Status Update on Markets – Thoughts on the rally, oil, SIA and REITs

Wanted to take the opportunity to share some thoughts on a few topics that you guys have written in on. Hope that this helps, and feel free to add on in the comments below!

It’s a lot of raw, unfiltered thoughts from me today, so hope that this gives you some idea of what I’m thinking of right now. I didn’t clean it up as much as I do for the weekend posts. So as always, this shouldn’t be taken as financial advice.

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Market rally

The market is still in risk on mode, driven on by a couple of factors:

1) End of quarter rebalancing – Lots of automated strategies will be rebalancing into equities as this is the end of Q1, these strategies will abate from tomorrow onwards, so let’s watch the performance after

2) Huge buying pressure – This happens in every big bear market. After a big fall in share prices, investors continue to look at share valuations from a historical basis. So when using the past 12 months’ earnings, stocks start to look cheap, but this fails to recognize that Q1 and Q2 earnings are going to fall off a cliff.

3) Bargains starting to emerge – In certain areas of the market that have been very hard hit, value is starting to emerge, so buying are coming out again to pick up the great buys. Situations like this call for active investing – which will lead to big outperformance against passive

My current position remains that most of my buy signals have triggered, therefore I view the buy window as open for the rest of 2020.

I have a rough framework to guide investment decisions in 2020, will share more this weekend.

I think that given that Phase I of the virus panic is over, the emphasis should shift away from macro analysis and more towards micro analysis, because value has started to emerge in certain parts of the market.

Over the next few weeks, will be doing more research into micro analysis (individual stocks) rather than macro analysis, updated thoughts to be shared via the FH Stock Watch.

On the macro, my view is that on the balance of probabilities, we *probably* see the market go down again before it goes up for good. There’s a lot of short term buying pressure from retail and quarterly rebalancing, but this will fade soon. And once that goes, we’ll see earnings come to the forefront, which will be a disaster. HY credit spreads are really bad, and cash flows are tight, so in the coming quarter or two we’ll start to see the big bankruptcies and layoffs start to happen. I find it hard to see stocks trading at all time highs given this backdrop, but I could be wrong on this, hence I’ve already started to average in.

Valuations is a big one too, because Q1 and Q2 earnings will fall off a cliff. For the S&P500 to go back to its all time high despite falling earnings will require multiple expansion, and I just don’t see multiple expansion happening in this climate. Stocks are driven by supply-demand, and with corporate buybacks out of the way, it’s hard to see where the big demand for stocks can come from.

None of the market technical indicate a sustained break out in prices is underway for now. Given this backdrop, any rally in the S&P500 up till 2750 can still be part of a bear market rally. If S&P500 goes back to the 2700 range (or close), I’ll make tactical reallocations to my portfolio.

The name of the game is quality here. I want to move up in quality, to blue chip names with rock solid balance sheets and good business models, and away from indebted companies with poor cash flows.

Oil

Couple of readers have asked for my thoughts on oil.

My position has always been that I don’t have any edge in the oil market (no special advantage), so I prefer to stay out of markets I don’t have an edge in.

My layman view on oil, is that the worse is not over. We’ve barely even started to seen the wave of corporate bankruptcies that will come from this, and it will come. So my layperson view is to completely avoid this market for now, unless I have at least some indication the worse is over. 

It’s going to be impossible to time the bottom in this market (because oil price is dictated by OPEC+ decision, nobody can predict their decisions unless you have insider info).

So the only 2 ways are to buy blind (before you know the bottom is in), or to buy late (after the bottom is in, and prices have rallied). 

Between the two, my preference is for the latter. I rather make less money, than lose big money.

But that said, if you have an edge in oil, or you know something I don’t for oil, then feel free to go ahead in the oil markets. Do share your comments below as well. ?

SIA Bailout

To break down the SIA deal simply, the bailout consisted of:

1. Rights issue (3 for 2 – new rights at $3, raising about 5 billion)

2. Convertible bonds (effective interest is 4% for first 4 years, 5% for next 3, 6% for final 3 – if not redeemed by 10 years, converts into shares based on the effective interest rates. Raises 3.5 billion)

Temasek will sweep up any unsubscribed offering, so basically Temasek is backstopping the entire bailout.

The key thing about this bailout is that it is massively dilutive. 

Some back of the envelope calculations from me – assuming an original share price of $9 pre-COVID19, after the dilutive rights, the final price of the shares will be about $5.

So assuming SIA recovers to its pre-COVID19 earnings and valuations, the share price for SIA should be around the $5+ range (really rough calculations).

Which means the current post-rights effective share price of SIA of $4.4 isn’t looking so attractive (assumes you buy now and subscribe for the rights in full).

I haven’t taken a look at SIA so closely yet because I think it’s way too early to be touching airlines, but ballpark number to get me interested will probably be in the $2 to $3 range.

It may never get to that price, in which case I just skip the stock entirely. Too many other bargains out there, with bigger upside and less risk.

If I did want to play SIA though, I think the right time to start looking is probably when the rights entitlement start to trade.

REITs

Regarding REITs, I’m pretty worried about the state of the corporate real estate (CRE) market this year.

Rentals are definitely going down, so that’s going to hurt a lot of the cashflow for the weaker guys – possible insolvencies for the more leveraged players. Valuations for real estate are bound to come down as well, the only question is how much.

One that I’m particularly worried about is WeWork. Everything everyone has ever said about WeWork is coming true, at a rapid pace. WeWork bonds are trading at 30% yields now, and I don’t see anything to dispute the market’s assessment of WeWork’s creditworthiness.

All the short term free lancers are going to be cutting their subscriptions, while WeWork is still on the hook for the underlying tenancy. Softbank isn’t going to come in anymore (they have their own problems), and I don’t really see who else would want to bail WeWork out in this climate.

Some questions on which is the best sector in real estate. I think this ultimately goes back to relative strength. 

Hospitality is definitely having a bad year, I think we’re going to see massive drops in distribution yield going forward. I’m hearing single digit occupancies in many big hotels. Some would say it’s been “priced in”, but I find it hard to see how a complete collapse in distribution yield can be properly priced in.

Retail will have a tough year as well. Lots of talk about landlords granting rental rebates, and if those rebates aren’t coming form the government, it’s going to come from a REIT’s distribution. Retail rental reversions probably stay weak for the rest of 2020.

Commercial is interesting. Office leases are locked in long term, but COVID19 and its work from home trend may accelerate the shift away from CBD towards business parks of suburban working locations with cheaper rents. Definitely one to watch for more clues on how this plays out.

Industrial is the most interesting one. Most real estate analysts tout Industrial as the safest place to be right now, and given the state of the other 3 classes, I don’t necessarily disagree. The problem with industrial though, is geographical exposure. A lot of the Industrial S-REITs have big exposure into US/Europe/Australia. Those are super tricky, because earnings could be really impacted going forward. So for industrial, picking the right asset portfolio is really crucial.

So that’s a rough summary of each sector, I’ll try to do more detailed writeups for each sector for the REITs Masterclass. It’s a really fantastic class if you want to invest in REITs though, so definitely check it out if you plan on buying REITs in 2020.