Sunday, November 18, 2018

Looming Crisis

This article contains information from the 3rd Scorecard Newsletter written on 30 Oct 2018 for my Moat Scorecard subscribers. However, do note that the future Scorecard Newsletter will be only created for the Moat Scorecard Subscribers.

This 3rd issue was released earlier than usual because I want to release this information earlier to the public because I felt they are important and I had to inform the readers. 

As of today, Straits Times Index is at 2966.45. The market had dropped 14.9% since the start of 2018.

It has not only happening to Singapore Market, but also in Hong Kong, China and Japan Market.

Hang Seng Index has fallen 19.4%, SSE Composite Index has fallen 23.3% and Nikkei Index has fallen 9.5% since the start of 2018.

On the other hand, USA Market seems like nothing has happened. Dow Jones Index has only fallen 3.05%, Nasdaq Composite has only fallen 1.1%, and S&P 500 Index has also only fallen 3.3% since the start of 2018.

Thus, if your portfolio is not in red for 2018, you are either heavy in cash, invested heavily in the USA Market or just a real damn good investor.

For me, I am no guru. This is because I am currently in the red zone too.

But why is this crisis occurring?

Many of you may think that this is due to Trade War or Fed Rate Hikes.

If you have been living in a well, then you probably wouldn’t know the stated issues.

Trade War

Trade War, as per Wikipedia, is about ongoing trade war between China and United State (US) as each country has introduced tariffs on goods traded with the other. US President Donald Trump had promised in his campaign to fix China's "longtime abuse of the broken international system and unfair practices". Starting in January 2018, it imposed a tariff on solar panel imports, most of which are manufactured in China. On July 6, US specifically targeted China by imposing 25% tariffs on $34 billion of imported Chinese goods as part of Trump's tariffs policy, which then led China to respond with similarly sized tariffs on US products. A tariff on an additional $16 billion of Chinese imports was added in mid-August, with China responding proportionately. A further tariff on $200 billion of Chinese goods went into effect on September 24, to which China responded with tariffs on $60 billion of US goods.

Fed Rate Hikes 

Federal Reserve System (Fed) has raised rate hikes for 3 times this year already. This has caused the low interest environment globally to rise significantly as well. For example, if your Singapore property mortgage has been on floating interest rate, you would have received the bank’s letter informing you that your mortgage interest rate has increased.

But should we be afraid?

In my opinion, we should look at the past to understand what has caused the 2008 crisis.

It is good to take note that 2008 was a global event.

You can read it all here.

From my perspective, I believe Collateralized Debt Obligation (CDO) that were sold globally was the main cause. In short, when gains become huge, it creates a bubble. When Lehman Brother collapsed and counter-parties to many CDOs are gone, Banks had to do write offs. When so many assets are being written off globally in various banks and companies, it escalates the crisis and many markets around the world collapse as well.

Then for a while, the world becomes quiet and business activity slows down till it almost stopped. If US didn’t proceed with the quantitative easing and pumped money into the economy. The global market will not have recovered so fast.

This brings me to the point of a topic I wrote last year – Money Supply . I believe money supply in the world is constant unless someone constantly print them or someone removes them from the world.

In the case of 2008 financial crisis, money was written off from each companies’ balance sheet around the world.

However, as of now, I do not foresee money is being written off companies’ balance sheet (Maybe only for companies’ doing ICO?). It has only been transferred. Thus, I do think that there will be no global crisis. It is more of a global transition period – from moving towards free trade to starting a trade war, and from a low interest rate environment to a slightly higher interest rate environment.

These are factors that can create major changes in the world, but once the world gets used to it, a new norm will be formed.

Nevertheless, prior to this new norm forming, the market will be uncertain and volatility will arise. Investors will probably need to be assured of their strategy and think long term.

On the other hand, I also realize there are potential global crisis factors forming around the world – and it is not related to US.

Yes, US started the trade wars, build walls and trying to keep everything to themselves. This will definitely create a short term strengthening of its economy. Thus, maybe that is why their index seems to be in a much better shape than other indexes around the world.

