Archives for posts with tag: Investing

The yield curve has inverted!

So what’s next? Why does this even matter? Where do I go from here?

What’s the Yield Curve?

The yield curve is simply https://www.marketwatch.com/story/the-yield-curve-inverted-here-are-5-things-investors-need-to-know-2019-03-22a two-dimensional chart showing the relationship between the yields paid (on the Y-axis) on bonds of different maturities (on the X-axis). The bonds here are U.S. government securities and hence, the only difference is the length of the maturity (i.e. how long investors have to keep their money invested in the bond until maturity)

By Ldecola – Own work, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=69078386

So what you can see is that for bonds with longer maturities, the yield paid is higher. For example, a 2-year bond might pay 2.5% p.a. while a 10-year bond pays 3% p.a.

In a normal world, this makes sense. After all, to entice investors to keep their money invested in a bond for a longer period, borrowers need to pay more interest.

Why Does the Yield Curve Invert?

That’s all good and fine but if that’s the case, then why does the yield curve invert? Well, as it turns out, if you hold a bond (which is an asset) but you need cash, you can always sell the bond on the secondary market. However, you’ll will have to accept whatever the market is willing to pay for your bond.

Let’s work through an example.

So, the way bonds work is that bonds pay investors a coupon (i.e. the interest) based on the Face Value of the bond. This Face Value is the principal amount that the investor receives upon the maturity of the bond. So for example, if a bond pays a coupon of 5% on a bond with maturity of 5 years and a face value of 100, then the investor receives $5/year for 5 years and $100 at the end of the fifth year.

So far so good?

However, if you have to sell the bond on the secondary market before it matures, the price that buyers are willing to pay may be less than the face value. This happens because would-be bond investors are weighing their other options given the environment at the time you, the bond seller, are trying to sell your bonds.

If there are more attractive investments out there or there is pessimism in the air, would-be buyers would offer a lower price for your bonds and vice versa if things seem to go swimmingly well.

So using the same example of a bond as above. If the market is willing to pay only $80 for your bond, the yield on this bond is now $5/80 which is 6.25% which is higher than the coupon yield.

This is exactly how and why yields change.

So, what is the inversion? And why it matters

An inversion happens when short-term yields are higher than long-term yields.

The short end of the curve is easy to explain because the Fed rate hikes have most influence on short-term rates and given the fact that the Fed has been raising rates since late 2015 and somewhat accelerated the hikes last year, the short end of the curve must have increased.

But what about the longer-term rates? Going by the logic in the previous section, this means that prices of bonds at the long end are much higher which is why yields at the long end have fallen.

This basically means that bond investors don’t mind getting less return for longer maturities since they expect things to get worse in the short-term and therefore, it’s a good return to “lock in” for the next X number of years. Furthermore, if a recession hits, the Fed will be forced to lower rates to ease monetary policy and when interest rates fall, bonds at the long end see greater capital gains as their Duration is longer*

The inverted yield curve has also freaked people out because the inversion of the yield curve has historically been a good leading indicator of recessions.

Final Thoughts

So while a recession may be imminent, I think we need to keep an eye on other indicators such as unemployment and payroll numbers etc. Singapore will obviously be hit bad in the event of a global recession since we count many of the major economies as our trading partners.

However, I think a recession and slowdown has been long overdue and maybe markets have already priced the worst in (or maybe, they haven’t) but we haven’t seen over-extended markets or exuberance like we have in the dot-com or GFC eras.

Personally, I’ve been on the defensive for some years and if the downturn comes, I’ll be one happy camper because it’s probably one of those moments that I’ll be able to deploy some cash.

Notes:
*Duration is a finance thing. Basically, it shows how many percent a bond price will change for a one percent change in interest rates.

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The Biggest Valuation Spread in 40 Years? (Meb Faber)

A spark of hope for those invested outside the U.S.

Shifting Risks in the Bond Market (A Wealth of Common Sense)

Yield curve flattening. ‘Nuff said.

The Rise of Netflix Competitors Has Pushed Consumers Back Toward Piracy (Vice)

Consumer behaviour is strange, isn’t it? Not really if you’ve studied econ 101. Basically, having to subscribe to other services means more cost for the consumer. Naturally, the consumer will turn to a cheaper (free!) option which is piracy. Content providers and creators can bitch all they want about piracy and the intellectual property rights but it’s their competitive behaviour that’s pushing consumers to the free option.

