After the March that we had, the past week felt like a breeze.
Lots to cover though, so I’ll skip the introduction.
As always, this article is written as at 3 April 2020, and will not be updated going forward. Updated thoughts are on Patron.
Do note that this is not financial advice. If you are in doubt as to the action you should take, please consult your stock broker or financial advisor.
Basics: What happened the past week
The past week was a lot less action packed in terms of big events.
This supports my thinking that Phase I of the Virus panic is now over. Phase I was characterized by forced deleveraging, and was a disorderly exit.
Phase II on the other hand, will be characterized by corporate defaults, and will play out more like a plain vanilla recession (or depression).
2 big events to talk about: (1) COVID-19 Bill, and (2) Asymptomatic Transmission.
COVID-19 Bill in Singapore
I wouldn’t say that yesterday’s shutdown had a material effect on share prices. The way I see it, once we started getting signs of community transmission in Singapore, an escalation in the shutdown was bound to happen – the only question was timing. Now that it’s happened, the timer starts running on when COVID19 in Singapore will come under control, which I see as a good thing.
What was unexpected though, was the implementation of the COVID-19 bill.
I genuinely did a double take when I saw this one.
For those who missed it (details here), this bill temporarily suspends all contractual obligations for parties hit by COVID19.
So let’s say you run a shop in a mall, selling stuffed toys to schoolkids. You think that COVID19 has hit your business. So you write an email to your landlord telling him how tough business is because of this virus. Now you no longer need to pay rent for the next 6 months, and the landlord cannot evict you, nor can they sue you. The rent is deferred, and you only pay the rent after the 6 months period if over (government has an option to extend for another 6 months). Oh, and don’t forget that you can just declare bankruptcy after 6 months, so the landlord never gets the rent.
Based on my reading of the Business Times article (correct me if its wrong), that’s what this new bill does. So I genuinely had a double take when I read this.
If it goes through in its current form, I think it’s not just going to be pain for the landlords, its going to be an insolvency event for the smaller REITs and more leveraged developers. A significant drop in the cash flow like that would bankrupt many real estate players.
To my mind, there’s an almost zero percent chance of this bill coming into effect in this form as reported. Almost zero.
The only way it comes into effect in this form is if government also delays all repayment obligations on the part of the landlord to the bank. Basically allowing the REITs and developers not to repay their property loans, and allowing them to defer any refinancing during this 6 month period. Or extending new lines of credit to the landlords.
Which then means the banks are in trouble.
So yeah, my suspicion is that this bill will be tweaked before being passed. Chances are it will be done via a change to a definition somewhere, or to create a carve out.
Whatever the case, the market (rightly so) freaked out once it saw this. REITs have been selling off ever since news of this bill came out on Wednesday night.
Why COVID-19 could be worse than what everyone is expecting
After last week’s article, I had a few great comments pointing out how I may be underplaying the virus situation.
So this week, I went into a deep dive into all virus related material.
And I started getting really worried.
I think the key here that many people are missing out on (myself included), is asymptomatic transmission.
The latest reports from China show that once the virus has been contained, asymptomatic transmission then becomes a problem. There are people in the population who have the virus, and are transmissible, but they have no visible symptoms. How do you weed them out from the system?
Now imagine Europe and US in May/June, after the shutdown is over.
They do a phased reopen.
They then discover new infections across the country, from asymptomatic transmissions. How do they respond?
And that’s happening in China right now, where after a 2 month shutdown, they now have asymptomatic transmission, forcing them to shut another county the past week.
Dark Forest thinking
Fans of the Three Body Problem are familiar with the Dark Forest thinking. To simplify – This theory states that because civilizations never know what other civilizations are thinking, they always have to assume the worst. I love it because it’s a very realistic take on human psychology – rather than the utopian Star Wars style thinking.
Let’s apply that logic here. It is now June, and Indonesia says that they have completely eradicated COVID19 on their shores. Brazil says the same. Does Singapore go on to allow Indonesians and Brazilians to enter Singapore freely? What about the US? What about Australia? Does the world believe each other?
The problem with COVID19 and asymptomatic transmission, is that it will be hard for countries to trust each other once this is over.
In the interests of protecting their own citizens and avoiding a new shutdown, every country will err on the side of caution. No country wants to be the first to lift COVID19 travel restrictions. It could become a game of trust, played out at a national level.
Now I don’t know exactly how this will play out, but my current thinking is that some form of COVID19 restrictions will remain in place well into Q3, even after the lockdowns have been lifted.
The economic impact could be massive.
How to invest in 2020?
