I originally intended to write this on the first week of august but got delayed due to a spike in workload.
Interest Rate Cut
On the last day of July, the federal reserve announced a widely expected interest rate cut (read: Why the Federal Reserve Cut Interest Rates). The rumors of an interest rate cut have been going around for some time, with the stock market fully pricing in the cut. The problem was that many believed the cut was going to be higher than the 25 basis points and thus many indices went red after the announcement.
2% Inflation Target
A cut in interest rates was supposed to bring the target inflation level up. A lower interest rate encourages more expenditure and investment rather than putting money into savings. In theory, higher spending leads to higher GDP due to the multiplier effect. This eventually leads to inflation unless somehow the cost of production decreases leading to lower prices for goods.
Cutting interest rates signals to investors that the economy is not as strong as many would like to think and this in turn leads to flight of safety from equities to fixed income instruments such as bonds. Increased demand for bonds cause the price of bonds to go above their face value, pushing down the yield. When yields get depressed far enough, you get to today’s yield curve inversion.
Yield Curve Inversion
The phrase “yield curve inversion” is now the hot topic around the internet, appearing on multiple news websites, video streaming as well as on social media. In short, a normal curve show reflect higher interest rates for longer maturity periods. This is because people expect a higher return for locking in their money for a longer period of time instead of being able to spend it in the present. The returns should also be higher than the current inflation else you essentially lose real value once the bond matures.
The yield curve has been used in the past as a tool to predict cycles in economic activity and many believe that a yield curve inversion means that a recession is on the horizon (read: What is a Yield Curve). In such uncertain times, businesses could start reducing their production in anticipation of the recession leading to reduced goods bought and possibly job cuts. This ripples on and could result in a recession.
Reading Tea Leaves
However, there have been times when an inverted yield curve did not result in an actual recession. Should there be a recession coming up, the expected timeline falls somewhere around 12 months to 18 months lag time based on historical data (August 2020).
Given the yield curve inversion, should I sell all my equities and start hoard cash?
Run for the Hills
I remember reading a few blog post last year explaining why the entire reits sector was going to experience a major sell down due to the rising interest rate environment. However, the sell down did not happen and the entire sector had a rather big run, only to draw back in the recent weeks. If I had taken the advice then and sold my reits, I would be looking at lost of capital gain and also dividends paid out during this period. Given that these companies are able to weather through the recession and not file for bankruptcy protection, I believe there is no need to cash out right now.
Time in the market is better than timing the market. Equities have always appreciated along with growth in global gdp. The difference this time is that global assets have inflated ever since QE added trillions into the money supply, hence there could be a possibility that investors fail to support current pe ratios after the economy recovers. On the other hand, as long as there are no other assets yielding higher returns than equities, I believe this scenario will be unlikely.
Gold
Some investors are turning to purchasing gold or gold derivatives to hedge against these uncertain times. For those who have consistently been accumulating gold over the years would have been rewarded when prices broke through 1500 USD recently. I do not intend to build up a position in gold as there is insufficient data to support the theory that over the long term, gold will produce decent returns. Thus, building up a holding in gold right now would be akin to gambling. I may turn out to be wrong and gold may skyrocket as equities crash but there is a lesson to be learnt in every scenario and serve a reminder that history does not predict future outcomes.
Entering China Markets
A few weeks back, I made somewhat a rash decision to build up a decent position in a Chinese company. This is one of the 3 companies I mentioned shortlisting in this post here. Well the boat did come back eventually, possibly due to fears that the trade war between the states and china will adversely affect the revenue for these china firms. However, I am certain the fundamentals of this company is strong and future earnings are rock solid due to the steady growth of their industry.
It may take years for me to recognise profits but for now this makes the second Chinese company which also happens to be unprofitable in my portfolio. The first one was a major disappointment and is my biggest mistake so far in the short journey into the world of equities. 30% paper loss isn’t a small issue but it is not the end of the world. I expect the loss to widen and in such situations, the right action to take it to cut losses and save the remaining capital instead of watching it go to zero. If it ever goes to zero.
Don’t Follow the Crowds
I was in accounting class one fine day and I received a stock tip from a friend. Guaranteed to earn a high return. This friend was rather successful in his stock picks, once earning 10% returns in a single day of trading. Therefore, his recommendations must be rather reliable, right?
I took a quick look into the company and found that many analysts were predicting a >30% upside and were rather confident in recommending this stock. A few days later, without sufficient due diligence, I submitted a limit order for 3% lower than the current trading price. As the share price has been steadily climbing for the past few weeks, I thought it will not be that much of a risk.
Transaction Completed?!