BBRG: Labor Market Is Doing Fine With Higher Minimum Wages (The Big Picture)

Another one for the Econ folk. Time to shut down the people who have only studied econ 101 and keep saying that a minimum wage will definitely cause an increase in unemployment.

It’s not so simple.

Given the rally in the markets from the start of the new year, a friend and I were discussing the likely direction of the markets. Now, we aren’t chartists nor are we professional economists or analysts* but my friend has a good sense for business and I…, well, I read a lot.

He was wondering about the potential implications of a slowdown in the Chinese economy and its impact on the world economy, and by extension, the world’s stock markets.

Based on what I’ve read, I think some serious shit could happen and I’ll lay out the conditions for it.

The Chinese Economy

It’s no secret that China’s economy is slowing down. It’s also no secret that the Chinese government has been trying to transition the Chinese economy from an investment-driven one to a consumer-driven one.

To a certain extent, China has been pretty successful in helping Chinese companies grow and gain the technological capabilities necessary for them to be world-class competitors.

If we just look around us today, many Chinese brands like Alibaba, Huawei, and Xiaomi have sizable shares of their respective industries. Within Asia, countries like Tencent (which owns the all-in-one app, Wechat) has also become so entwined with people’s lives that it’s going to be hard for their Western counterparts to gain a foothold. So, the bottom line is that it’s no secret that China’s investment-driven strategy has produced some results.

However, what many people outside of China probably don’t realise is how the Chinese government directed investment spending in China. It turns out that the Chinese government was leaving it up to the banks and its related entities.

And while the rest of the world recovered, this worked fine. Unfortunately, the returns started to slow down once the low-hanging fruit was picked and obviously, lots of money has been either lost through corruption or just bad investments.

The best examples of this are how much money was flowing into overseas property markets like Canada’s and Australia’s or how Chinese companies with non-existent business models (think bike-sharing firms like Ofo) expanded in so many markets so quickly.

In short, to paraphrase the Washington Post article in the link above, China’s debt-fuelled stimulus is getting less and less effective. Which brings us to the better question: What’s next?

China’s Gameplan

I’m not an expert on China but if I had to guess, China realised that returns on investment were slowing down due to diminishing returns and/or corruption were those who had access to the money were just misappropriating it and moving the money overseas into property and other forms of wanton spending.

Therefore, their solution to “pay off” the debt that was circulating in the economy was to have their domestic economy take over. If their households started to consume more and take on more borrowing in order to do so, the previously issued debts of the firms could be “rolled over” into newly created debts that would be borne by the consumers.

The second thrust would be for Chinese firms to expand overseas as much as possible to earn foreign currency. This would directly help pay off the debts created as it would be a return on the investment.

The third thrust is to have the RMB become more widely accepted as a reserve currency which is pretty much a variant of the first strategy as the world takes on more debt which “offsets” the amount of debt owed by Chinese firms.

What Could Go Wrong?

As 2018 showed, the Chinese consumer is not exactly picking up the slack from the firms. Although in part due to Trump’s trade war and the Huawei situation, Chinese consumer spending is projected to slow and evidence of it is showing up in the projected fall in iPhone sales as well as the drop in car sales.

As for the second thrust, Trump’s trade war, as well as a projected slowdown in most major economies, is making this strategy a no-go. Ofo looks like it’s preparing to go bankrupt which shows you how tight credit is in the startup space.

The third thrust is also unlikely to work even with China’s “One Belt, One Road” idea because that idea pretty much depends on China lending money to developing countries to build all sorts of infrastructure like ports and railroads. This means taking on more credit risk for the Chinese financial system which is the opposite of what China needs.**

Conclusion

Don’t get me wrong. It’s not like I don’t want China to succeed. China’s economy slowing will mean a lot of pain for the rest of the world. After all, it is the world’s second-largest economy. Much of Asia also depends on China to buy raw materials or supply us with goods.

What I’m saying is that China needs a lot to go right for it to restructure its economy and given the state of affairs in the world today, it really needs Trump to stop his ridiculous trade war and the fed to loosen credit so that Chinese firms can breathe easy.

