The global stock market has just had an amazing rally in April despite a looming recession ahead. Do you feel puzzled and frustrated by this? Did you sell your stocks in March or were you waiting on the sidelines?
The further we get into this global lockdown due to the COVID-19 pandemic, the clearer the extent of the economic fallout is becoming – and it is not pretty. The IMF has already stated that the coming “Great Lockdown” recession will be the steepest in almost a century. They warned that the world economy’s contraction and recovery would be worse than anticipated. Back home, MAS has confirmed that “the Singapore economy will enter into a recession this year”.
But why has there been such a disconnect with the stock market? Where is the second wave of a stock market crash that everybody was talking about? What about a 1929 kind of depression? Won’t there be a recession after all?
What is happening today is hardly a surprise to me. If you read my article on March 13, “The stock market plunged: should you buy or sell now?”, I outlined how the market would recover and to which level it could go. I didn’t have a crystal ball, but it was a high probability event to me.
Today, I want to dive deeper into this topic. I want to explain to you why the market behaved this way and what you may expect in the future.
Why do stock prices go up?
Most people think that a company’s stock price goes up because the company is solid and profitable. But this is only half the story.
The stocks you and I buy and sell are publicly traded “free float” shares. Once the company lists its stock, it largely depends on the supply and demand of the market. However, the fact is that “money flows” affect stock prices more than other factors nowadays.
Think about it, if you own the stock of a “good” company, but nobody wants to buy from you, do you think the share price will go up?
To understand this point, let’s revisit a scene in the movie “Crash Landing on You.” In Episode 5, the super-rich South Korean Yoon Se-ri, who was in desperate need of cash in North Korea goes to a pawn shop. She wants to pawn her 2019 FW limited edition “Chopard Happy Sport” watch which she had bought for US $80,000. She asks for US $20,000 and thought the pawnbroker was getting a good bargain.
However, the pawnbroker valued it by weight and decided it was much too light to be worth anything. He paid her just 20,000 ₩ (US $22) for the exchange!
Although the stock price may “peg” to the company’s fundamentals in theory, most of the stock price movements day to day are not due to any change in the company’s fundamentals, but rather the number of buyers and sellers.
If we think about the stock market as representing the collective value of the underlying stocks, you will realize that “money flow” is the primary reason for boosting stock prices in recent years. There is simply more and more money pouring into it, including the many share buybacks by the companies themselves.
People often talk about how Warren Buffett made money by investing in stocks. But few people realize that anyone who simply stayed in the market for that long could amass a similar fortune, because the baby boomers were just adding more and more money in the US stock market. You didn’t need to be smart, you just needed to stay invested over a long period (measured in decades).
No matter how good a company is supposed to be, if there is no buyer, the stock price won’t go up. In fact, if the stock price is sluggish for too long, the company may choose to privatise the company to gain control and realize the value. That’s why we have seen a wave of privatisation occurring in the Singapore stock exchange in 2018 and 2019.
Additional reading: Privatisation: a new norm in the stock market that affects your retirement.
Why did the US have the best stock market performance in the last decade?
Once you understand that “money flow” is the key driver for a stock market rally, it is not difficult to understand what the financial world went through after the 2008 global financial crisis.
If you had been investing in Singapore stocks for the past 10 years, you made less than 20%. But if you had invested in the US market, your return would be a whooping 200% – even after the recent correction!
Additional Reading: 3 Myths of STI ETF Investing.
That is why I always said that you should always invest globally. Many Singaporeans only invest in Singapore stocks because they are familiar with the names, but you can’t use the same investment strategy for the US market to invest in other markets.
Additional Reading: How to invest as an Asian Investor
If you look at the chart again, the stock market performance from even the second and third-largest economies, namely China and Japan, are also far behind. Why?
You probably know that the US has printed a lot of money through quantitative easing after the 2008 global financial crisis. With so much money flying into the market, it was not surprising that the demand for US assets was high and thus the prices went up.
In fact, not only did US stocks go up, but the US bond markets and the real estate market went up tremendously as well.
