Every month, I publish an investment note called “Ivan’s Reflection”. The purpose is to document my thought process so I can review if they are right and wrong in the future. Note this letter is exclusive to my clients. It creates transparency for my clients and forces me to be accountable for my investment decisions so I can improve in the future. So by the time you read this, it is already a few months since it was written.
You contact me to understand more about my investment management services. Below is my reflection on April 5, 2020.
- COVID-19 and Oil Crisis is a 1-2 punch which caused turmoil in the financial markets.
- However ugly the current situation is, it is eventually just a blip in your investment journey.
- Focus on your original investment objective and stick with the plans.
- If you invest for growth, drip into the market when the asset prices become cheaper.
- If you invest for income, focus on passive income from the portfolio instead of capital value.
- Stay invested, diversify, and keep some dry powder in case markets move lower.
- If you stop investing now, you may miss one of the biggest bull runs which happens once every 10 years.
Warren Buffett is wrong
When asked about his opinion about the stock market in early March, Warren Buffett, known as the “king of stock investing” told the reporter that he had only seen “circuit breaker” once in his lifetime (in 1987). (Circuit breakers are regulatory measures to temporarily halt in trading on an exchange, which is in place to curb panic-selling).
The 89-year-old said this confidently,
“If you stick around long enough, you’ll see everything in markets,”
Warren Buffett obviously didn’t see everything. In the next 10 days after his interview, he has witnessed 5 more circuit breakers. It became a joke in the financial world:
- On March 8, 2020: Warren Buffett said, “I have lived 89 years, I have only seen one circuit breaker”;
- On March 9, 2020: Warren Buffett said, “I have lived 89 years, I have only seen two circuit breakers”;
- On March 12, 2020: Warren Buffet said, “I have lived 89 years, I have only seen three circuit breakers”;
- On March 16, 2020: Warren Buffet said, “I…”;
- On March 18, 2020: Warren Buffet said, “I am too young…”
You may remember I told you this horse-may-talk story last year during our client get together seminar. When you investing for the long term such as retirement, anything can happen. And we don’t know when and how it will happen.
There was a global pandemic before, there was an oil crisis before, there was a debt crisis before too. But it has never been a time when all the 3 crisis happening at the same time in history.
No financial model could forecast and manage such repetitive shocks (anyone who “missed” it are just lucky). This makes the risks management and portfolio positions extremely difficult.
Nevertheless, I want to remind you, which I have repeated many times before, a bear market is part and parcel of your investment journey. When we talk about 8% to 10% long term returns, that is not only including good years but bad years like now already. It is an average return.
In fact, over an investment horizon of 30 years, you will likely experience 8 to 9 bear markets, and this is just one of them. Bear markets have short life spans (1/4 of the time), and markets generally trend upwards 3/4 of the time. As terrifying as it might feel in the throes of a bear market, there is no need to lose your sleep.
There is also no need to read too much of the headline news of the exponentially increased number of new COVID-19 cases and global lockdown. Forward-looking markets already prepared for economic pain when they began to tumble 30%. The market always knows first!
The moments of truth will emerge in the weeks to come: Can we slow the spread of the virus? Can the monetary and fiscal policy measures produce the desired effect? How will the conflicts between the Saudis and Russia dissolve?
You can do everything correctly, but still, lose money
The US stock market crash, which subsequently led to the global stock market meltdown, is not an unforeseeable event. GMC portfolios are prepared for this. If you read carefully about my updates in the past few months, here were my comments:
- Global assets are overvalued and we need to be cautious about any downturn.
- We limit US stock exposure to be below 30%.
- We have diversified the portfolio to a wide range of assets.
- For stock selection, companies with good cash flow and fewer debts are preferred.
- Global central banks do not have sufficient interest rate to cut and thus monetary policy will NOT work.
- Global governments will have to issue big stimulus fiscal packages.
At that time, these seemed to be good plans, and thing generally turned up the way they were predicted. but the portfolio still suffered greatly in March as the oil crisis was unexpected. It was a 1-2 punch!
