Sunday, 13 December 2015

Ahead of the Grand Battle

This time round, the US Federal Reserves is probably finally going to raise interest rates. Although the stock market is not at multi-year lows, the impact of the first interest rate rise in almost 10 years from an unprecedented low of 0.25% has far-fetched implications on currencies, commodities, bonds, stocks, properties and world economies. It is undeniably a grand battle on multiple fronts. 

If you have been following this blog, you will notice that my views on interest rate rises have shifted from being bearish in Jun (see Getting Ready for US Interest Rate Rises) to being optimistic at least in the short term in Sep (see A Jittery September). The economic implications of the interest rate rise are still valid, however, I believe that such expectations have been priced in and investor psychology of selling before a bad news would take centrestage at least in the short term. 

In line with this analysis, I have moved approximately 25% of my capital from cash into equities since the stock market rout in Aug just as most investors have moved in the opposite direction. Considering that the Straits Times Index is at a still-high level of 2,800 points versus the final battle during the Global Financial Crisis (GFC) which took place at 1,600 points, such a move appears premature. In fact, a post-event analysis of the investment decisions made during the GFC shows that it is better to wait for some clarity on the situation before making major moves (see Be Cautious While Being Greedy). In other words, is this period of rising interest rates reminiscent of Sep 2007 when stocks were beginning to collapse in an unfolding housing and financial crisis or Feb 2009 when stocks were making a recovery after monetary authorities around the world came to the rescue? Thus, a frantic search for some clarity began in Sep to make sense of the various economic developments since the stock market rout in Aug (see A Jittery September). Rightly or wrongly, some sense had been established with regards to the global economy to guide investment decisions, although the situation on oil & gas have become murkier as they have their own dynamics in addition to being influenced by interest rates.

Coming back to the move from cash into equities, it was also influenced by another factor. In the midst of this stock market roller-coaster, there was a little-heralded announcement in end Oct that affected very few people but shook the foundation of my equity-centric investment strategy. It was OCBC's announcement of its intention to redeem its 4.2% preference share. To understand the impact of this move on my investment strategy, you can refer to Behind Every Successful Bear Market Recovery is A Cash-Like Instrument, which was written when OCBC redeemed another of its preference share 2 years ago. This is the third time I am kicked out of a preference share, having been kicked out of OCBC5.1% and UOB5.05% preference shares previously.

Thus, I had to find a new parking place to replace the OCBC 4.2% preference share. DBS' 4.7% preference share is the most obvious choice. It still has another 5 years to run before it is eligible for redemption. However, the recent liquidity squeeze on fixed-income securities (see Sneak Attack on My Cash Reservoirs) made me reconsider the validity of my assumption that sufficient liquidity is always present when needed. Given the limited number of good fixed-income securities and the underestimation of liquidity risks in times of crisis, the portion allocated to fixed-income securities has to reduce. Moreover, I also dislike paying a high premium for fixed-income securities.

That leaves Singapore Government Securities (SGS), Singapore Savings Bonds (SSB), fixed deposits and cash as the options. While they are good in preserving capital and have very good liquidity, they lose value to inflation in the long run. Moreover, SGS is a poor choice in the current environment of rising interest rates. Cash will always be an important component of my portfolio, but too much of it will drag down the overall performance of the portfolio. So, instead of retreating further into the safety of cash & fixed deposits, I decided to advance deeper into equities, trying to look for 1-2 stocks which I could entrust my capital for a long period of time. It is a totally new investment strategy. Although this might not be the most comforting of times to move from fixed-income & cash into equities, if it were more comforting, the price would be higher.

In another 3 days' time, we will know whether this major move from fixed-income & cash into equities is sheer madness or justified confidence. I do not like war, but if war comes, I will respond accordingly. My biggest worry is the US Fed chickening out again, just like it did in Sep. If so, the casualties will be very heavy. The difference this time is I will no longer have OCBC's preference shares to cover my back.

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  1. Like u, I'll have to look for another place to park my parents funds. Likely I'll get more fcl for them, since their portfolio is non equities based. Oh well, maybe another retail bond or pref shares will come from banks? haha

    1. Yes, hopefully more companies will come out with their own retail bonds. There's too little choice currently.