Notes:
*Well, not likely those guys are likely to be any more accurate.
**Lending money to third world countries for infrastructure projects in which neither borrower nor lender has much experience executing is a disaster. China may have another agenda through this but that’s another story altogether. See Sri Lanka’s experience with their Hambantota port.


Do not pray for an easy life, pray for the strength to endure a difficult one.

– Bruce Lee

2018 hasn’t been a very good year for me – the stock market hasn’t helped with building my net worth, I fell had to take sick leave from work twice in the last quarter alone when I usually go a whole year without taking sick leave. At times, I haven’t felt like doing much either because of this sense of boredom and jadedness with life and work.

Within the family, there have also been some health scares. Earlier in the year, our cat had a little bit of tummy troubles following his visit to the groomers. Then, the older family members faced some health problems.

Thankfully, 2018’s about to be over. And we should recognise and celebrate the things that made the year great. These are my “Best of 2018” and I hope you find yours too.

Market Calls and Cryptocurrencies

One of the few things I identified right was how overhyped crypto was at the beginning of the year. Of course, by then, cryptos had already fallen quite a bit from the peak reached at the end of 2017 but let me pat myself on the back for calling the bullshit on the investment that is crypto.

3 Feb – More tales from the crypt(ocurrency)
14 June – So, who still wants to buy bitcoin?

But even more prescient than Crypto which I was largely skeptical of as an investment in 2017 was recognising the flow of easy money into the tech space.

10 July – State of the (U.S.) markets
11 Aug – State of the Markets (1 August 2018)

Now, before I get too swell-headed, I must confess that it’s not like I made profits from my views. I just got lucky that the tide against tech turned so much in such a short period of time.

Easy credit could have continued and I’d just as easily be labelled as someone who made a prediction and got it wrong. That’s the danger when shorting markets and unless you’re as experienced as someone like Jim Chanos, you shouldn’t do it.

This isn’t a how my portfolio did in 2018 post so I’ll leave it here. Look out for that when the year actually ends.

Learning New Skills

2018 was the year that I finally put whatever programming I picked up to good use. I wrote a script to automate some super bothersome tasks at work and if I had the time, I probably could write more scripts. I also messed around with some webscraping for stock data (shhh! Don’t tell anyone.) and I guess the next step would be having that data on a site for everyone to view. More importantly, I created a page to document the STI’s PE10. It went live at the end of July and I update it every first day of the month.

You can check it out here.

I’m hoping that in the not-too-far future I’ll have the chance to learn programming with a little more guidance and that I’ll actually have a chance to create sites that are useful. Best part is that I’m going to have my job give me time off (with pay!) to go do that. That’ll probably happen end 2019 or in 2020.

New Knowledge – habit formation

If I didn’t learn anything new all year, then that year would be a certain disaster.

James Clear’s Atomic Habits is easily one of the best things I’ve read this year. He gives really sound strategies on how you can form new habits and ditch bad ones. In fact, I didn’t know it then but I was using some of the same strategies to lose weight and practice mindfulness meditation.

This led me to cut sugar from coffee and I’ve lost even more weight than before and am at the same weight that I was in high school. Once again, the message is instructive – you have to make it a paradigm shift/lifestyle change rather than use willpower to make the change.

To drive the point home, let me give you another example.

I also developed the habit of writing roughly 3 blog posts a week this year and while it isn’t much, that’s helped boost traffic to my blog this year.

My blog stats across the years…pathetic but hey, this is a personal blog after all. I’m writing for personal amusement and not to bring in some dough.

You can see that this year is the year where, apart from April when I was on holiday for a week, the views each month were consistently above 2,000 (coloured blue). So what gives?

Well, the main things that happened was (1) that I finally got my new device, and more importantly (2) my wife started going to gym every weekend.

What has that got to do with anything? Well, every weekend, while she at the gym, I pumped out blog posts over coffee while waiting for her to be done.

This is precisely what Clear was talking about in his book. New habits need to have some place in your routine in order to become part of your life. This might be particularly instructive for some people as the new year is coming around and new year usually means new resolutions. If you really want to achieve something in the new year, you need to change your habits and not just hit some targets for a couple of weeks through sheer willpower.