As always, how to invest in 2020 is unique to your own risk appetite and investment objectives. You need to decide for yourself. No one can tell you how to invest, other than yourself.
In the second part of this article, I will share my own approach to investing in 2020, and you guys can decide if its relevant for you.
Step 1 – Decide Asset Allocation
The first step to investing, and one that should have been done way before 2020. This requires me to decide the asset allocation I want to adopt, based on my risk appetite, and my read of the global macro cycle.
Broad asset classes are: Stocks, REITs, Bonds, Cash, Gold, Commodities.
For me personally, my current asset allocation is heavily tilted towards gold, cash and bonds, and as 2020 – 2021 plays out, it will gradually rotate into stocks and REITs.
My full portfolio breakdown is available on Patron for those who are interested.
Step 2 – Decide Final Portfolio Allocation
Next I will decide what I want my final portfolio to look like after the COVID19 crisis is over. I break it down by asset class, and within each class I break it down into individual components. So I decide how much REITs I want to own, and then decide how much of each REIT. It’s a dream list for stocks if you like.
In 2020, I think quality will be king in the coming months, because a lot of the smaller players are going bankrupt. My rules for stock selection are:
- Sound balance sheet to outlast COVID-19
- Resilient business model that will rebound after COVID-19. Ideally:
- Products that are loved by consumers and add customer value
- Competitive advantage
- Good margins
- Cash flow – can’t stress this enough, cash flow is king. Look for companies with strong cash flow
Stocks on my watchlist are on Patron.
Step 3 – Execute
So now I know the start, and I know the end. The next part, and the hardest part, is the execution.
I view the buy window as being open for 2020, and what’s going on out there right now is just a stock picker’s dream. Active investing is a MUST in this climate. Certain counters are selling are firesale prices, while others are at ridiculous valuations. If you index, you’re just buying the average of the market, and the average doesn’t look at cheap to me right now.
In particular, I think the Singapore market has a lot of high quality gems available, at fantastic prices. US and China/HK markets less so (especially for the big caps) – but we will get there in the coming months. For US/China/HK, the small and mid caps have already been decimated, so lots of value if you can pick up the high quality ones. But remember to look for cash flow and balance sheet strength, the wave of corporate defaults hasn’t even started.
What macro signals to monitor for 2020 – Phase II?
What I also wanted to share, was the macro framework to approach investing in this market.
The 3 buy signals I used for Phase I of this crisis have worked really well, and I wanted to build on them for Phase II.
As always, I’m searching for contrary views here. Let me know where you disagree, let me know where I am wrong, and we can discuss in the comments section below.
Macro Signal 1 – Virus Situation
The virus situation HAS to be number 1. Everything flows back to the virus situation. If this isn’t contained, the economy cannot restart, and stocks continue to freefall.
My base case assumes Europe and US doing phased reopens in May/June, with COVID-19 restrictions remaining in place until Q3.
I suspect COVID-19 restrictions only go away once a vaccine is developed.
Now I am not a doctor so I have no idea when this will come into play, but from what I’m reading – Absolute best case scenario, all the stars align style situation – we’re probably looking at Q3/Q4 earliest for a vaccine.
Base case? Probably 2021 for a vaccine.
A lot of news surrounding the use of Chloroquine as a treatment. If this works, the problem could go away quickly, so it’s definitely one to monitor – but for now, I’m not that optimistic.
I am very worried about the situation in Latam (esp Brazil), Africa, and Indonesia. If the virus gets out of hand there, the human tragedy could be unbelievable. So all those are at the top of my radar.
Macro Signal 2 – USD Strength and EM collapse
My latest thinking is that the peak in USD strength, may mark the bottoming out of this crisis.
It’s a bold call I know, so I wanted to break it down.
A few weeks ago (read this for more context), I talked about how the King Dollar (USD) will wreck the global economy. The underlying thesis is that companies and countries borrowed in USD in the good times, and entered into USD obligations. Business has now dried up, so they no longer get paid in USD. But the obligations remain. So all these companies and countries are now scrambling to find USD.
I also talked about how the swap lines extended by the Feds will solve the short term strength in the USD, but that will be short lived. The USD will come roaring back.
And that has played out exactly like we discussed.
Why do the swap lines not work? The simple answer is transmission. The swap lines go to the central banks, but it is the companies that need the USD the most.
And how do companies get USD from the central bank?
They can’t, so they need to borrow via a bank, who then borrows from the Central Bank. And the real problem now, is that no bank wants to lend, because why do they want to take on the credit risk? There is a real chance the company cannot repay the bank, which puts the bank in a tough spot.
