

Oops.

However this is not my first rodeo. I know shares in growth companies can look too expensive for years in a bull market, and I was happy to book the gains in the good times. A kicking was coming someday. The snag was I didn’t know when.

But will the legions of new investors who only began trading in 2020 and have never seen a bear market be so sanguine?

Thursday and Friday felt like a panicked liquidation – of traders on margin, if not of actual funds – but at the index level prices only dipped a little. This was a very localized earthquake.

There’s a lot more selling to come if people truly get the fear.

Of course, as I alluded to above much of the fastest money has moved onto trading cryptocurrencies.

Doubling your money in a growth stock in a year was a snooze-fest for Boomers by comparison to alt-coins and the like.

I wonder what such traders made of the past 24 hours in crypto prices on checking their screens this morning:

Come back plunging growth stocks – all is forgiven!

It sure looks like the euphoria is over.

Don’t stop me now

If you’re a passive index fund investor then you’re entitled to feel pretty good about all this.

For UK investors, the Vanguard World Index Fund was down less than 1% in the week.

It actually rose on Friday!

The mega-tech companies that dominate the market (Alphabet, Microsoft, Amazon and the like, though not Meta) have barely wobbled so far.

Passive investors also save themselves a lot of grey hairs by avoiding days like Friday – albeit at the cost of rarely being able to brag about your returns on Twitter.

Most people will do much better with index funds than stock picking, which is why we recommend passive investing so much on Monevator.

But I wouldn’t get too complacent.

An interesting feature of the recent sell-off is that it’s occurred while the all-important US ten-year yield has actually been softening.

Indeed market expectations for US interest rates are flattening across all maturities recently.

Say what?

Basically, as of recent days, the market is seemingly expecting US interest rates to rise less in the future.

That could be because it foresees another recession, maybe virus-driven.

It could be because it’s thinking that inflation is more transitory, after all.

Or it could be that bond investors are growing increasingly fearful in general, perhaps due to the same flight to safety instinct that drove the mass dumping of expensive growth stocks this week.

After all, if you expected Omicron to lock us all inside again, then the likes of Zoom Video should perhaps be rising.

So there’s some circles to be squared here.

I could speculate about this all day but it’s not really our beat.

Suffice to say we’re potentially in one of those periods of dislocation for the markets, where things change and it only looks obvious how in hindsight.

It had seemed like stock markets were getting ‘healthier’ in 2021.

Last year’s returns were dominated by the biggest companies. But the spoils had been shared more evenly recently, as Morningstar reported:

Will this continue?Maybe the recent sell-off is evidence of investors coming to their senses, as value investors might put it, and dumping their growth shares for solidly profitable companies?

Or is a new bear market coming – taking out the easy targets before moving on to the biggest prey?

Who knows. Anyone being too defensive has made a mistake for most of the past ten years.

I was too exposed to growth stocks in partly because the end of the year is usually so strong, and the outlook seemed favourable until a fortnight ago. Things can change quickly.

Who wants to live forever

We’re all playing a long-term game. As an active investor, I believe I can outperform the market by discerning the best companies that will prosper over the next 5-10 years (albeit I shuffle my cards continually, which is heresy in the circles I hail from).

I even bought some growth shares on Friday – buying into boutique cloud provider Digital Ocean and adding to old favourite Mercadolibre (the so-called ‘Amazon of Latin America’, only not that Amazon…)

These still look like long-term winners to me. But in the short-term anything can happen.

Meanwhile for passive investors, the best defense is and always will be diversification. Even steep crashes will eventually look like blips provided you’re properly diversified and can hold and add through such declines.

Because a time will come – maybe next week, maybe next decade – when the sort of falls growth stocks ‘enjoyed’ on Friday will occur at the index level.

The S&P 500 will be down 8% in a day. The FTSE 100 will be off double-digits.

It’s always inconceivable until it happens. But it does happen.

Maybe this week was the market re-calibrating for a long expansion ahead. Perhaps the old companies that burn and bash stuff are due some time in the sun.

The bull market is dead – long live the bull market!

Perhaps, but I fancy it still isn’t a bad time to make sure you’ve got the right balance in your portfolio for navigating whatever comes next.

Have a great weekend.

[continue reading…]

A new investor has a thousand ways to be confused by the stock market. Hearing the old adage ‘buy the rumour, sell the news’ won’t help.

What on earth?!

• Why buy shares when you’re not sure what’s going on?

• Or sell when a great thing is finally confirmed?

• Why be uncertain at all in 2021 – when the facts are just a Google away?

If you’re asking these questions, then you don’t yet understand how markets work.

Which is what makes this old instruction so – well – instructive.

Buy the rumour because the market prices forward

The basic idea here was as familiar to white-wigged traders swapping paper in 17th Century Amsterdam as it is to today’s meme stock chasers punting on Freetrade and RobinHood.

Buying the rumour is all about what is priced into a share – and when – and whether you have an edge against your fellow share sharks.

In theory, a share price reflects the market’s best guess as to the current value of all the cash that will ever come due to its holder in the future – with a discount applied for risk and the time value of money.

Of course, prices can be buffeted by emotions and fads. This is what we mean when we gravely intone how a share “has become disconnected from fundamentals”. Recall, say, the manic trading of GameStop in early 2021.

But most of the time, most of the share price in an efficient market reflects a best estimate of a company’s cash generation potential.