Personal Front

On the personal front, this year marks the 6th year that my wife and I have been married and I couldn’t be happier. I’ll be lying if I said that we are happy 100% of the time but I’m pretty sure that on average, we’re happier together than we are apart.

I need to work on communicating with my wife more. Maybe it’s a guy thing or it could be just me but I’m not very good at communication (that’s why I have this blog!).

Our cat is also just the best thing that’s ever happened to us. He’s the one thing that makes me wake up at 6:45 am every single day and he really bosses me around until he gets his food. Then, he’s just the sweetest thing who will do whatever he wants: chilling under the bed, on his cat tree, cat window or on the sofa because he wants some attention from us.

This is his first full year with us and I know he’ll be with us forever. If you love cats, check him out on Instagram (@kingteddy_thetabbycat). Also, please donate to the Cat Welfare Society if you can. If you want a cat, adopt. Don’t shop.

2019, please be nice to me

I hope 2019 will be good for you and if anything, I’ll be working on the things I can control – my emotions, my temper, my actions, my reaction to events that are out of my control.

Goodbye 2018.

Markets have had a horrible December so far. For those outside the U.S., the whole year has been terrible. The problem with all of this is it only seems like it’ll get worse.

Here’s an opinion piece by former banker, and author, Satyajit Das, that was on Bloomberg and republished in The Business Times:

THE “everything bubble” is deflating. The fact that it’s happening relatively slowly shouldn’t blind us to the real threat: The world is dangerously underestimating how hard it’ll be to deal with the fallout once it pops. 
 

Frothy markets can’t disguise the warning signs. The shift to tighter monetary policies in the West is putting pressure on global equity and real-estate values. Even more critically, it’s weakening credit markets. Over-indebted emerging markets face headwinds from rising borrowing costs and dollar shortages. 

I don’t have any particular insight into the financial sector or the rumblings in the corporate debt markets but from what I’ve been reading, it seems that tighter credit markets have finally hit home.

What we’ve yet to see a a major default by a corporation that is Too Big To Fail. Once we have that, it’ll be the catalyst for a further drop in the markets that will take markets down to bargain bin territory.

A Market of Our Making

The funny thing is how this whole mess is a market of policy missteps. Barry Ritholtz made a good case for how Trump basically did everything wrong – he did a terrible job replacing a Fed Chief that’s more partial to a gradual tightening with one that’s more hawkish. He also screwed up on trade with his trade policy, and now it seems that he’s bent on taking the U.S. close to a shutdown.

Over in the U.K., things aren’t looking so hot either and you can argue that it all started with David Cameron’s promise of a referendum on Brexit. Now it seems that lawmakers can’t agree on Brexit and the deadline is looming.

Closer to home, one Dr. M across the Causeway isn’t making things easy for us. What and how big the fallout will be from the increase in tensions between Singapore and Malaysia remains to be seen but I’m pretty sure that any major hit to our economy and markets isn’t going to come from Malaysia.

Take cover but be ready

In short, I think things could get worse before it gets better. This is particularly true for U.S. markets because valuations there haven’t come down as much (major indexes there have only just reached correction territory).

For the local markets, things are cheap but we’re not quite at basement bargain levels. We’ll need at least another 7-10% drop in the index to take us there. And at that point, people invested in more leveraged counters like REITs will be feeling a lot of pain.

Let me state it up front: I’m not a fan of products offered by insurance companies.

Photo by Pixabay on Pexels.com

In Singapore, insurance companies no longer just provide the pooling and spreading of risks. The industry underwent a transformation decades ago that rebranded insurance agents into financial planners.

The message there being that financial planners no longer just help you plan to avoid unfortunate incidents that can happen but also prepare for the inevitable which is that one fine day, you’ll stop work but still need money i.e. retirement.

An Agency Problem

As Buffett once said, “Never ask your barber if you need a haircut.” Similarly, the common model of compensation for financial planners is a commission based on the dollar value of products that they sell. On top of this, the agency that they belong to typically has a quota that they require to meet. Add to that the problem that most people don’t really understand statistics well enough to make an informed decision and you have a recipe for being sold products that you either don’t need or is designed to benefit the seller rather than the buyer.

