Sunday 31 January 2016

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:

Sunday 24 January 2016

Financial News Can Be Very Scary At Times

The trading year kicked off with a decline in Chinese equities and a fall in Chinese Yuan (CNY). The news that China had allowed its currency to fall further since the depreciation last Aug triggered further declines in global equities. Aggravating the worries was news that China's foreign exchange (FX) reserves had declined by a record USD108 billion in Dec alone and by USD513 billion in 2015. Having experienced the Asian Financial Crisis (AFC) in 1997/98 where regional currencies depreciated significantly and set off a recession and a deep bear market in equities, I started to worry whether there would be a repeat of AFC.

The news flow is worrying enough. As mentioned earlier, China's FX reserves had declined by a record USD513 billion in 2015 to USD3.33 trillion, which represented a decline of 13.3%. Yet, CNY had not depreciated against USD by much. A year ago, the exchange rate was 1 USD to 6.2556 CNY. A year later and with a 13.3% decline in FX, the exchange rate is 1 USD to 6.5788 CNY, which is a much smaller decline of 4.9%. Even though China has the largest FX reserves in the world (the next largest FX reserves is Japan's at USD1.23 trillion), it set me thinking whether China has sufficient reserves to defend its currency from further depreciation. Add on the news in Dec that China had created a CNY exchange rate index referencing to a basket of currencies instead of solely to USD, it further suggests that China is prepared to depreciate its currency against USD further. All these are truly worrying news.

Fig 1: 1-Year Movement in USD:CNY

A very intense analysis was carried out over the weekend to determine whether there would be a repeat of AFC. Looking back at AFC, countries that faced large capital outflows had several options (other than seeking assistance from the International Monetary Fund):
  • Allow its currency to depreciate
  • Raise interest rates
  • Impose capital controls
  • Do any combination of the above

In China's case, raising interest rates is out of the question, as doing so will further cause its economy to slow down. In fact, it is doing the opposite to stimulate its economy. China, however, has capital controls in place. The big question then is how tight and effective are the capital controls in stemming the outflow. Since I am no expert in macroeconomics, I turned to the internet to search for answers to this question. The answers were found in an article by The Economist at Capital flight from China: Flow dynamics. A crude assessment suggests the article to be correct, since if the capital controls were weak, China would risk aggravating the outflow by lowering interest rates. In any case, China could always tighten further its capital controls should present ones be insufficient.

Having resolved the biggest risk, I started to wonder why was I not aware of the CNY depreciation in 2015 given that it was such a big news. Was it because I had focused so extensively on US' interest rate rise in the West that I became oblivious to the emergence of an even bigger risk in the East? The answer can be found in the CNY:SGD exchange rate movement below.

Fig 2: 1-Year Movement in CNY:SGD

The CNY:SGD exchange rate had barely moved in 2015! A year ago, it was at 1 CNY to 0.2149 SGD. A year later, it is now at 1 CNY to 0.2171 SGD. Despite all the news about CNY depreciation, CNY actually appreciated against SGD by a very slight 1%! The figure below shows the relative movement of CNY against the major currencies of Euro (EUR) and Japanese Yen (JPY). A positive figure means that CNY rose against the competing currency.

Fig 3: 1-Year Movement in CNY Against Major Currencies

Compared to a year ago, CNY declined by 1.1% against EUR and 4.8% against JPY, in addition to a 5.0% decline against USD. The recent decline against JPY in Jan was due to investors rushing into JPY to seek a safe haven. However, as late as Nov, CNY had appreciated against EUR and JPY, notwithstanding the widely announced CNY depreciation in Aug that triggered a global equities rout that month! The figure below shows the currency movements from USD's point of view.

Fig 4: 1-Year Movement in USD Against Major Currencies

With the exception of JPY, USD had appreciated by 5.2%, 4.1% and 6.3% against CNY, EUR and SGD. So, really, the much talked about CNY depreciation against USD has as much do to with USD strength as well as CNY weakness! If it were solely CNY weakness, we would expect it to depreciate by similar margins against EUR (and other currencies like SGD) as well, but it did not. On the other hand, it is quite clear that USD is appreciating against almost all major and regional currencies. Yet, financial news choose to focus on CNY weakness rather than USD strength.

Also, it was not too long ago when EUR and JPY had depreciated significantly against USD. See the figure below for the 5-year movement of USD against major currencies.

Fig 5: 5-Year Movement in USD Against Major Currencies

Nobody raised any concerns when EUR depreciated by 26% or when JPY depreciated by 45% against USD over the 5-year period, but when CNY depreciated by 5.2% in Aug and Jan, it became extremely big news. Even though China's slowing economy and CNY weakness pose important risks to the global economy, there is no need for financial news to be so dramatic!

