On Exit Programs and Central Bank Tightening (22 Feb 2010)

The US Federal Reserve increased its discount rate on Friday from 0.5% to 0.75%. This is the interest rate which it charges banks for emergency loans. The move set the market abuzz last Friday and contributed to the fall in markets on Friday as there were fears on whether this was a shift in monetary policy for the Federal Reserve. (Currently the Fed Fund rate stands at a historic low of 0.25%).

Many investors are currently worried about changes in policy from central banks. In a way, the many measures taken by central banks across the world in the aftermath of the Lehman Brother’s crisis has fostered a certain amount of expectations. The perception is that the whole world was in danger of plunging into a deep crisis, a deep depression, so extreme measures had to be taken.

Now, though we have clearly put the worst of the crisis behind us, we still want those extremely loose monetary policies to continue. We want rock bottom interest rates to continue, and we want central banks to continue to keep the tap open, and to continue to inject tons of money into the system. In a way, its like falling down, and ending up in crutches. Doctors will recommend trying to walk even while our legs hurt, but initially, we want to stay in our crutches because it hurts. We may even end up relying on them if we don’t recover well precisely because we did not exercise them enough while recovering. As a result, those crutches, which should have been temporary, become permanent.

We are facing the same situation right now. Stock markets, used to the extremely loose monetary policies and massive stimulus packages rolled out by governments all over the world are now reacting negatively at the various pullbacks. So far, the pullbacks have actually been fairly mild. The Fed has not even raised its actual Fed Fund rate. Only the discount rate was raised, and banks these days are hardly utilising it in the first place. Yet, the reaction was still negative.

In my mind, I see it as necessary, and in fact, I would rather it happens and take any correction that comes with it. While we remain at an unrealistically low interest rate environment with loose policies, there will always be the nagging fear of bubbles developing, and any recovery will never be complete, since it was achieved with the “crutches” of government aid. Only when we are back to a more “normal” interest rate environment, and when government policies are lesser based on a crisis type of environment, and yet, the global economy demonstrates that it can still grow, will there be a more sustained increase in markets.

So, my sense is that I would rather not fear any upcoming change of government policy towards tightening. It was good while it lasted, but everyone knows it would never be permanent. Let any jitters and corrections happen now, it will only allow the market recovery later to be longer, and more sustained. Most importantly, keep the bigger picture, and longer-term target in mind.  

Chinese New Year Rally? (9 Feb 2010)

Markets have continued to be volatile. But the Singapore, Taiwan and Hong Kong markets have shown unexpected strength today (Tuesday), after the selloff over the last two weeks. Could this be the start of a Chinese New Year Rally?

Even if it doesn’t start this week, I believe markets will start moving back up in the weeks after the Chinese New Year. Current troubles are mainly those occurring in regions outside of Asia. About Europe, which is where the main concerns seem to lie right now. To me, it is inconceivable that the Eurozone countries will allow the entire Eurozone to be dragged down by just a few country’s troubles. Yes, Greece has problems, but would they be allowed to balloon to such an extent that the Euro comes under jeopardy? I find that extremely hard to believe.

Would the likes of France, Germany, Switzerland, and the many other countries in the EC allow Greece to affect investor’s confidence of the Euro to such an extent that the Euro goes into freefall? I believe they would either bail out Greece, or if they don’t want to foot the bill, even take the more drastic step of delinking Greece’s currency from the Euro.

Notice that now, there is hardly any mention about China tightening any more? The reason is that it was a knee jerk reaction. Now that it is over and done with, as China continues to post strong economic growth numbers, we will see a rally because it shows that despite the tightening, growth can continue. In fact, this will hold true for the other concerns plaguing the market right now, including the current Greece troubles and the Euro coming under pressure.

As the economy continues to improve, many of these concerns will gradually fade away or at least become priced into the market. For now, because of the sharp sell off over the last two weeks, it is a good time for bargain hunting. As always though, maintain some diversification even as you bargain hunt and don’t take on more risk than you can bear. The worst would be if in hind sight, it was good to buy in now if you held it over 2 years, but you failed to hold it because the market then corrected another 5% before it hit bottom this year, and you panicked and sold out at the bottom.

I have only shifted 25% of my bond funds, so I still have 75% of what I started the year with, ready to take advantage of a any further drops. Even if we see a rally from here on, I would mind, because the amount I am shifting into equities is one which I am comfortable with. Sometimes, it better not be too greedy, although its better to be greedy when people are fearful and to be cautious when people are greedy.

Here's wishing everyone a fruitful and prosperous lunar new year! Gong Xi Fa Cai!

Euro Woes and US Jobless Claims (5 Feb 2010)

It’s a sea of red today across all Asian markets. Its not just Asian markets, Europe markets are down and US markets fell last night as well. Oil and gold prices are down too. US jobless claims turned out higher than expected, rocking US markets, then in Europe, the high debts run up by countries like Greece has investors worried it would spread to other European countries that has also run up large public debts. Notice that no mention is made now about China tightening anymore, because that’s old news already.