I’m not saying that financial planners are inherently dishonest. I’m just saying that most of them are telling you things that the marketing material tells them rather than what a person really requires for financial independence.*

Enter AXA’s latest product

Kyith over at Investment Moats did a breakdown of this product that promises escalating payout over the years. This deals with the problem of inflation (which is fantastic since most products don’t) and if you get this plan, you probably can be relatively assured that you retain purchasing power as you age.

So what’s the problem with this product?

Well, as Kyith calculated/estimated, the returns for this product (depending on the performance of the non-guaranteed portion) is probably anywhere from 1.92% to 3.75%. At the high end, that is scarcely better than the 10-year Singapore Savings Bond which has virtually no default risk.

Now, I’m using AXA’s product as an example. I don’t believe the other insurance companies can provide anything much better because their costs would be about the same and for them to generate more alpha (i.e. higher returns than a similar competitor) would be to take on more risk which may not be allowed by regulations.

There are much better alternatives

I would even argue that for such long time-frames, you could put your money in equities and expect much higher rates of return. While financial planners may argue that equity returns are non-guaranteed, I would say the same for their products. I would take my chances with the lower cost alternative which is a broad-based market ETF or index fund.

Buy Term, Invest the Rest


As far as insurance is concerned, I would remember the quote above. Buy for protection and learn how to generate returns on your own. You don’t really need an organisation to add layers and collect fees for doing nothing much more than “helping” you to invest. There’s so much information on the internet and anyway, most of us can’t really do much better than the market anyway.

Notes:
*By way of reasoning, my challenge for financial planners is to show me a successful planner who made money from actual financial planning rather than their commissions.

It’s been a terrible week for me. I was pretty much in bed for the first two days of the week and I couldn’t eat much until Thursday. Thankfully, I’m feeling close to a 100% now.

Hope your week ahead won’t be anywhere near as bad as mine was this week.

Photo by Mikes Photos on Pexels.com

The Big Read: Cryptocurrency crash offers industry the reality check it needs (TODAY Online)

Great read on the aftermath (yes, you’ve read it first. I’m calling it an aftermath) of investing in Cryptos with accounts from those who had substantial (relative to probably their own net worth) skin in the game.

Good lessons abound and I wish I had kept better records or accounts of what was happening in ’07, ’08 and ’09. I was only in university then and beginning to start learning about the markets but I remember how some guys were trading warrants and making/losing 5-figure sums in the room that us Honours year students were given to use.

That was in ’07 and of course, we know what came after. I would have liked to remember a little better how I felt about the markets in ’08 and ’09 because the sentiment now in 2018 certainly fits those times better.

Of course, in recent times, we haven’t seen the participation of the masses in any widespread, crazy speculation (apart from a tiny group in crypto) so my question now is: What is the next shoe to fall?

As Singapore’s population ages, I suspect we’ll see this sort of thing start to pop up as well. I mean, we hear of elderly folks being conned of their CPF savings through various means (appealing to their vices, taking advantage of their less-than-once-stellar mental faculties etc.) but I’m waiting to see if it happens at the financial institutions level.

I suspect it’ll come from the financial institutions offering a product that isn’t actually designed to give returns much better than the risk-free rate but with all the “protection” of a bond. That sounds like Structured Products which kind of gave banks a bad rep but if you know of anything new, do let me know. It’s fascinating stuff really.

Russell Napier: Equity Markets and Structural Change (Enterprising Investor)

A plausible sounding narrative for where U.S. markets are headed in the longer term. Not optimistic but if it does happen, it would provide a good buying opportunity.

Could we Model Our Retirement Spending like Endowment Funds? (Investment Moats)

Sharing this not because it’s a new idea to me but I think it could be a paradigm shift for many people.

Most people aim to accumulate a certain sum before they retire and upon retirement, spend down the sum and upon their deathbed, leave the rest for their beneficiaries.

It’s not that I think that’s wrong but I think the pros of acting as if your money should last forever outweigh the idea behind spending it down.

For starters, aiming to have the accumulated sum grow/last forever means greater prudence in spending. It also means greater prudence in investing as it requires a proper plan for investing the money instead of sticking to investments that guarantee the principal at the expense of purchasing power.

