Well… what a week!
I think in some ways, the events of the past week may prove to be as important as March 2020 itself.
And the implications for financial markets should not be understated.
Whatever investing gameplan I had before this week – it’s time to throw it out the window.
Ukraine War results in more Sticky inflation
The list of sanctions from the West has been heavily covered in the media.
Very simply – Russian entities are now cut off from the western financial system.
Overnight, this made it incredibly tricky to transact with Russian counterparties, because you don’t know whether the payment will clear.
Effectively, Russian exports had no buyer overnight.
And as we covered in last week’s article, Russia is a MAJOR PRODUCER of global commodities.
The net result is a massive supply shock in global commodities markets.
This is what happened to commodity prices.
Wheat up 40%, oil, aluminium, palladium, up 20%.
This week alone.
If you thought 2021 and COVID was bad for global supply chains.
Well if this war drags on… it’s only just getting started.
What does this mean for Financial Markets?
Historically speaking, every time oil goes above $100, a global recession usually follows.
Maybe a recession isn’t a done deal here.
But with commodity prices tearing higher as we speak, we’re almost guaranteed to head into a broader economic slowdown.
Right at the same time, the Feds are going to be forced to hike interest rates into slowing economic growth.
Which asset classes do well in inflation (or stagflation)?
So it got me thinking.
The probability of stagflation just went up a whole lot the past week.
What do I, as a Singapore investor, want to own in a high inflation, rising interest rates scenario? With possibly slowing economic growth?
Historically speaking, what you want to own is:
- Real Estate
- Stocks (but only stocks with pricing power and strong cash flows)
Now translating that into actual stock names – what would make sense for a Singapore investor like myself, to buy in 2022 to hedge against inflation (or stagflation)?
Top 5 Inflation Stocks to buy in 2022 – As a Singapore Investor
Ascendas REIT (or Mapletree Industrial Trust, Mapletree Commercial Trust etc)
The most classic inflation hedge – real estate.
I think a good argument can be made that Singapore residential real estate is a good hedge too, and I don’t disagree.
But with residential real estate, there are ABSD rules to consider, the need to manage the property… it’s just not for everyone.
As easier way might be to play it via S-REITs.
For me, if I want to hedge inflation via REITs, I want to buy (1) high quality commercial real estate, (2) backed by a solid sponsor, and (3) in a stable, gateway city.
Ascendas REIT, CapitaLand Integrated Commercial Trust, Mapletree Industrial Trust, Mapletree Commercial Trust, they all fit in my books.
And at this price, you’re buying in at a 5.5% yield too.
I mean of course, if s*** really hits the fan, these REITs can drop another 10-15% from here. But if they do I’m just going to back up the truck.
A lot of you have asked whether it’s fine to buy REITs with US or European properties.
I think it’s perfectly fine, as long as you understand that real estate is a local business.
Just because you buy a REIT, doesn’t mean you can outsource the property due diligence to someone else. You still need to understand what real estate you’re buying, and whether you’re paying a fair price for it.
Exxon Mobil (or Chevron, Conoco Phillips or other Oil Major)
Oil in theory sounds like a good inflation hedge.
Inflation is going up because oil is going up, and by owning oil stocks you’re benefitting from rising oil prices right?
The problem though, is that over the past week, oil prices have gone vertical, but oil stocks have not moved much in comparison.
See the chart below, where blue is the oil price, and red is the oil stocks ETF (XLE).
Notice how they decoupled the past week?
The problem if oil stays above $100 for long, is that the global economy will start to slow.
As consumers spend more money on food, transport, and electricity, they have less money to buy discretionary goods.
And at some point, that demand destruction will feed back into oil prices.
I’m up 100% or more on my energy positions accumulated in 2020, but oil this high makes me very nervous about them.
Alternatively, you can play the commodities trade via an energy ETF like XLE, or a metals ETF like XME.
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OCBC Bank (or DBS Bank or UOB Bank)
Interestingly, banks actually do decently in inflationary scenarios.
They don’t go vertical like commodity prices, but they do manage to hold their own because the rising interest rates translates into higher interest income for banks.
The tricky part though – is whether the rising interest rates trigger an economic slowdown?
To put it simply, if interest rates go up too much, then the whole economy slows down, loan growth slows, and loan default goes up.
Bad for banks.
If interest rates go up moderately, then economic growth chugs along, loan growth and loan default rates are good.
Great for banks.
So banks like a goldilocks kind of inflationary scenario.
Are we going to see goldilocks?
Frankly, nobody knows the answer to that.
At current prices, the 3 local banks DBS, UOB and OCBC are trading at about a 3%+ dividend yield. Coupled with capital gains long term, you could maybe eke out a 6% long term return?
Like I said, you won’t get crazy rich holding the banks at these prices, but you may at least be able to hedge inflation.
A big tail risk here is that you don’t know how much hidden exposure the global banks have to Russian assets – all of which have been marked down to zero this week. Hopefully, the Singapore banks should be more shielded, but sometimes you never know.
AMD (or Intel, Micron, Qualcomm etc)
The first 3 on this list are the more classic inflation hedges.
