January 2016

Note: For the title of each post, I have now decided to use an article from Bloomberg that describes the current sentiment of the day:

Charting the Markets: The 2016 Equities Sell-Off Continues

Its a day more before I leave for London, and much has been accomplished. We had an intensive reshuffling of our portfolio, trimming positions of stocks that had appreciated significantly since our purchase, and adding to our current positions.

I am not too keen on portfolio churning, but in this instance, I find it necessary for us to take small losses on our positions given the level of opportunity available in the market. It has not been easy to fight our behavioral biases – the chief one being loss aversion. But we must. 

To achieve superior returns, one must act in a way that others are unwilling, or unable to.

With the market falling, and no end in sight, it is sometimes hard to stomach that just by waiting a couple more days, we could have obtained the same position at a cheaper price. But let me make the following observation: 

Investors do not become poor by being too early in a market downturn, but because they are too late in a market upturn.

Let us return to objective data. On a CAPE ratio, the South East Asian markets at all time historical lows. On the basis of P/B, markets have only been as cheap three times in history – 1997, 2003, 2008.

The current P/B stands at 1.3x for the MSCI Asia ex-Japan Index, 1.5 s.d. from its mean of 1.9x. Investors who have bought at these levels have always reaped significant rewards.

The markets have priced an economic crisis on the scale of the Great Financial Crisis – where one does not exist. Time will tell if I am right, but there exists no signs of widespread risk taking and hubris that existed in the run-up to 2008.

Investors have been cautious, investing out a lack of necessity instead of greed due to record low interest rates. In particular the Singapore government has been prudent, moving to restrict leverage within the system that has bore fruit, with housing prices coming out their exuberance in 2013.

China is a worry – no doubt. But let us recall that much of the pain that is happening now is because of a deliberate act of policy. Reigning in corruption, liberalizing the market, moving away from government led infrastructure projects to a consumption based economy. These are not easy feats to accomplish, and significant progress has been made.

Rome is not built in a day, and its important to remember even developed financial centers like New York, Hong Kong and Singapore underwent their own tumultuous periods. Thats how society evolves, two steps forward one step back.

This is not to say China will not have problems. But which country that chooses the free markets does not? It is an endless cycle where each boom creates excesses that are cleared out by the ensuing bust, sowing the seeds for the next boom.

It’s not pretty, but its the best system we have.

But enough digression. If China slows down, there is no doubt that many of the businesses we own will be hurt in the short run. But lets keep in mind two things

1. There is no correlation between GDP growth and stock market returns.

2. Winters do not last forever, and spring will eventually come.

Many of our companies are cash rich, with well enough resources to withstand the storm that hits. Belts will be trimmed, budgets cut. But they will emerge as their weaker, over-leveraged competitors are wiped out. Leverage is a two way sword.

Importantly, through our holdings, we now have a part owner-ship of some of the best commercial property in the CBD (and outside it) of Hong Kong, Singapore and China. Financial hubs are not built easily, and the demand of such quality properties will always be there.

Inflation is our friend, and while I cannot forecast the short term price movements, I can say with confidence that 10, 15 years from now, these properties will be worth far more than they are today. Replacement costs will rise with inflation, manpower and the scarcity of land.

It is indeed a weird feeling to be the most optimistic when everyone around me speaks of fear, panic and ruin. And yet, this has always been the way that we have generated significant out-performance against the markets. By moving against the crowd. By buying at the point of maximum pessimism.

I remember the eternal words of Sir John Templeton:

“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.”

We are now at that point of pessimism. All is required of us now is patience, patience, patience.


Buysell Ratio
Source: Asia Insider Limited

So the ratio of insider buying to insider selling has hit an all time high of 4.7x.

One other point which I find really interesting is that the greatest cumulative value of buying and selling was done in 2007.

It seems half the people in the room drank their own cool-aid.

Thoughts on Insider Buying/Selling

I don’t think we have enough data here to form a clear conclusion from the Singapore markets. But there’s been quite a bit of academic research showing that heavy insider buying does lead to out-performance.

For me, its a matter of common sense.

If I think the company is cheap, but the Board of Directors are engaged in heavy selling, I would re-examine my thesis very slowly and carefully again.

Likewise, if the directors are buying heavily, that’s a net positive to me.

The current economic climate has produced incredible investment opportunities.

The trip to Hong Kong led me to conclude two things:

  1. Residential housing prices are due for a major correction
  2. The demand for prime district commercial properties will continue to be strong with Hong Kong serving as the financial hub for Asia to access China.