To conclude, there are several lessons that I learnt from this episode, namely:
  • Financial news can be more scary than things really are at times.
  • I should not focus exclusively on a much heralded risk and become oblivious to the emergence of a much greater risk.
  • A position of weakness (i.e. overexposure to stocks due to a tactical bet on the January effect) can affect rational thinking.

Lastly, I leave you with a quote from Peter Lynch, "There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of the newscasters. Sell a stock because the company's fundamentals deteriorate, not because the sky is falling.".

Sunday 17 January 2016

Confidence Can Only Be Built From Within

When the stock market drops, do you search the internet to find out what is happening? I do occasionally. It is OK if you just need to find out the reasons, but if you are searching for reassurances that it will not drop further, then it can be quite futile. When you read a negative opinion, you will be worried about your investments and search for more opinions, hoping to find one that will refute the previous opinion. However, even if you find one such opinion, you will still not feel assured and continue to search for more confirmation. The end result is you will end up very tired from all those searching and still feel just as unassured as when you started. Even if all the opinions you found are reassuring, the moment the stock market drops further, all your new-found confidence will be shattered. Confidence cannot be acquired from outside, it can only be built from within.

The reason why you will still feel unassured after reading all available opinions on the internet is because these opinions do not belong to you. You might agree with the opinions, but without going through the thought process of deriving these opinions, the confidence you have with them is only as strong as the next stock market movement. The correctness of these opinions is judged by the outcome (i.e. stock market movement) rather than the strength of the facts and arguments. On the other hand, if the opinion were derived by you based on available facts, the correctness of this opinion is judged not only by the outcome, but by the strength of the facts and arguments. Even when the outcome is unfavourable, you can re-run the thought process again, taking in new facts that you had omitted or just emerged, and re-evaluate that opinion. You will have much more confidence in the opinion that you derived.

There is another important thing you need to know about the stock market. It is often said that the stock market reflects all available information. We should assess what kind of information does the stock market really reflect. Consider stock recommendations from stock brokers. Even though everyone has access to the same facts, different stock analysts will come up with different price targets. Based on their own price targets relative to the current stock market price, they will then recommend to buy, hold or sell the stock in question. When investors follow up on these recommendations to buy or sell in the stock market, they are transferring the opinions of their stock analysts into the stock market. Even for investors who do not rely on stock recommendations from analysts, there is an analyst within all of us who will perform the same activities. Thus, the stock market actions that we see are really reflections of different opinions from thousands of stock market participants rather than indisputable facts which nobody would disagree.

If the stock market were to reflect indisputable facts, I would say that the stock market is always right. But if the stock market merely reflects opinions, and we know that opinions can be right or wrong not matter how strongly expressed, it means that the stock market is not always right! History has shown that the stock market can deviate from economic fundamentals from time to time, which is why we have stories such as Mr Market and timeless wisdom from investment legends to ignore the stock market. In essence, the stock market is again some other people's opinions expressed in the form of price quotations. Do you still want to treat the stock market as the indisputable truth and be extremely concerned over what level the stock market closes everyday?

If the stock market were to reflect the opinions of all investors, it might still serve as a good reference. However, it is not. You probably know of people who think the stock market is undervalued but have no money to buy further. Their opinions are not reflected in the stock market. In fact, the stock market only reflects the opinions of a very small minority of investors. Take for example, Singtel, which had the highest transaction value on Friday. A total of 31.0M shares changed hands. This was the result of 6,263 trades conducted. Assuming 2 investors per trade (i.e. a buyer and a seller), the closing price of Singtel at $3.56 reflects the aggregate opinions of 12,526 investors (plus an undisclosed number of investors who placed orders in the queue but were not successful and another undisclosed number of investors were watching on the sidelines). Contrast this with the 298,709 shareholders of Singtel (again, plus an undisclosed number of interested investors who are not shareholders) and you will see that the stock market really only reflects the opinions of a very small minority of interested investors. You might want to read The Stock Market is a Voting Machine for more information.

So really, to find the assurance that you need, you need to ignore other people's opinions, especially that of the stock market. That is not to say that you should not read other people's opinions, but it should be to identify the facts that they use to derive their opinions and analyse those facts and form your own conclusion. You might still agree with those opinions eventually, but because you have gone through your own independent and rigorous analysis, the confidence you have with that opinion is much stronger and not affected by what the stock market does next.

Not only do you need to form your own opinions about the stock market, you need to form your own opinions about individual stocks that you hold as well as your overall asset allocation and adjust them according to your opinions. Only then can you achieve the assurance that you need face whatever the stock market throws at you.