They are the stuff that worked in the 1970s, the last time we had real inflation in the developed world.
But this is 2022, and we can’t invest like it’s 1970 anymore.
So for the last 2 I wanted to give it a 21st century twist.
Semiconductors was one area that really stood out for me.
In inflation, you want stocks with (1) pricing power, and (2) strong cash flow.
Check, and check.
Semiconductors are the 2022 equivalent of caterpillar.
Any government or country that wants to invest heavily in digital infrastructure, inevitably needs to buy semiconductors.
And with semiconductor supply this tight, semiconductor stocks are just printing cash at the moment.
For me, AMD is a name I’ve been accumulating since the $50s ($112 now), and I love it because of how well AMD chips perform vs Intel. And hold their own vs NVIDIA.
But sometimes with these macro plays, there’s no need to get caught up in stock picking. Indexers can just stick with an ETF like SOXX.
Alternatively, names like Intel, Micron, Qualcomm are all viable too, each with their own pros and cons.
NVIDIA is the tricky one, because of how high flying a stock it has been the past few years. When/if macro reverses, the drop in multiples could be tricky.
Big Tech / FAANG+
So many of you have reached out to ask whether Big Tech / FAANG is a good inflation hedge, and how well they will hold up in a rising interest rate + high inflation climate.
The honest answer – I don’t know.
But I can try to reason from first principles.
Google and Microsoft are viewed as the strongest of the FAANG. Solid business model, pricing power, and generating an absolute truckload of cashflow.
Classic inflation hedges.
You can even argue that the crash in growth stocks is great for Big Tech, because they can come in and scoop up competitors with their massive warchest. We saw this with Microsoft buying Activision Blizzard.
On the flipside though, Facebook has shown us how vulnerable the FAANG can be.
With inflation on the rise, expect margin compression for the FAANG. Coupled with COVID reopenings removing a massive tailwind for the digital economy, and it’s a tricky time for tech in general.
Investor sentiment can be a very fickle thing.
Just look at Sea.
Investors love your stock, until the day they don’t.
This happened to the Nifty Fifty in the 1970s, when stocks like IBM and Dow Chemical were stock market darlings.
And then the market broke, and even though the Nifty Fifty continued growing earnings, their share price underperformed for decades because of unrealistic starting valuations.
Of course, I’m not saying the same will happen to the FAANG, and I myself own exposure via QQQ.
But as investors, it’s important to be alive to the risk.
Everybody thought Alibaba was a no brainer in 2020 too. Look what happened.
Very Honourable Mention: Gold
No list on inflation hedges will be complete without mentioning gold.
Gold is one of the funkiest asset classes.
Gold in your portfolio does almost nothing for decades.
And then the one day you need it, and it will save your life.
Imagine if you’re a Russian, Ukrainian or Venezuelan. All the money in stocks doesn’t count for much anymore.
But the gold you own – it’s the only thing that matters.
Over the past month, gold has performed perfectly as the portfolio hedge of last resort. When geopolitical tensions went through the roof and nuclear forces were being put on alert, gold held its value very well.
I get all the arguments that fiat currency today is no longer backed by gold, and that crypto may have replaced gold.
But I myself have a chunk of physical gold bullion lying around in a bank vault somewhere.
It is the inflation hedge of last resort, when nothing else works.
Honourable Mention: Inflation Stocks to buy in 2022 for Singapore Investors
Uranium might have been a big winner the past week.
Now that Europe has woken up to the importance of energy independence, they’re going to want to build up alternative energy, fast.
Solar and wind are useful, but they cannot replace fossil fuels because of lack of consistency. Sometimes the wind just doesn’t blow, and the sun isn’t shining.
Which leaves nuclear.
Uranium is necessary to power nuclear power plants – and look at who produces uranium.
Kazakhstan is the number one producer, with Russia and Ukraine pretty high up on the list too.
Which means that over the past week – we may have just seen a massive demand jump, coupled with a huge supply shock for Uranium.
With Uranium, you can just pick up an ETF like URA, or if you want to stock pick Cameco is the largest uranium miner in the world.
There’s a saying that in war, everyone is a loser except the military industrial complex.
I hate war with all my heart, and I wish that this conflict were over.
But you can’t deny that war is good for defence stocks.
Here is BAE systems, the largest publicly traded “defence stock” (or arms manufacturer) in Europe.
And here’s Rheinmetall AG, the German “defence stock”.
Germany pledged to spend an extra 100 billion euros on defence the past week.
This might just be the catalyst to reverse 6 decades of falling defence spending in the EU:
Closer to home, ST Engineering is the local equivalent of a defence stock, and there may be spillover benefits.
Treasury Inflation Linked Bonds (TIPS)
And finally… TIPS
Or Treasury Inflation Linked Bonds.
Frankly, it’s a bit too sophisticated for the retail investor, and I personally don’t hold any.
But there’s no denying that TIPS are arguably an even purer way of hedging inflation directly.
A lot of you have asked me about the viability of using TIPS to hedge inflation, and I think it’s perfectly workable. It is a bit of a sophisticated product though, so you do need to know what you’re doing.