It is like the movie – Attack On Titan. Once you get too comfortable within the wall, bad things will then happen. Only time will tell.

Then what are the possible potential global crisis factors?

1. China’s debt and the shadow banking industry within the country.

China’s companies’ taking on increasing leverage is dangerous. As of a Bloomberg’s’ article, China has RMB 34 trillion debt. Just look at how HNA Group has been trying to reduce their debt!

However, the amount probably did not include the leverage within China's shadow banking industry. Companies in China lend among themselves. Overseas companies, even those from Singapore, lend to Companies in China too.

For Overseas companies that lend to companies in China, I do believe China companies that took these loans do not necessarily need to report them on its balance sheet. As for Overseas companies that lend to these China Companies, they reported interest earned. Thus, there is a gap between the asset earned and the liability declared. In the event, the China Companies’ defaulted on the loan, S-Chip kind of scandal will start to appear.

In spite of the above, let’s be less worried on this issue, as Xi has been encouraging reporting via The Three Board Listing, as well as cracking down shadow banking. In addition, China has also been cracking down on the P2P Industry.

2. Deutsche Bank

As per Wikipedia, Deutsche Bank AG (DB) is a German investment bank and financial services company headquartered in Frankfurt, Hesse, Germany. It is reported to have Euro 1.475 trillion in assets in 2017.

In 2016, there has been a report that stated DB is one of riskiest bank in the world.

As of today, you should have also read about the Euro Debt Crisis that start in 2009 and became very bad in 2012. Currently, there are many weak countries within the continent that has taken on the support from other countries or the European Union. All these happened because the big brother in Europe, Germany, gave them the support.

Therefore, it seems to me that, in the event Deutsche Bank falls, Germany that has a GDP of $3.677 trillion, will be in a bad shape. This could re-activate the “muted” Euro Crisis again.

Nevertheless, it has been good to know that DB understand this risk and has been cutting their leverage exposure.

But let’s hope it does not get sucked into the next topic.

3. Collateralized Loan Obligation (CLO)

As explained on Investopedia, “A collateralized loan obligation (CLO) is a security backed by a pool of debt, often low-rated corporate loans. Collateralized loan obligations are similar to collateralized mortgage obligations (CMO), except that the underlying loans are of a different type and character.”

So how is this different from CDO/CMO? I doubt so. Generally, I do not think people learn. Once the margins increase significantly, more financial companies will get on board.

Just read the following headlines and amount for the month of Oct 2018 (other than the last article):

Article 1 – “…market-leading forecast for 2018 CLO issuance to $130B”  – This is for 1 year only.

Article 2 – “…a pair of fixed-rate tranches in its new €412 million…”

Article 3 – “…second securitization of short-term mortgages…$597 million…”

Article 4 – “…weekly volumes…$1.7Bn…”

Article 5 – “7.4 billion euros of new issue priced from July to September”

Article 6 – “C.L.O., a cousin of the mortgage-related product that malfunctioned a decade ago, has become one of the hottest investments on Wall Street.”

Article 7 – “…$133.7 million will headline a commercial real estate collateralized loan obligation (CLO), wrapping $462 million in debt overall…”

Article 8 – “Singapore…”

OMG, I am speechless. The scariest fact is that this was not reported widely, especially towards the mass market.

In short, how should retail investors protect themselves?

In terms of strategy, you can re-read my post here.

Regardless, from my personal standpoint, I believe there is no need to go full cash as some investors did. But it is good to stay cautious and hold some cash to act as opportunities start to arise.

On the other hand, if you are looking to create a watchlist, I will suggest to look for a company that is (1) debt free, (2) high cash or high free cash flow, with (3) low liabilities and (4) HIGH MOAT.

I hope you had learnt something from this article.

Good Luck!

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2 comments:

  1. Decent article by TUBS as always. Blessings! www.theholyfinancier.com

    ReplyDelete
    Replies
    1. Hi Holyfinancier,

      Thanks for the compliment. Articles like this takes effort and I hope to value add to readers investing journey.

      Regards,
      TUB

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