Finally, if you truly understand the essence of what I am trying to explain in this post, then you will also realise that you should ignore all that I say in this blog, because these are solely my opinions! You will have to come up with your own opinions and conclusions.


See related blog posts:

Sunday 10 January 2016

I Don't Know Where The Market Is Heading, But I Should Know Where I Stand

In all my years of experience in the stock market, I never had to deal with a stock market crash in the first week of the trading year. I usually make a tactical bet on the January effect, especially this year as the US Federal Reserve had just made its first interest rate move. This means that I am overexposed to the stock market just as the crash came. The slew of economic news also sent me back to the drawing board to make sense of what is happening and going to happen.

Despite spending an inordinate amount of time on Friday and Saturday trying to figure out what is happening, I still have not reached a conclusion. I almost wanted to stop blogging this week to continue to figure it out. On the other hand, I had a much easier time figuring out the amount of war chest I should keep now and when I should deploy it and by how much. This current state of jittery is both due to the new economic news that I had not considered previously as well as a recent dislocation in my investment plan as I adjust to the loss of a bank's preference share which had served very well in the past as a counter-weight to equities in my investment plan (see Ahead of the Grand Battle for the circumstances leading to the current state of affairs). The conclusion from all these thinking is that there will always be certain things that we could not figure out correctly. When that happens, a good solution is to leave it to the war chest to manage all these uncertainties. After all, the war chest exists because we cannot predict what is going to happen. If we could predict accurately what is going to happen, we would have bought or sold at the right time and do not need to keep a war chest for unexpected events. 

So, really, what I need to do to manage all these market turmoil, economic news and jittery is to admit defeat in the Battle of the 1st Interest Rate Rise, undo the tactical bet and quickly re-establish a new investment plan. In a game where there are 2 players (i.e. you and the market), at least one person must be rational at any one time. If both players are irrational at the same time, the outcome can be unpredictable. The more irrational the market is, the more rational we must become. If I lose money in the stock market, it is usually not because I lost to the market, but because I lost to myself.

Finally, I leave you with a light-hearted view of how the stock market works to relieve the stress: The Stock Market is a Voting Machine.


See related blog posts:

Sunday 3 January 2016

The Dogs and Puppies of STI for 2016

This time last year, I updated the Dogs and Puppies of STI for 2015. They are as follows (see The Dogs and Puppies of STI for 2015 for more info):

Puppies of STI 2015
  • A-Reit
  • CapitaMall Trust
  • HPH Trust
  • SingTel
  • ST Engineering
Other Dogs of STI 2015
  • Keppel Corp
  • SembCorp
  • SIA Engineering
  • SPH
  • Starhub

How did they perform in 2015? The results are shown below.


Price 31/12/14 Price 31/12/15 Div Div Yield Return
(excl. Div)
Return
(incl. Div)
Puppies





  A-Reit $2.38 $2.28 17.70 7.4% -4.2% 3.2%
  CapitaMall $2.04 $1.93 11.23 5.5% -5.4% 0.1%
  HPH Trust US$ $0.69 $0.53 4.87 7.1% -23.2% -16.1%
  SingTel $3.90 $3.70 17.50 4.5% -5.1% -0.6%
  ST Engg $3.40 $3.01 16.00 4.7% -11.5% -6.8%
Non-Puppies





  Keppel Corp $8.85 $6.51 48.00 5.4% -26.4% -21.0%
  SembCorp $4.45 $3.05 16.00 3.6% -31.5% -27.9%
  SIA Engg $4.22 $3.70 14.50 3.4% -12.3% -8.9%
  SPH $4.21 $3.94 20.00 4.8% -6.4% -1.7%
  Starhub $4.15 $3.70 20.00 4.8% -10.8% -6.0%







Dogs


5.1% -13.7% -8.6%
Puppies


5.8% -9.9% -4.0%
STI 3365.15 2882.73 97.00 2.9% -14.3% -11.5%

As shown above, both the Dogs and Puppies outperformed the STI in 2015, although all 3 have negative returns. Inclusive of dividends, the Dogs returned -8.6% while the Puppies returned -4.0%, both better than STI's -11.5%. A key factor for the overperformance is the higher dividend yields of the Dogs and Puppies, which have yields of 5.1% and 5.8% respectively, compared to STI's 2.9%. Excluding dividends, the Dogs returned -13.7%, which is only marginally better than STI's -14.3%. The Puppies did better than the Dogs, returning -9.9%.