Why I avoid REITS now
Some of you asked me why we were NOT investing in S-REITs (Singapore Real Estate Investment Trusts), which was purported as a safe haven. Because REIT is not a safe asset to start with.
The March situation is that no matter what you invest, safe or unsafe, you would have lost money. Below are all the performance of major stock markets and bond markets. I have explained the reasons in my interim updates to you in March.
Even the traditional safe assets such as US Treasury Bonds and Gold have seen more than 30% volatility in a short span of weeks.
Income Portfolio did worse than Growth Portfolio
The Income portfolio was designed to generate passive income so you can retire comfortably. It was designed to be more diversified and less correlated to the stock market. If you have invested in Income for a while, you know this has proven to be the case.
However, if you are in the income portfolio, you may have noticed a notable underperformance of income portfolio comparing to the Growth portfolio during this period and you may wonder why.
The issue that we are facing now is a collapse of all asset prices at the same time. As mentioned earlier, this is a rare event that has a 0.1% chance of happening.
Income assets are generally asset-heavy and relatively less liquidate in nature. Think about your house, you don’t get a daily valuation of your property, that is why you feel it is stable.
In a crisis like this, the price of many income assets is distorted due to a liquidity crunch. As the financial world is avoiding debt, assets such as property, preferred shares and infrastructure faced a severe sold off than many other assets.
Worse still, the oil price war has caused more damages to the infrastructure stocks as the sector is heavily exposed to energy. Think about your power station, oil plant, etc. So it was a double whammy.
What should we do next?
I mentioned earlier that if you invest for retirement, you will encounter 7 to 8 such bear markets. Which means that ¼ of your investing period is in a downturn like this and ¾ of the period are in bull markets.
I have thought about this long and hard for the past few weeks.
- Should we hold more cash?
- Or should we take the opportunities to buy more?
To get this started, we need to go back to the basics of why we are investing.
Investing for Growth
Your goal is to grow your wealth to a target number in x number of years through capital investment and regular contribution.
We all know that market goes in cycles.
Should you stop contributing just because the market is down? As we know you probably spend ¼ of the period in a bear market and ¾ of the period in the bull market, you will miss the biggest rally if you are not preparing bullets during the bear markets.
Basic math will tell you that even a 40% market crash doesn’t derail your wealth-building process as the 6% to 8% long term projection already factored in the crashes over the years. Some years you make, some years you lose. It is part and parcel of the investing process.
So I propose to continue contributing whatever we have planned, provided that you have set aside 6 months of emergency cash.
Investing for Income
Your goal is to rely on the portfolio’s passive income to fund your retirement. If you have invested a condo and collecting rental as your passive income, would you quickly sell your condo if the latest valuation showed that it has dropped 30% in value? You probably won’t. Because your objective is to collect the rental income.
The same goes for Income Portfolio.
Now imagine this period is your retirement days, no work, no pay. Your income has stopped but your expenses continue. This is a very good period for you to stress test your retirement strategy.
- Can you rely on the passive income to cover your expenses from this portfolio? The answer is yes.
- Do you really need to care about the value of your portfolio? Probably not.
Therefore, I propose you start receiving passive income from this portfolio and see if it works. If it doesn’t work now, it won’t work for your retirement. Because the time you retire, you still have more than 30 years of relying on this.
What if there is a recession?
“I heard that a recession is coming, shouldn’t we hold cash now?”
Fear feeds itself. Recession is a scary word that can be easily passed around. Some saying that it will be like the 2008 financial crisis, some even suggest that the 1929 great depression is coming.
Let’s think about this logically.
Does a stock market crash derail your retirement plan?
Just like when the market is good, everybody was saying that it would continue to go up. When the bad days come, the doomsayers are everywhere now.
The latest US stock market crash has a resembles 1987 crash in terms of speed and scales. If you look at the chart below, it looks as scary as today right?
But if you look at the next chart, it is what has happened since then. I bet you can easily find the 1987 crash, which is just a blip in your investment journey.
I want to highlight this to you and you understand what a stock market crash means to your investment.