So USD transmission is going to be a problem in the days ahead, and until that is solved, the USD will soar. Remember that the companies and countries continue to owe USD obligations, so the stronger the USD, the harder it is for them to repay those obligations.
My thinking is that the USD will continue to soar, and this will spell doom for many Emerging Market (EM) countries and companies. My thinking is also that this saga will be so bad, that it will spell the start of the end for the USD as a reserve currency. Once all this is over, people will be seriously looking for an alternative to the USD.
But closer to home, the short term impact on EM could be massive. These guys are hit by a double whammy of capital outflows (investors pulling cash out of the country) and falling earnings (commodities price collapse, fall in global demand), which impacts their ability to repay.
It plays out broadly like the Asian Financial Crisis, with a few notable exceptions.
I think this time around, Asian EM is not as highly leveraged. They’ve learnt the lessons of 97, so they are better prepared. It will still be bad, but not 1997 style bad.
The most vulnerable to me are Indonesia (IDR), Malaysia (MYR) and Australia (AUD). Australia is lucky because they have a direct USD swap line to the Feds that has rescued the AUD, but Indonesia and Malaysia don’t have such swap lines.
So yeah, it’s going to get worse before it gets better. Don’t forget that no man is an Island, so a weak Malaysia and Indonesia, is really bad news for Singapore as well.
Watching how this dynamic plays out will be highly instructive for buy signals. USD peaking could mark the bottom.
Macro Signal 3 – Policy Responses (including regulatory policy, or Fiscal and Monetary Stimulus)
Policy responses to address the economic fallout of COVID19 can be split into 3:
- Regulatory Policy – stuff like the COVID19 Bill
- Fiscal Stimulus – like the 2T package from the US, and Singapore’s supplemental budget
- Monetary Stimulus –action from the Feds and ECB going forward
Whatever that’s been done so far, only goes towards helping Phase I.
Phase II will play out rapidly in the coming months, and more of the 3 measures above will be required.
The speed and effectiveness of the policies as they are being rolled out will be key to determine the impact on financial markets, and the timing at which I buy.
I will share my analysis on all these in the months ahead, every weekend, rain or shine, so just check back on Financial Horse every weekend.
Macro Signal 4 – Corporate bankruptcies and Layoffs
The past week has given us a taste of this, with a huge wave of corporate downgrades, and the first oil bankruptcy (Whiting Petroleum).
Make no mistake, this is just the start. I expect a massive wave of corporate bankruptcies and layoffs over the next quarter or two.
In particular, I’m very worried about a big name bankruptcy. In 2008 we had Lehman brothers. In 2020, which household name is going to go under?
WeWork in particular is high on my list. I just don’t see how they can survive in this market. Cash flow is in shreds (all the freelancers have cancelled) and Softbank has pulled out of the $3 billion share buyout. The Softbank loan was conditional on the share buyout, so that’s gone too.
Who else can or will bail out WeWork in times like this?
Don’t forget that WeWork is the number 1 tenant in many key markets, so a WeWork bankruptcy kills the corporate real estate (CRE) market globally. If it happens, that just could be this crisis’s Lehman Brothers.
The worse the news coming out of this area, the stronger the buy signal. I know it’s a bit of a schadenfreude, which does make me sad too.
Closing Thoughts: Marathon, not a race
A lot of people are still thinking we get a V shaped recovery (in absolute terms, not QoQ). I don’t know what these guys are on, but I wouldn’t mind having some.
But I hope to be proven wrong, because just like you, I want this recession to be over quick.
For reference though, here are Bank of America’s latest GDP forecasts, which are stunning. -30% QoQ annualized for Q2, and -6% YoY for 2020. Unbelievable if true.
If numbers like these are to be believed, then this race should be treated as a marathon, not a sprint.
I think that the real decline may lie ahead of us, not behind.
In particular, I think that commercial real estate prices are going to collapse in 2020, and this is going to be a generational opportunity to pick up high quality REITs on the cheap. ?
I think we’re getting there, but we’re not there just yet.
For those who want to seriously invest in REITs in 2020, you want to learn about REITs NOW, so that when the collapse happens, you are ready to execute your buy orders.
The REITs Masterclass that we just launched is by far the most in depth and comprehensive REITs course in Singapore right now, nothing else even comes close. It’s an online course so it’s a perfect way to make use of your time while stuck at home. ?
There’s also a launch promotion so it’s 25% off until next Sunday (12 April). Sign up now and you also get free 3 months access to the highest tier of Patron (worth $150). Truly a fantastic deal so don’t wait! Link here for more details!
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