So it is not difficult to understand why the market cheered recently for the large (and for now unlimited) asset purchases launched by the Fed and other central banks globally. The market says, since the Fed has bought investment-grade bonds and high yield bonds, maybe they will buy stocks sometime in the future too.
But just printing money and supporting assets by the central banks are not enough. Other central banks, such as the Bank of Japan, have done it for a long time, but it hasn’t worked out well for them.
What is so special about the US stock market?
I talked briefly about this question in this article discussing the US-China Trade War. It is not an easy subject, so let me just summarize three main points.
- The US Dollar – The 1945 U.S.-Saudi agreement created the petrodollar. The US dollar became the preeminent currency globally (until now) because it is used for international trade, including oil. The wealth of many non-US countries is linked to the “value of the dollar”. If you understand that a country’s “interest rate is the price of its currency”, you may have some idea why the recent aggressive moves of the US interest rate shakes global markets.
- US Technology – for many parts of the world, you can’t live without US technology. From the Windows operating system and office software we use, to computer chips and the global network infrastructure, the US has a dominate position. You can choose not to drink coffee at a Starbucks, but you can’t live a modern life without US corporations taking a profit from it.
- The US Military – the presence of the US military is to re-enforce the first two points. The United States engaged in forty-six military interventions in other countries from 1948–1991. Incredibly, from 1992–2017 that number increased fourfold to 188! And many of these interventions happened in the Middle East. This is how you can better understand the recent oil crisis, which is caused by the conflicts between the Saudis, Russia and the US.
Of course, given this favourable macro backdrop, the US has produced many excellent companies and they developed the most advanced financial market now.
Will this continue? The world has long talked about “de-dollarization”, but no one has succeeded. The Yen failed, the Euro failed. Now the world’s eyes are on China, and that is the main cause of the US-China trade war, because it is against the US’s interest.
I don’t know if you have watched the Korea 2013 movie “Flu”. It is a nice show and you can relate it to today’s COVID-19 situation. In the show, the “United States Forces Korea” was supposed to bomb the infected Korean civilian, but the situation was saved by the main actress’s daughter, Mi-reu. (Lucky us that we don’t face the same situation today.)
Like it or not, the US has the largest economy, the best financial market and the largest companies. If any market were to recover from the recession first, I would put my bet on the US (though it doesn’t mean the rally will last forever).
But there is a wild card today, which is China. With the US sovereign debt going to zero interest, will China become the next safe haven? It is interesting to observe. Economics 101 will tell you that once a country goes down the path of printing money and becomes hugely indebted, its currency will depreciate. But then, why is the US dollar standing strong for now?
Additional Reading: Why a foreigner should invest in China A-shares.
Why does the US care so much about the stock market?
The US government has a long history of supporting the stock market.
After the stock market crash of 1987, then-Federal Reserve Chairman Alan Greenspan cut interest rates aggressively as a commitment on behalf of the central bank to support asset prices. This was called the “Greenspan Put”. (The term “put” refers to a put option, a contractual obligation giving its holder the right to sell an asset at a particular price to a counterparty, in this case, the government.)
Later, during the 2008 global financial crisis, then Federal Reserve Chairman Ben Bernanke continued the tradition for another round of the “Bernanke Put”.
Last year, the so-called “Yellen put” (after former Fed Chairman Janet Yellen) rolled over into the “Powell put” (after current Fed Chairman Jerome Powell).
US President Donald Trump clearly views the stock market as a key barometer of his own success as a leader. After all, it was only when the market plunged in March that Trump began to treat the pandemic with the seriousness it deserved. Why?
Well, unlike we Asians who like to save, the American’s wealth was built on the stock market. The rise of the US 401(k) retirement plans (similar to Singapore’s CPF) and shifts in allocation by pension funds seeking higher returns, have democratized equity ownership. Based on the American Association of Individual Investor’s survey, an average American has nearly 60% of his personal investment in the stock market!
It is a no-brainer that any politician who wants to win the election has to take care of the stock market.
Unfortunately, Singaporeans are doing the opposite. In one of my articles from 2014, I highlighted that Singaporeans have one of the highest savings rates in the world.
Additional reading: What do Singaporeans invest in for retirement planning?
