Prudence is the Name of the Game

Today is the last day of January. After the stock market rout this month, it is time to take stock of the current portfolio allocation and articulate the game plan for the rest of the year. 

Entering January, I had moved about 25% from cash/ fixed income into equities to bet on US Federal Reserve's interest rate rise. Also included in the move was a tactical bet on the January effect. As things stand, this move turned out to be wrong. A review of my portfolio shows there are 3 areas of stress, namely, a collection of oil & gas (O&G) stocks, a 15% concentration in Global Logistic Properties (GLP) and stocks in general. The current war chest level stands around 37%. The past 3 weekends were spent analysing what is happening to China, O&G stocks, GLP, potential bargain hunting opportunities and the adequacy of the war chest.  

China remains the most important risk and currently, there is no clarity on how things will eventually turn out. Rather than assume the worst and sell stocks, the decision is to keep good stocks, trim unnecessary ones and maintain an appropriate level of war chest to manage the fallout in the event of the worst case happening. As part of the scenario planning, the war chest is allocated to the various areas of stress in the portfolio.

On O&G stocks, there seems to be some light at the end of the tunnel (hopefully it is not the headlight from an oncoming train) with the recent recovery in oil prices. Even so, O&G stocks are unlikely to recover by themselves to their original purchase prices. Additional capital is needed to bail them out. Approximately 5% of the war chest is reserved for this purpose. 

GLP is fundamentally sound. Its risks stem mainly from the external environments in which it operates, i.e. China and Brazil, which make up 63% of its total net asset value. Ignoring the China factor, it should be able to recover on its own without needing additional capital. Nevertheless, it might be dragged down further by China's woes and 5% of the war chest is reserved for it. 

For general bargain hunting in the event of further market declines, approximately 10% of the war chest is allocated to it. On top of that, there is a need for a psychological cushion of about 15% to tide through the depth of any potential stock market crisis. Summing up all the allocations, that works out to be about 35%, which is very close to the current level of 37%. That means that the current war chest is sufficient to manage any potential crisis, but there is no room for further errors. At current stock market levels, any stock purchase must be accompanied by a corresponding sale of existing stocks. It is from this perspective that I view the current bargains that have emerged in the stock market.

Currently, banks and telcos have dropped to attractive levels. However, both sectors carry risks that I do not have the capacity to manage. For banks, the main risks are China's slowdown dragging down the global and regional economies which banks have exposure to and a glut in the local property market. Let us leave the China factor aside, since it is not clear how it will pan out. As for the local property market, it is quite clear that there is an oversupply in properties, a slowdown in the rental market due to the tightening of foreign labour and rising interest rates. If the local economy slows down further, it could add strains to the banks' balance sheets, which already have to grapple with a prolonged slump in shipping and a sharp decline in O&G and other commodities. Although attractive, I will have to leave it to other people to make money from the banks.

As for the telcos, the risk is the possible entry of a fourth telco. My experience as a consumer suggests that the existing telcos have not been competing as fiercely as before, as I seem to be paying more on my mobile phone and cable broadband bills in recent years. On the other hand, the entry of MyRepublic in the fibre broadband market has caused prices to drop significantly. So, competition from the fourth telco is a major risk. Since I have never invested in telcos and enjoyed their handsome dividends and steady capital appreciation before, I prefer not to join them in the potential decline now.

This post summarises my investment plan for 2016. China remains a key risk, and until clarity is established on this issue, I will have to be prudent in my bargain hunting. 

See related blog posts:

• Be Cautious While Being Greedy
• Different Types of Bears
• I Don't Know Where The Market Is Heading, But I Should Know Where I Stand