The biggest downside is what the growing sum of money is meant to do. If the beneficiaries are too few, you end up with a generation of spoiled heirs who will eventually squander it all.

Updated the STI PE10 stats.

airport bank board business

Photo by Pixabay on Pexels.com

 

As of 1 Dec 2018, the STI closed at 3,117.61 with a PE of 11.53x. That gives it a PE10 of 12.6x or if you prefer, a ten-year average earnings yield of 7.94%. On this basis, markets haven’t been this cheap since early 2017.

In fact, the STI was cheaper just a weak ago which shows us how fast sentiments can change. The STI would have been cheaper still if we go back to late October where it briefly dropped below the 3,000 mark.

Over in U.S markets, November was probably a horrid month for most investors. Major drops in the Dow, S&P, Oil and even Bitcoin marked a month where the only refuge was in cash.

 

 

 

In case you weren’t following the crypto scene, “hodl” is a typo for “hold” and someone that became a meme for crypto fanboys to buy and hold crypto for the long run.

close up of coins

Photo by Pixabay on Pexels.com

As Josh Brown reminds us, this week is roughly the one year anniversary of when most of the world suddenly realised that people were “making tons of money” from investing in something called “bitcoin”.

Plenty of other cryptocurrencies followed but we haven’t really heard of the widespread use case being implemented. That basically means that the usefulness of bitcoin and other cryptos have not been proven yet. The only thing that has been proven is that the technology consumes a shit ton of energy.

I hate to say I told you so but I told you so (here, here, and here).

The next shoe is already dropping

airport bank board business

Photo by Pixabay on Pexels.com

By the way, remember when I said that bitcoin and cryptos were just a symptom of easy money going into certain areas of the market and those areas ride a lot on optimism which has a high chance of not coming true?

That whole setup largely explains why tech has been getting hammered the way it has. Just a few months ago, we were talking about companies with trillion dollar market caps. As of today, Apple’s market cap has fallen to just under $750b and is no longer the largest publicly-traded company as measured by market cap. As of writing, that honour belongs to Microsoft.

Now, don’t get me wrong. I’m not saying that Apple is a lousy investment or a company on the brink of disaster. What I’m saying is that the fact that what’s happening in the markets right now is all a reflection of Mr. Market’s mood swings. Just a few months ago, he was totally positive on tech which propelled Apple and Amazon to trillion dollar market caps. Right now, the bipolar Mr. Market is obviously running the other way.

 

In local news

So what does all the above mean for the local market?

Surprisingly, the STI has held up relatively well despite the carnage in tech. Possibly because the STI is financials-heavy and our markets don’t really have a huge pie in the tech sector. The property and financial sector will hit the STI much harder than anything in tech and to be honest, those sectors have been hit pretty hard already in the last few months.

However, MAS has come out to warn that interest rates are on their way up and that households need to “be prudent”*. For some months now, I’ve been saying the same thing. That if mortgage holders aren’t able to service their loans with an interest rate of at least 3%, then they need to be very careful.

The STI is going to fall much further if an economic downturn happens and interest rates in the U.S. continue to march upwards as that will directly impact defaults in the loan sector. I mean, what could be worse than losing your job while your loans get more expensive?

Having said that, valuations on the STI are not demanding. If you ask me, it’s on the cheap side (but not dirt cheap!) but the macro headwinds seem to be blowing hard.

Notes:

*It’s nice that MAS gives a mention that interest rates in SG are closely linked to rates in the U.S. If you want to know why, here was my take on it.

Sorry for the late notice but the PE10 has been updated.

airport bank board business

Photo by Pixabay on Pexels.com

 

Following the selloff in the last week of October, the PE10 reached lows that we haven’t seen since early 2017. At a PE10 of 12.2x, that translates into a 10-year earnings yield of slightly over 8%.

It’s cheap but it certainly isn’t dirt cheap. Dirt cheap would be when the PE10 is hovering around 10x average 10-year earnings. That would mean that the STI would be at levels of around 2500 or so.

Having said that, there’s no guarantee that the STI will fall to those levels. The market has run up a bit since I took the reading so who knows where we’re headed. What I’m confident enough to say is: based on what we’re seeing in the market, we’re certainly close to cheap than expensive.