Legal systems and financial hubs are not built overnight – as China came to learn last year. Such systems take decades of mistakes and experiences to build up, painful lessons which Hong Kong endured in 1997.

Interestingly enough, the dramatic increase in price has not led to a typical supply side response, as what was seen in 1996. Although the government has set long term increased in housing supply that is 1.6x the average completion of the last ten years, two points must be taken:

  1. Supply the last ten years has been extremely low
  2. This supply side response by the government will take time to bear fruition

Given the relatively small size of flats, it seems to me that new families must move out at some point of time.

Another boon to property developers is that the cost of land has fallen by close to 40% since its peak – meaning that a drop in property prices may be buffered by lowered input cost.

In light of this, I find it hard to see where the sustained massive drop in prices will come from, with forthcoming supply low and players acting rationally, and pent up demand there.

Still, this says nothing about the short term price movements and if economic conditions worsened, the key to survival will be liquidity and solvency.

Avoid companies with bloated balance sheets, and find ones that are trading at the biggest discounts to book value.

There exists now an opportunity to buy prime district land at 60-70 cents on the dollar, a remarkable feat on its own.

Interestingly enough, the premium/discount anomaly seems to persist just as it does in close ended funds. A similar strategy should be utilized.

To close off, one must also consider not only the premium/discount, but the implicit growth in book values.

Inflation guarantees that the replacement cost of these investment properties will be significantly higher five or ten years from now. Add on the productive economic activity of these companies from reinvesting rental income and property development, and one should see a growth in book of 5 – 7%. This does not include dividend payments.

The key here is to always be selective, and paying below NAV. More research is needed.

This will in turn imply we receive the full rental income of the properties, but at 60% of market price. Our net rental yield becomes dramatically higher as a result.

Counters that look interesting are:

  1. Hang Lung Properties 0101 HKEX
  2. Henderson Land 0012 HKEX
  3. Sino Land 0083 HKEX
  4. Cheung Kong Property 1113 HKEX
  5. Sun Hung Kai 0016 HKEX,


In continuing with the series, I like to draw attention to the valuations of the STI Index, which notoriously received the dubious distinction of having as bad a year as Greece.


It’s probably worthwhile to note that the last 5 years have not been by any measure a particularly exuberant time in the stock market (especially in comparison to 2005 – 2007).

This lower valuations have also resulted in a corresponding surge in the dividend yield of the STI to close to 4%, a near record high.

Some large capitalization stocks are extremely cheap, trading at close to 2008 levels.

Can stocks go lower?


But I would argue that hoping for the bottom in 2008 valuations is a case of being penny wise pound foolish. Risk reward ratios are skewed towards risking 10 cents on the dollar to make 50 cents to a $1.

We should probably bear in mind that the 2008-2009 crisis was a crisis that it rivalled the Great Depression, so whether one should expect that kind of valuation levels to materialize is up to debate.

Personally, we haven’t seen the mad excesses of the 2005 – 2007 period, and certainly none of those seen in the run up to the 1997 crisis.

Source : Emerging Perspectives

And how about the rise of interest rates in the US which is widely believed to bring about the ruin for corporates? Well… the available data we have on instances where interest rates have risen do not actually support that conclusion.

Source : Emerging Perspectives
Source : Emerging Perspectives

In the end valuations are what drives the long run stock market returns. And by this measure, emerging markets are cheap (Singapore stocks are priced similarly).

JP Morgan Market Insights

Final Thoughts:

All that is required now is patience and fortitude of character. Markets have always been volatile – something that investors in stocks must come to terms with one way or the other.

Cheap valuations do not mean stock prices go up straight away.

However, in my view, investors have the odds stacked heavily in their favour. If investors can be calm and cool-headed as others panic in the next few months, than they can look forward to satisfactory returns in the coming years.

There’s plenty of noise in the markets at the moment. Plenty of market manipulation (whether true or perceived!).

It reminds me of the time that Asia went through its own “learning lessons” in the 1990s. That’s just part and parcel of the capital markets.

But ultimately, valuations are what really drives stock market returns in the long run.

The below charts serve as a signpost to know where we are in terms of market valuations.
1 PetroChina

2 Industrial and Commercial Bank of China Ltd

3 Agricultural Bank of China Co Ltd

4 Bank of China

5 China Life Insurance

6 China Petroleum & Chemical Corporation

7 Ping An Insurance

8 China Merchant Ban

9 China Shenhua Energy

10 Citic

** Data from Thomson Reuters