Granted, this theoretical truth is seen best in an economist’s model. It’s not always so apparent in the hurly burly of a real-life stock exchange.

Not least because the market is no single entity. There’s no godlike bookkeeper with one eye on Excel and the other eye on the newswires.

Rather the market comprises millions of individuals, funds, and AI algorithms churning billions of shares. There’s a wide disparity in aims and time horizons. There’s also a varied appetite for risk and reward.

Mr Market has many faces

Sometimes in aggregate investors are greedy, and will pay a lot for future cashflows. That leads to higher equity prices.

Other times they’re scared and prefer the certainty of cash in the bank. This reduces the general appetite for shares.1

Much of the time, very few market participants are seemingly doing any sort of discounted cash flow analysis or similar on those future earnings at all.

Instead they are chasing news. Or rising prices. They are buying because of an economic report or a release from a rival firm. Or a million more reasons.

A fund manager may pay more because it was sunny on the way to work, or because her database says a share is priced cheaply compared to history.

An investor may put money into Tesco because he just did his shopping there. He may buy on the rumour that a new gizmo is already selling out. He may sell on a hunch that a popular CEO is leaving.

Yet the object of most of this guesswork typically does have some bearing on future earnings. Okay, not that sunny commute maybe, but leadership changes or a smash hit product will impact the bottom line someday.

It all adds up.

You can think of a share price’s moves in the short-term as almost like the result of ‘Asking the Audience’ in Who Wants To Be A Millionaire.

Trades on a stock exchange are like votes cast with money.

Told you so

Sooner or later, any bit of guesswork is confirmed or refuted.

A CEO stays or goes. The hit Christmas toy sells out – or it transpires such rumours were a marketing stunt. Or maybe the toy does sell out, but only because they didn’t make enough of them. As a result the anticipated earnings boom never happens.

When millions of rumours are replaced by more knowledge in this way – whether through formal press releases, or by altering the profit and loss statement or the balance sheet in a firm’s reporting – mis-pricing begins to be corrected.

A bit of froth is taken off a share price here. Some gloom is dispelled there.

And so – over the long-term – share prices track earnings.

True, you may have to wait an age to see this. Think Amazon or Tesla.

Alternatively, the relationship between profits and a share price might be apparent quite quickly with a consumer staples company like Unilever.

Cyclical outfits such as miners typically see their share prices rise and fall well ahead of big earnings changes, like cats chasing their own shadows.

And did you notice I said ahead of earnings?

Wait for a cyclical company to confirm a downturn and you’ll probably have already taken a chunky loss by the time the news arrives.

Guessing ahead is the name of the game with cyclicals.

Buy the rumour to buy mispriced shares

Hopefully the adage ‘buy on the rumour sell on the news’ now makes sense.

If you’re trying to beat the market, you need to think and do something different to the market in aggregate, as represented by current share prices.

You might value a particular security differently.

Perhaps you’re operating at a different timescale to most participants?

Maybe you have a different attitude towards risk and reward.

(An apparent bargain price is often just a discount applied by the market to reflect the chances of something good and expected never happening.)

In any event, in most cases being able to anticipate something before it happens will be more profitable than waiting until everybody knows about it from an official news release.

Sure we can argue at the margins.

For example, the momentum factor’s history of out-performance may be due to investors taking longer than expected to properly incorporate new information – even when fully confirmed – into their valuations.

Meanwhile a lover of so-called quality shares like Warren Buffett or the UK’s Nick Train might argue the market systemically undervalues long-term compounded earnings generated by duller, more predictable companies.

I’m the sort of investing nerd who would happily debate all this with you in the pub, but that’s for another day.

Just make sure you grasp the main point before you look for exceptions.

Don’t be that guy

Don’t be like the talking heads on financial TV who every day seem amazed: “Monevator Enterprises shares soared after-hours despite reporting big losses”.

The market already knew that losses were coming. Investors expected even bigger losses. Or they didn’t appreciate a shift in the earnings mix. Maybe they like the new-news that the CEO is flogging off the loss-making divisions.

Or perhaps it’s one of a hundred other things.

“Why have my shares plummeted after Monevator Inc. reported record profits? The stock market is insane!” – say day traders everywhere, every day.

Perhaps the market is indeed slightly over- or under-pricing your shares. (It’s very unlikely to have the valuation right on the nose.)

Or maybe it has cottoned on to the fact that the surge in revenues at your company looks unsustainable.

That your company is juicing profits by under-investing.

Or a hundred other things.

If I had a drink for every time I’ve heard media pundits or online posters bewailing an ‘irrational’ market that in fact was looking months or years ahead – and long before you were – then I’d be checking myself into the Priory.

Not least because I’ve bewailed like that myself, too.

We’re all only human.

Buy the rumour, sell the news

Remember, the stock market is a forward-looking prediction machine. It tries to discount the value of what it sees through the mists of time ahead via today’s share prices. It’s doing this all the time.

You’re probably best off not trying to do it better than the millions of smart people and machines that make up the market.

Invest passively, buy index funds, and benefit from their hard work.

But if you must play the crazy game of active investing, stop obsessing over what everyone already knows – or what they think they know.

Think different, and before they do.

1. You can see this in varying CAPE ratios over time, as investor fear and greed ebbs and flows. [↩]