A few days later, a notification flashed on my phone. An email was sent by the broker informing me of a successful transaction. For a moment, I was confused for I had forgot the limit order was still in effect. To my horror, the share price had dipped that day, wiping out a few support levels in one go. Damage is done. Just ensure such incidents do not happen again in the future, I told myself.
Pure Dumb Luck
Strangely, the share price recovered and eventually went on to hit record highs above my entry price. Let’s just see where this goes, I thought to myself, pushing back the urge to dump the shares and keep the small profit from this irresponsible speculation. This was the next biggest mistake. Shortly after, the share price crashed and has never recovered to levels where I could break even.
Is there a chance that the share price will appreciate back to levels near my entry price. Definitely, but not in the short term. As the ROE is decent and they are almost a monopoly in their field with a rather big pile of cash ready for inorganic growth via acquisitions and JVs, a recovery is within expectations provided management is competent and the trade wars do not take a turn for the worst. The moral of the story is this: do not follow blindly where people tell you to go and take analysts reports with a rather large pinch of salt, especially when most of them are basing their recommendations on the same story painted by the company.
Don’t Miss Something Till It’s Gone
Humans are strange. Myself included. We are more inclined to notice things which are not there instead of appreciating what is. Hence sometimes, we learn too late to seize the moment and be content with what we have. Once it’s gone, it’s might stay that way forever.
Is the grass really greener on the other side?
Recently, I had a opportunity to cover an event with a new combination of semi-pro level DSLR and lens. This was the dream setup – larger and brighter viewfinder, superior auto-focus and metering system, as well as more physical controls for faster change of settings. Many times in the past I have missed shots due to slow and inaccurate autofocus of my entry level DSLR and cheap lens, so this time round, I was in a much better position to capture satisfactory photos.
So what went wrong? A myriad of factors.
- Being unfamiliar with the setup. It is crucial to be familiar with your equipment, to know its shortcomings and how to work around them. Many frustrating moments could have been avoided wondering where a certain setting was and why the photo was not what I expected.
- Optical stabilization. An extension of the first point and the reason for this section’s title. I was so used to having image stabilization and cheated out on having sufficient shutter speeds that once the feature was not available, my inferior shooting technique gave way. The result was still acceptable on the cameras display, but once the full resolution is projected onto a monitor, the blurriness becomes shamefully appalling.
- Compensating for back focus. Again, another extension of the first point. Not knowing the setup beforehand meant that I was unaware the setup had a back focusing issue. This could have easily been compensated for with a simple AF fine-tuning.
- Lack of creativity. Recently, my thought process has dulled to the point that the photos no longer appear interesting and pleasing. That is if I could say it ever was. The photo of dog at the beach was one of my first photos taken with my DSLR, whilst I couldn’t say it is exceptionally good or even getting considered for an award, it is nonetheless way better than the average photo I took for the event.
It is said that over the journey of taking photographs, one’s taste and style changes. Change is unavoidable. If change leads to improvement, then all’s well. I have to find my inspiration once again.
Portfolio Update
Due to my investment strategy being “buy and hold” and having a relatively small portfolio value compared to the average investor, most of the time there is no activity resulting in changes to my portfolio composition.
Taking a safer stance
Recent changes this year include a small addition of fixed income and initiating a position in a china company. The fixed income portion is meant to lower the growing amount of cash reserves on hand and also to increase the annual inflow of cash. Allocating this cash into equities could provide more than four times the upside annually but by nature of the credibility of the issuer, there is negligible downside to the bonds especially in these turbulent times.
After a sell off in May 2019, my portfolio has recovered slowly in June and July, hitting an all time high in August following an unexpected rally in two of my holdings which had been depressed for well over a year. Following the interest rate cut and further developments on the US-China trade war, my portfolio now registers a 13.4% drop over the all time high portfolio value.
Falling and falling
The result is hardly shocking. I anticipate further drops over the next few months, possibly reaching levels of the November 2018 selloff. At the worst point of the selloff, I had losses exceeding 6% on the my invested capital. Strangely, I do not recall being significantly aware of this event, perhaps due to having too much schoolwork to focus on that the “BUY ON DIPS” alarm was not heard.
Opportunity to Accumulate
Should my portfolio once again turn red, I intend to unlock my cash reserves and buy more equities. The cash reserves is now a major drag on total returns especially as it grows over time. However, it is not a good idea to fully pump all available cash into equities/bonds. Opportunities to buy undervalued stocks or flash sales do happen occasionally and having no cash to take advantage of this would be rather unfortunate. Berkshire Hathaway is reported to be holding cash in value of about 122 Billion (read: Buffett Steers Clear of Buying Stocks; Berkshire’s Cash Pile Hits a Record). Doesn’t hurt to trust the Oracle.