The overperformance of the Dogs and Puppies relative to STI in 2015 reversed the underperformance in 2014, when STI returned a postive 9.0%. Generally, the relative performance of the Dogs and Puppies relative to STI is to be expected. Due to the inclusion of REITs in the STI, which have much higher dividend yields compared to the other component stocks, the Dogs and Puppies will have a higher weightage of REITs. In the 2015 edition, there were 3 REITs in the Dogs and Puppies, namely, A-Reit, CapitaMall Trust and HPH Trust. Because of their higher dividend yields, REITs also tend to have less price fluctuations. Thus, in the years when STI is rising (e.g. 2014), the Dogs and Puppies will tend to underperform it. Conversely, in the years when STI is falling (e.g. 2015), the Dogs and Puppies will tend to overperform it.

What happens if you exclude the REITs from the Dogs and Puppies? The performance for 2015 is as shown in the table below.


Price 31/12/14 Price 31/12/15 Div Div Yield Return
(excl. Div)
Return
(incl. Div)
Puppies





  Noble Grp $1.14 $0.40 0.95 0.8% -64.9% -64.1%
  Olam $2.02 $1.82 2.50 1.2% -9.9% -8.7%
  SembMar $3.26 $1.75 12.00 3.7% -46.3% -42.6%
  SingTel $3.90 $3.70 17.50 4.5% -5.1% -0.6%
  ST Engg $3.40 $3.01 16.00 4.7% -11.5% -6.8%
Non-Puppies





  Keppel Corp $8.85 $6.51 48.00 5.4% -26.4% -21.0%
  SembCorp $4.45 $3.05 16.00 3.6% -31.5% -27.9%
  SIA Engg $4.22 $3.70 14.50 3.4% -12.3% -8.9%
  SPH $4.21 $3.94 20.00 4.8% -6.4% -1.7%
  Starhub $4.15 $3.70 20.00 4.8% -10.8% -6.0%







Dogs


3.7% -22.5% -18.8%
Puppies


3.0% -27.5% -24.6%
STI 3365.15 2882.73 97.00 2.9% -14.3% -11.5%

Noble, Olam and SembMar will take the places of A-Reit, CapitaMall Trust and HPH Trust among the Puppies. Inclusive of dividends, Noble dropped by 64.1% and SembMar dropped by 42.6% in 2015, pulling down the performance of Dogs and Puppies to -18.8% and -24.6% respectively. Thus, it is perhaps better to stick to the original Dogs of Dow theory and not try to tinker with it!

Moving on to 2016, the table below shows the dividend yields of STI component stocks in descending order:

Counter Div (cents) Price 31/12/15 Div Yield Remarks
HPH Trust US$ 4.87 $0.53 9.19% Puppy
A-Reit 17.70 $2.28 7.76% Puppy
Kep Corp 48.00 $6.51 7.37% Dog
SembMar 12.00 $1.75 6.86% Puppy
CapitaMall 11.23 $1.93 5.82% Puppy
UOB 110.00 $19.61 5.61% Dog
StarHub 20.00 $3.70 5.41% Dog
ST Engg 16.00 $3.01 5.32% Puppy
SembCorp 16.00 $3.05 5.25% Dog
SPH 20.00 $3.94 5.08% Dog
YZJ 5.50 $1.11 4.98%
SingTel 17.50 $3.70 4.73%
OCBC Bk 36.00 $8.80 4.09%
SIA Engg 14.50 $3.70 3.92%
SGX 29.00 $7.70 3.77%
SATS 14.00 $3.84 3.65%
DBS 60.00 $16.69 3.59%
ThaiBev 2.38 $0.69 3.45%
ComfortDelGro 8.50 $3.05 2.79%
Wilmar 8.00 $2.94 2.72%
HKLand US$ 19.00 $7.00 2.71%
Capitaland 9.00 $3.35 2.69%
GLP 5.50 $2.15 2.56%
SIA 27.00 $11.20 2.41%
UOL 15.00 $6.24 2.40%
Noble Grp 0.95 $0.40 2.38%
Jardine C&C 78.30 $34.85 2.25%
CityDev 16.00 $7.65 2.09%
Genting SP 1.00 $0.77 1.30%
GoldenAgri 0.18 $0.34 0.52%

Just to recap, the Dogs of STI are the 10 highest-yielding dividend stocks in the STI, while the Puppies of STI are the 5 lowest-priced stocks among the Dogs of STI. Thus, the Dogs and Puppies of STI for 2016 are as follows:

Puppies of STI 2016
  • A-Reit
  • CapitaMall Trust
  • HPH Trust
  • SembMar
  • ST Engineering
Other Dogs of STI 2016
  • Keppel Corp
  • SembCorp
  • SPH
  • Starhub
  • UOB

So far, since 2014, the Dogs & Puppies and STI have won 1 time each. Which will win in 2016? We shall wait and see!


See related blog posts: