Sunday 25 September 2016

The Exit Might Be Narrower Than Expected

As expected, but disappointingly, US Federal Reserve did not raise interest rates on Wed. The reasons for my pessimism for the current economic conditions are explained in What Have We Got After 8 Years of Easy Money? Unless we see evidence of coordinated fiscal stimulus from governments around the world to increase aggregate demand, more liquidity via easy monetary conditions will only lead to more value destruction as we have seen so far. Given the precarious investing environment, I have been gradually taking money off the table and building up my defences, before everyone else starts to rush for the exit. Based on the experience of the last 12 months, I believe the exit might be narrower than most people expect.

12 months is not a long time. However, over the same period, we have had at least 3 market declines, namely:
  • Aug 2015 - China's renminbi devaluation triggering worries about China's economic slowdown
  • Jan 2016 - China's stock market circuit-breaker meltdown and oil price collapse
  • Apr/May 2016 - "Sell in May and Go Away" syndrome?

In all these 3 episodes, the declines were fast and furious. See the figures below for the extent and duration of the decline. Note that the no. of days in the figures refers to the no. of trading days.

Fig. 1: STI Decline in Aug 2015

Fig. 2: STI Decline in Jan 2016

Fig. 3: STI Decline in Apr/May 2016

In fact, these 3 episodes are not the only times the stock market has declined so rapidly. As far back as Jun 2013, when then Fed chairman raised the possibility of slowing down and scaling back its bond purchases under the Quantitative Easing programme, the markets had also gone into a tailspin, triggering the famous Taper Tantrum. However, neither the extent or the speed of decline matched those that we observed in the last 12 months.

Fig. 4: STI Decline in Jun 2013

A summary of the declines is shown in the table below.

No. of
Avg Daily Decline
22 May 13 - 24 Jun 13 3454.37 3074.31 22 -11.0% -0.50%
24 Jul 15 - 24 Aug 15 3352.65 2843.39 19 -15.2% -0.80%
31 Dec 15 - 21 Jan 16 2882.73 2532.70 14 -12.1% -0.87%
21 Apr 16 - 6 May 16 2960.78 2730.80 10 -7.8% -0.78%

The purpose of this post is not to encourage anyone to sell. Perhaps the market might climb the wall of worry and rise further. However, for those who believe that they can wait until the last moment and run faster than the rest, they might wish to take the above findings into consideration. The exit might be narrower than most people expect.

Sunday 18 September 2016

What Have We Got After 8 Years of Easy Money?

2 unusual events happened in July. The first was the Brexit referendum, in which Britons unexpectedly voted to leave the European Union, but the stock markets, equally unexpectedly, did not crash. Within 4 trading days, the Straits Times Index was back to where it was before the vote. It turned out that the markets had correctly predicted that central banks around the world would rush to loosen monetary conditions further to avoid a market crisis from developing because of Brexit. The second was the yields on 10-year Singapore Government Securities dipped below the interest rate of a 1-year fixed deposit that I had placed barely 3 months earlier in Apr. Granted that we are talking about different time periods (Apr vs Jul) and different credit risks (corporate vs government), but the fact that a 10-year government bond could not beat the yield on a 1-year fixed deposit simply amazes me. Is this a warning sign that the financial markets are close to a top?

Actually, both these 2 events are related. Because of a rush by central banks to loosen monetary conditions, which were already very loose, yields on government bonds dropped further, to the extent of going below that of a fixed deposit. Since the Global Financial Crisis (GFC) in 2008, central banks have kept interest rates at historically low levels. US interest rates are now only 0.25% to 0.5%. Several countries, such as Eurozone, Japan, Denmark, Sweden and Switzerland have even taken the unprecedented step of dropping interest rates to negative levels since Jun 2014! As if low/ negative interest rates are not sufficient, US and other central banks have carried out multiple rounds of Quantitative Easing (QE) to flood the markets with cash since Nov 2008!

Back in Nov 2008, if someone had told me that interest rates would remain at historically low levels for 8 years and central banks around the world would take turns to implement multiple rounds of QE, I would have predicted a booming global economy at risk of overheating and a raging bull run in the equities and bond markets!

Yet, 8 years later, what have we got? Sure, in the financial markets, we have a very long bull run in US equities and global government bonds. In Singapore, however, the STI did not even come close to breaching the level achieved prior to GFC, stopping at around 3,500 points versus the peak of around 3,800 points in Oct 2007.

In the real economy, the picture is even worse. Instead of a booming economy at risk of overheating, we have poor business and/or low margins in industries ranging from Oil & Gas, agriculture, commodities, shipping, shipbuilding, properties and banks. In the REIT space, almost every sector ranging from office, retail, hotel and industrial are facing challenges, due to either oversupply or changing demand. In some of the industries mentioned, some companies have even entered judicial management. Banks, being the barometer of the general health of the economy, are facing rising Non-Performing Loans. This is not a picture of a booming economy, but rather, a picture of an ailing economy.

Some people might argue that the reasons for the economic difficulties are OPEC countries flooding the crude oil market, property cooling measures and slowing global economies, especially that of China. These are valid reasons. However, aren't low/ negative interest rates and QE supposed to revive the slowing global economies? With the exception of the US economy, 8 years of low interest rates and multiple rounds of QE have not been able to add to the overall demand in the global economies. Instead, the flood of easy money have added to the overall supply by making it easy for companies to borrow money and build capacity. Ironically and in spite of the flood of easy money, what we have is not more money, but a fairly wide-ranging destruction of value across many industries. Investors who have lost money in stocks in the above-mentioned industries, despite a long-running US equities bull market, would understand best.

The value destruction described above affects companies and investors. Losses are, after all, part and parcel of investing. However, what is of major concern is that the same scenario seems to be playing out at the individual consumer level in the area of residential properties. On the one hand, we hear stories of a glut of completed properties and difficulty in finding tenants. At the same time, we also hear news of some new residential properties selling like hot cakes. Properties are not cheap these days. Without $1 million, you cannot buy a private property with enough space for a family of 4. Yet, there is no shortage of buyers for such properties. The situation is reminiscent of Offshore Support Vessel (OSV) companies which took on huge debts to expand their fleets of OSVs rapidly when oil price was high but are now having difficulties finding charterers to hire their OSVs. For these OSV companies, they will have to significantly tighten their belts and slowly pay down their debts for many years in order to stay afloat. If the same situation affects residential properties, many people will have to likewise tighten their belts and pay down debts. The local economy, which is predominantly services-based, will grow fairly slowly for several years.

The US Federal Reserves will meet to discuss interest rates in the coming week on 20 and 21 Sep. I doubt they will raise interest rates at this meeting. However, after witnessing the widespread destruction of value across multiple industries, I am in favour of raising interest rates.

Interestingly, despite 8 years of low and even negative interest rates, it requires the occurrence of an extraordinary event with economic significance, the Brexit referendum, and the equally extraordinary absence of an accompanying shock to the stock markets, for me to realise what is happening. Having said that, it does not mean that the financial markets will crash soon. It has been 3 years since the taper tantrum of Jun 2013 when then Fed chairman raised the possibility of scaling back its QE bond purchases, but the financial markets have gone on to achieve new heights. However, I have no wish to invest further in such an environment and will shore up my cash position when the opportunities arise.

If you wish to have a second opinion on the state of the global economies, you can refer to the writings of Rolf Suey.

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Sunday 11 September 2016

Bye Bye, OSIM!

OSIM has been officially delisted on 26 Aug. This post is a compilation of 2 short stories to remember it. Both are follow-ups from my previous post on OSIM, which you can read at No, I Didn't Buy OSIM at 6¢ During GFC.

The first story is about buying OSIM. When I wrote the post last Nov, 7 years after the depth of Global Financial Crisis (GFC), I never expected I would ever buy OSIM, especially since I did not buy it at 6¢ during GFC. At the time of the post, it was trading at $1.36. As things turned out, OSIM continued to fall from its peak of $2.90, until at $1.025, I decided it was sufficiently undervalued given its past growth records. Thus, the stock that I hesitated to buy at 6¢ during GFC, I had no reservations about buying it at $1.025, 17 times above the price at which I gave it a miss!

Fig. 1: OSIM Share Price

At 6¢ in 2008, I hesitated to buy OSIM because it was losing a lot of money due to a poor acquisition in US at that time. Subsequently, OSIM went from an all-time low of 5¢ to an all-time high of $2.90 for a 58-bagger. However, despite its astronomical rise, I have not regretted giving it a miss at 6¢, for reasons explained in No, I Didn't Buy OSIM at 6¢ During GFC.

At $1.025 in 2015, I decided to buy OSIM because it had fallen from a high of $2.90 to $1.025. It was facing declining business, but given its past growth records and acquisition of TWG Tea, I considered it as an fallen angel. The fact that I had missed out on a 58-bagger did not bother me. What mattered most was whether OSIM could get back to its former growth path. As things turned out, OSIM's founder decided to privatise the company in Mar at an eventual price of $1.39. I made 36% in a short span of 4 months, which covered the difficult period in Jan when stock markets around the world crashed. But like all good stocks being privatised, I was reluctant to see it go and would not get to see if my premise that OSIM could return to its former glory would be correct.

Thus, same stock, but different times, different prices and different actions. There is no emotional baggage involved.

The second story is about other stocks like OSIM. In the same post last Nov, I nearly wanted to quote another stock that had also fallen significantly like OSIM in 2008 and ask readers whether they would buy the stock at 10¢ in Nov 2015, in the hope of finding another multi-bagger like OSIM. The stock in question was China Fishery. See the figure below for China Fish's share price at the time of the previous blog post.

Fig. 2: China Fish Share Price

As things turned out, China Fish went into provisional liquidation barely 3 weeks later. Thus, buying stocks that have fallen significantly does not always produce multi-baggers like OSIM. For every OSIM that rebounds strongly, there are always other stocks that sink deeper!

Like OSIM and China Fish, Oil & Gas stocks have also fallen significantly. Which path would they take subsequently? At the time of this post, Linc Energy, Technics Oil & Gas and Swiber have all gone into voluntary administration/ judicial management.

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Sunday 4 September 2016

My Oil & Gas Fightback

Finally, we have come to the grand finale on the Oil & Gas (O&G) series. When I started writing on O&G stocks in May, I did not think that I could write 14 posts on it. This final post summarises the initial ignorance on the severity of the oil crash, the mid-way realisation that something was amiss and the subsequent adjustments in investment strategies. This journey has not been a straight path. Along the way, mistakes were made, trial-and-error adjustments were carried out, inconsistent investment strategies were executed while trying to understand the full picture, etc. The journey has not ended, and it remains to be seen whether the current investment strategies could withstand the test of time, but there are reasons to be cautiously optimistic.

The Initial Ignorance

Even before the oil price crashed in Jun 2014, I had a couple of O&G stocks in my portfolio. But when O&G stocks started to crash in Oct 2014, I decided to pick up a few more of them. It was a classsic case of value investing, whereby stocks with good earnings fell and became "undervalued". When earnings and stock prices temporarily diverge, there are only 2 ways they would re-converge. Either the stock prices recover, which means value investors make money, or the earnings fall, which means value investors got stuck. At that time, it was widely assumed that the fall in oil price was only temporary and it was a matter of time before stock prices recover. Unfortunately, it was earnings that fell instead of stock prices recovering.

Looking back at the mistakes made during this period of time, I would not be too hard on myself. Like a chess game, there are only a few opening moves. Very few people would think 50 steps ahead of it. My usual steps before initiating a position in a stock are to check on past earnings, future prospects (as described by the company in the financial statements), balance sheet strength, cashflows, etc. If the above checks are satisfactory, the stock price is reasonable and the overall stock allocation is within limits, the stock would be purchased. If I think too long, I might just miss the opportunity.

Although O&G stocks are in a very bad shape, the above checks have nevertheless helped to sieve out companies with high debts and allow the problem to be more manageable. Among the O&G stocks in my portfolio, only Keppel Corp and KrisEnergy (more on this stock later) have debt/equity ratios above 50%. The worst perfoming stock in my portfolio, MTQ, has a debt/equity ratio of 39%. There is a fighting chance that both Keppel Corp and MTQ will survive the harsh and long winter.

The Mid-Way Realisation

The consensus in Dec 2014 was that the oil price collapse was only temporary and would soon recover to its original level prior to Jun 2014. However, as time passed, the anticipated recovery in oil price and O&G stock prices did not happen. It was around mid 2015 that I realised something was amiss and began to adjust my investment strategies in O&G stocks. The investment strategies then were fairly inconsistent as I tried to figure out the full picture. Although I realised that the downstream sectors were more stable than the upstream sectors, I nevertheless went ahead to buy Keppel Corp at $6.82 in Sep 2015. It was just too attempting to pass up the offer, considering that I had sold it at $8.20 just 2 months ago. 

The revised investment strategies are discussed in the sections below.

Exploit Weaknesses in the Attack

As we now know, OPEC decided to flood the market with oil to remove other competitors and win back market share. This is bad news for the upstream O&G companies which rely on oil majors and drilling contractors for their business. However, even the best attack has some weaknesses. The more oil OPEC countries pump to increase market share, the more oil that needs to be transported, processed and stored. This actually benefits the downstream O&G companies that build and maintain petrochemical plants, storage tanks, oil terminals, etc. Rotary was the first stock to be averaged down in Apr 2015 based on this strategy, but it was too early and the price fell further. PEC was averaged down in Oct 2015, Hiap Seng was added in Jan 2016 and Hai Leck was added in Jun/Jul 2016. For more information on the downstream O&G companies, you can refer to My Downstream Oil & Gas Recovery Operations.

Avoid Frontal Attack

The oil crash severely affected every sector on the upstream side, starting from Exploration & Production (E&P) and following the industry value chain down to oil services, Offshore Support Vessel (OSV) and ship/ rig building (see the industry value chain in The Missing Link Between Oil Price & O&G Profitability). However, there is usually a timing delay as the effects move downwards due to contractual obligations. The storm is currently fiercest in the oil services and OSV sectors. Both Technics Oil & Gas and Swiber are in judicial management. Although ship/ rig building companies look better than oil services and OSV companies financially, it is mainly because the full force of the storm has not hit them! I have a conceptual model for understanding the various O&G sectors in What Moving Averages Can Teach Us About O&G Stocks.

Therefore, if possible, it is best to avoid companies in the oil services, OSV and ship/ rig building sectors. Unfortunately, it is easier said than done. Even I have stocks in these sectors. Among them, MTQ is at the most risk. I can only hope that both MTQ and Keppel Corp will survive, preferably without the need to raise additional capital via heavily discounted rights issues.

Counter-attack from Behind

The full force of the storm has left crude oil and the E&P sector. It is safe to say that oil price has bottomed out in Jan 2016. I averaged down on Lyxor Commodities, an Exchange Traded Fund that tracks the prices of oil and other commodities, in Jan 2016 and added 3 E&P companies, namely, Interra Resources, KrisEnergy and Ramba Energy (still more on these stocks later), in Jun 2016.

Moving forward, when the full force of the storm leaves the oil services, OSV and ship/rig building sectors, I will be coming in to pick up whatever that is left of these sectors.

Adopt a Nothing-To-Lose Mentality

Thus far, I have discussed my investment strategies in O&G stocks. I am predominantly an investor who prefers profitable companies. However, I also know how to speculate. When going by the book leads to a precarious situation, sometimes not going by the book can turn the difficult situation around. I have small speculative positions in loss-making companies, such as Hiap Seng (loss-making in FY2015, but turned around in FY2016) and the 3 E&P companies mentioned above.

Do not look down on the small size of these positions. It is precisely because they are small that they have the potential to become multi-baggers. Because the positions are small, the money thrown into these stocks are mentally written off the moment they are purchased. In other words, there is nothing to lose on these speculative positions. I cannot emphasize enough that O&G stocks are extremely risky stocks. However, when something extremely risky meets a nothing-to-lose mentality, the risk-reward balance tilts in favour of the latter.

This strategy works only if the position is small enough to be written off. If it is too large, it is difficult to write off the full amount and adopt the nothing-to-lose mentality. Not only that, there is usually a need to diversify as much as possible to reduce the risk of individual stocks really losing money. This is why I have 3 E&P stocks instead of just one. However, this also presents one of the challenges of adopting this strategy. While $1,000 in 1 stock might be easy to write off, a total of say, $10,000 in 10 stocks might not be that easy to write off. 

Moverover, although I talked about "throwing" money, nobody likes to really lose money. Thus, stocks selected under this strategy have some evidence of being able to turn around. If they have no chance of turning around, using this strategy will only mean losing more money.

Moving forward, this will be another of my strategies to pick up O&G stocks on the cheap. Please note that the purpose of this post is not to encourage you to take highly speculative positions. It is a recollection of my O&G turnaround strategies.

Superseded: A Rising Tide Lifts All Boats

Earlier this year, I had another strategy, which assumed that a rising oil price would lift the price of all O&G stocks. This was based on the premise that the market fails to understand The Missing Link Between Oil Price & O&G Profitability, so that all O&G stocks will rise when oil price rises. However, post-Brexit referendum, the rise in oil price has been disrupted. Post-Swiber, the market has figured out that some O&G companies have significant challenges in surviving the long and harsh winter. This strategy no longer works.


The O&G battle has gone on for 2 years already. It will probably not end for another few more years. Personally, this battle has been fairly spectacular, from the initial ignorance of the severity of the oil crash, to a mid-way realisation that the usual way of value investing cannot continue, to development and execution of a set of multi-pronged strategies of exploiting weaknesses in the attack, avoiding frontal attack, counter-attacking from behind and countering high risks with a nothing-to-lose mentality. This battle is no longer just about recovering all the losses, but also about bragging rights. Regardless of the outcome of this battle, it will surely go down as one of the legendary investment battles in memory!

Just a reminder, this post is not a recommendation for anyone to buy or sell any O&G stocks. It is a recollection of my strategies to turn around the O&G stocks in my portfolio.

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