A stock market crash is disastrous only if you give up investing (holding 100% cash) after it happens!
Every recession is different
Most people have little experience in the recession because “we are too young”. Yet few people bother to conduct a deep study of recession and just pass the words around.
People like to repeat what others say, without knowing if they have heard it correctly in the first place. – Ivan Guan
Recession is a complex topic which takes a book to explain. But I just want to draw the conclusion first: 1929 and today are not the same. Although it doesn’t mean that the US won’t go for the recession or depression, the way it will go through is not going to be a replica.
1929 was a US recession. At that time, the US is not the most powerful nation in the world yet. At the same time, the US was still on a gold standard which prevents them from printing money. This means they cannot “export” their problems to the other parts of the world as effectively as today. The crisis worsened due to tightening at the wrong time.
Today’s situation may be more akin to the 2008 global financial crisis:
- There is an asset bubble due to uncontrolled corporate debt issuance (in 2008 it was housing debt).
- The bubble in 2008 was subprime loan derivatives which blended good loans and bad loans in one vehicle. This time, it is the trillion-dollar ETF industry which blended good stocks and bad stocks in one fund.
I envision the end story of this bubble bust like this:
- Bad assets will be shaken out from the index and good assets will be picked.
- Active management will play a vital role in riding through this crisis by avoiding obvious bad assets.
- The US will still try to “export” the damage to the rest of the world by the traditional weapons that they have: dollars, military intervention, technology control and may ultimately become unscratched.
- The countries who do not have an independent monetary policy, and borrowed using foreign currencies, will pay for the bills.
But the wild card is China. Let me give a bit of explanation.
Why do people say “when the US sneezes, the world catches a cold”?
Since World War II, the US became a dominant power in the world. They successfully suppressed the rise of Japan (the 2nd largest economy then).
With the rise of Chinese power as the second-largest economy, Donald Trump tried to play the same trick to China and started the US-China Trade War. Things went well, but COVID-19 disrupted the whole situation.
This article from Straits Time, US goes MIA in Asia as disease surges, has a good summary of the situation while the US has lost its affluence in Asia this time. The chart below shows that the US stock market (in blue) and China stock markets (in orange) have vastly different behaviours.
Ride along with the market
Our main objective in this challenging environment was, and remains twofold:
- Reduce portfolio risks.
- Keep the rebound capacity.
You may think it is scary for the market to fell 30% in 19 days. Do you know how many days does the market take to recover? From March 24 to March 26, it took the US market 3 days to recover 20%!
Do you know what does it mean? If means if we have sold all our US stock holdings on panic, we are 20% behind after 3 days. Luckily we didn’t.
But it is practically a challenge to achieve both at the same time.
- If you reduce the portfolio risks by holding cash, you will miss the future rally.
- If you take on positions now, the market may drop more.
Given the current price level and macro outlook, the efficient market should have priced in the worst. Therefore, it would be relatively safer to stay long.
Though it is a painful decision, my judgement call is to ride through this market.
Stay Invested and refrain from panic selling
- Even the most hardcore bull can lose its mind during a sell-down.
- Even I myself can be emotionally affected during this period. Thus taking a side is important.
- Selling in a downtrend market is a relief for your pain, but it is not a wise choice.
Maintain portfolio diversification, refrain from being overconfident in any investment ideas
- Diversification reduced the downside risk, but not necessarily sacrifice the return.
- By reducing the portfolio’s volatility by across asset classes, geography and sectors help smooth the returns.
Buy more stocks when the market is down, sell more when the market is up, selectively
- Hold on dry powder in case markets move lower.
- But buying selectively.
- Focus on quality and capital appreciation, abandon income and value.
- Trust active managers can do a better job to pick the best stocks than the index.
- We want to be 100% equity at the end of this bear market, not 100% cash.
The recent stagnation of the market shows that everybody is waiting. Which is a good thing, because it means the extreme fear is disappearing. The fear index, VIX, has reached near 2008 level 2 weeks ago, and now it has dropped nearly half.
I think as long as the COVID-19 escalation slows down, the market will start to go up.
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