How to hedge Inflation, as a Singapore Investor in 2022?
As this article has shown, it’s quite clear there’s not just 1 way to hedge inflation.
The last time inflation was a problem was the 1970s, and just like in the 1970s, there’s no magic asset class that will save you.
What would make sense is to hold a broad basket of stocks and asset classes, to properly hedge against rising prices.
As shared in previous articles, I’m generally holding elevated cash levels at the moment, parked in a mix of high yield accounts, money market funds, Singapore Savings Bonds and CPF-OA.
While also holding onto a broad basket of US, China and Singapore stocks.
Together with S-REITs, and Singapore residential properties.
I’ve started buying S-REITs since last week, and I intend to continue averaging in going forward.
The original plan was to wait for the Feds to blink to deploy the bulk of my dry powder, but with the events of the past week, the timeline needs to be tweaked drastically.
For full updates on my portfolio allocation and changes to positioning, do check out Patreon.
Closing Thoughts: Nobody wins in War
I think that in some ways, even the West may not have fully appreciated the consequences of their sanctions on Russia.
I do anticipate that the second and third order effects here are going to be much bigger than anyone is expecting.
Russia and Ukraine are major global commodity suppliers. A ton of airfreight logistics and supply chains pass through Russia/Ukraine.
Whatever supply chain disruptions we saw in 2021, multiply that by 2 if this war goes on.
When food and oil prices go up, governments will come under pressure to subsidize prices.
The developed nations can afford to do it, but doing so will only drive inflation higher. The poorer nations can’t, and the risk of regime change will surge.
Whatever way you look at it, the Russian invasion of Ukraine, and the sanctions response from the West, is nothing short of an absolute humanitarian crisis.
I for one, am hoping that cooler heads prevail in the days ahead.
As always, this article is written on 4 March 2022 and will not be updated going forward. Latest thoughts (and my stock watch and personal portfolio) are available on Patreon.
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Good point about the oil producer stock prices not matching the rise in oil prices. Yes, I think oil is overbought here. The Indians and Chinese can buy Russian oil, as long as they can transport it. US shale can ramp up in 6 months (maybe 6 weeks).
Long term Russian crude production will decline without Western technical assistance, but thats not here and now.
True, that’s a good point.
Thanks for the interesting article. Just couple of comments
1. If Schroeders chart is correct, one simply needs to buy Reits, it does well in all scenarios with a positive return so no need to guess which scenario we will be in.
2. When looking at banks, I wonder if one should only consider the 3 Singapore banks which as you mentioned in a previous article, have already soared in voice. In contrast，European banks have plummeted, some by 20-30% in just one week. Not all have exposure to Russia e.g. Lloyds which is purely a domestic bank but they have still fallen with the market. I suspect there are bargains to be had right now. Furthermore, it is the first time in years that we are now likely to have positive interest rates in Europe which will help banks there tremendously. Maybe you can consider an article on this?
While the war will have an impact on the market, I don’t necessarily think it will be long lasting. Either it will end with a peace treaty in the coming few months with reduction of sanctions or it will drag on for years in which case the world will adapt. After all, besides a few key commodities, neither Russia or Ukraine are a big fraction of the global economy. I suspect there will likely be some kind of agreement found eventually – continuing in this fashion will destroy both Russia and Ukraine and also have a significant negative impact on the West. It is also not in the interests of the West to push Russia into such a corner that it feels it has nothing left to lose and lashes out with nuclear weapons. At some point, calmer minds on all sides will reassert themselves.
Grreat comment as always. Couple of views from me:
1. I believe this is using US REIT data. So the past 50 years was a secular boom in US real estate, which is why the numbers look so good. If one is buying REITs with Singapore property, the question is whether Singapore CRE will boom the same way in the next 30 years? Or if it is say European real estate, then the answer gets even trickier.
2. Very interesting point on the European banks. Funding stress has gone up noticeably the past week, and lots of reports of margin calls, and big holes in bank balance sheets because of Russian assets being marked to zero overnight. That would explain the big drop, but as to whether it’s over, frankly nobody will know. Interesting though, might be worth a deeper dive.
3. The impact of war – Originally I thought it would blow over too. But then when the West unveiled their list of sanctions, I was blown over. I did not expect them to respond with such a broad list of sanctions, of which the impact can be very far ranging. I suspect even the politicians themselves may not have fully appreciated the implications of what they were doing.
But in any case, once it was unveiled, the market response was chaos. Started in commodity prices, but now spilling over to dollar funding stress and credit spreads. Looks like the early stages of March 2020.
Hopefully like you said, cooler heads will prevail, and we’ll see a ceasefire / rollback of the sanctions in the coming days. Otherwise, this has the potential to spiral out of control.
Great idea abt long suffering European banks, maybe we finally see a +ve sign on Euro interest rates!
A stagnating economy, coupled with rising interest rate, …. will this still be a positive for Singapore REIT?
Yeah that’s a good question. I suppose the answer will depend on how bad the economic slowdown is, how high rates go, and also what type of real estate and located in which city?
Reits can hedge inflation in some conditions, but not all.