This is nothing to be proud of because it means that we are severely under-invested! It is also the cause of our sluggish Singapore stock market and people’s craziness about property investment.
You are not immune even if you are not investing!
You may say, I don’t care, I am not investing anyway. I just put my money in the CPF and the property market. You probably can do this if you are in the US or China, but not if you’re in Singapore. You are underestimating how the global macro trend affects your personal wealth.
CPF won’t escape a global recession
Many people have talked about the good interest rate the CPF offers, but few care how the return is delivered. The CPF interest rate was never guaranteed, and it is exposed to the same investment challenges which everybody is facing today. The government has done a good job maintaining a stable rate for a long time, but now how long can they continue to do so in a zero interest rate environment?
The property bull market is over
We all agree that investing goes in cycles but somehow most people believe that prices of residential property, especially the ones in Singapore, will always go up. Maybe over a very long period, it will, but it is probably longer than you can imagine. Do you know how many years it took for Singapore property prices to recover from the Asian Financial Crisis? 13 years! Your wealth could have multiplied a few times if your money had been in the US stock market instead.
I talked about this concept in this 2014 article when MAS tried to ease the property cooling measures. I was a strong believer that soaring property prices had done more harm to Singapore than good (look at the miserable Singapore stock market for the past 10 years). A cleansing process is needed. The last thing we want is another frantic wave of selling en bloc and aggressive land bidding by developers.
Additional Reading: Why is the ease of total debt servicing ratio restriction disappointing?
And I fully support our government’s stand today when they say that despite the COVID-19 situation, there are “no plans to ease property cooling measures”.
How to navigate through this recession
If you want to survive this recession, you need to know how this will end. Recently, I had an interview with Channel News Asia 938 and I talked about a few things:
- How does the current situation differ from global recessions of the past?
- Should you cash out of the stock market?
- Is it time to buy REITs and blue-chip stocks?
- Is Dollar-Cost Averaging a good strategy now?
- What do you need to do to ensure that your finances are in good shape?
You can listen to the 15-minute recording below if you missed it.
With global central banks aggressively printing money, it seems that the stock market has been saved. But that is the US stock market, not Singapore’s. There is no free lunch in the world, who will foot the bill?
If you are not an average American, things may not look as rosy as they seem. With broken supply chains and closing of businesses, we will run into rapid inflation at some point in the future.
I know you are not feeling it because we have been in a deflation environment for too long and most people are numb about inflation. But mark my words,
Inflation is how wealth is transferred and how debt problems are resolved. – Ivan Guan
Think about it this way, if you borrowed money to buy a property, you have a huge debt that you cannot pay off in your lifetime. But what will happen if inflation comes? Suddenly you can pay off your debt easily because the amount you borrowed is in fixed dollars; but, your earning power will be relatively higher.
That is why a recession along with inflation are both necessary for the financial world to move forward. Recession and inflation do two things:
- A recession pushes companies into bankruptcy so that their debts are written off at the expense of creditors (the bond investors)
- Then, a recession paves the way for inflation to reduce debt in real terms at the expense of savers.
This is the wealth transfer process that many people have no clue about. You will see an increase in asset prices but no increase in purchasing power.
We were all taught that tomorrow is better than today. What a recession does is the reverse. What if today’s dollar is worth more than tomorrow’s value? What if a squanderer lives a better life than a saver?
Practically, it is very challenging today to invest and at the same time to reduce risks.
- If you reduce your portfolio risks by holding cash, you will miss the future rally.
- If you take on stock market positions now, the market may drop even more.
That is why you need to re-evaluate your portfolio and think about what assumptions you made based on when you bought certain investments. This re-evaluation is important because there will continue to be a disparity between what you think and how the stock market will perform in the future. You need to see which asset classes the market is giving a thumbs up to and which asset classes the market is dumping like the plague.
If you are following the herd, you may not make a quick fortune. But if you are going against the herd, you have a high chance to be wrong. You need to think about which assets have the ability to preserve value and that is where the money will flow too.
I also want to caution you that at this level, the stock market is no longer cheap. You need to be extremely mindful not to take excessive leverage during this period as you don’t want to be caught in the situation to force sell your positions due to volatilities.
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