But should investors be selling out now? Ideally, most of us should already be in a diversified portfolio with some fixed income funds to help stabalise our portfolios. Bond funds don’t make as much money as equity funds, but they are worth their weight in gold during times like these. But unless your portfolio is in a big mess, now is not the time to think about upping your fixed income allocation just because it seems more stable now. Because when the market slumps like this and we switch out from equities into bonds, we are likely just selling out of equities at a low.

Ideally, when we rebalanced your portfolio previously at the end of the year, we would have taken profit from your equities or equity funds. Then now, we would actually be in a position to take advantage of the current volatility to look for bargains in the beaten down equities and slowly accumulate.

On my own personal portfolio, I just switched a quarter of my bond funds into equities. And if the market falls further, I will switch more. I work on a worst case scenario basis. Since we are not back to all time highs, and since markets dropped 50% in 2008, what's the maximum downside to markets? It could range anywhere between 10% to 30%. (Things would have to really collapse for it to fall below that).

Hence, I am prepared to switch gradually the rest of my bond funds into equity funds if the fall continues. This would be in proportion to the extent of the current drop. But even if it never reaches 30% down (in my opinion it won't), and it rebounds whether after falling 10% or 20%, that is fine.

The key thing to note is that in any kind of market slump, things eventually do turn around. Jumping in too early can hurt just as much as jumping into the market too late. But trying to time the exact bottom of the market is likely to be impossible as well. I think most people didn't dare to enter markets back in March 2009.

The main point I am trying to make, always have a diversified portfolio, with some amount into bonds or bond funds. This allows you to take advantage of exactly the market slumps like the one we are seeing now. Be patient, have the daring to go in slowly as everyone is selling out. There will definitely be bargains available. Investing is about not letting your emotions take hold, and also about being patient. Markets are very short sighted, they are falling now because everyone is selling. Although the picture could look very different 6 to 9 months later, markets can’t look that far out. All they care about is that in the immediate short term, US jobless claims numbers are bad, and Greece’s troubles are causing Europe markets and the Euro to take a pounding.

One interesting trend I have noted so far, is that Indonesia, Malaysia and Turkey are still holding quite up quite well. For Indonesia and Turkey, these two are interesting, while I would not have pegged them as strong performers in a year where external trade recovers, they will do well even if the external trade remains bad! That’s because Indonesia and Turkey have large domestic markets, and exports are a relatively small part of their economy. They are to a large extent “self sufficient”. So, it may be a good hedge to consider in counterpoint, even though I still think that external trade should recover this year.

Malaysia on the other hand, is mainly a more defensive type of market, and hot money flows more to other markets than Malaysia. Hence, when investors are spooked and hot money flows in the opposite direction, Malaysia suffers the least.

Well, the weekend is here. My switches will buy in on next Monday (the switch sells happened on Wednesday). I won’t know if Monday, thing are going to get better or worse. Short term fluctuations are notoriously hard to predict. However, I do know that at times like this, do not panic! When the market is frightened, as it is now, every news that comes out will see a negative spin in it. Don’t let it get to you. I doubt if the world will suddenly go into a huge U turn and plunge back into recession again. But it does look like the year of the Tiger is going to be a very bumpy one, so hang on tight! Just make sure not to let your portfolio become so exposed to risk that you can’t even celebrate the Lunar New Year without worrying about it.

Shifted 20% of my Bond funds into Equity Funds (3 Feb 2010)

I mentioned in my previous blog post that if markets went down further, and are down 10%, I would shift some of my bonds into equities. I waited a couple of more days, during which I added another $3,000 into equities, but it seems like we have reached a certain lull in the market. Things are still quite volatile, as can be seen by sometimes very wide swings in the market, but we seemed to have reached a certain “support” point.

Now, I would clarify here first, I am not a chartist, and it is unlikely that I will ever be. I prefer to focus on fundamentals and adopt a longer term mentality then just two weeks or 3 months. But I was bullish at the start of the year, and nothing that has happened since has really changed the fundamentals of the global recovery we see taking place. This means that when markets fall lower, I get tempted to put even more into equities.

Its just as well I forced myself to rebalance my portfolio in December, and even though I was bullish equities, I ended up moving some money into my bond funds because my equity funds had outperformed the bond funds by spades in 2009. Thus, I now have nearly $52,000 in bond funds, and so if I feel that I want to take advantage of a market correction to add back into my equity funds, I can.

However, instead of adding everything, I shifted 20%. Here’s how I see things going. In actuality, most Asian markets are not even down 10% yet, they are only down around 7 to 8%. But overall, I am bullish for the year, so this could be as low as they go before markets start to recover again. However, nothing is ever a sure thing in life. So, I look at worst case scenarios and alternate scenarios.

Firstly, at this stage, I don’t see a double dip recession happening. And even in recession years, a big market crash would typically be 30% down from their peaks. Assuming a worst case scenario (which I don’t believe will happen). I would want to be 100% into equities if markets are down 30% because we would probably be at or near the bottom by then already. Markets are only down 8% at this point, so instead of shifting all of my bond funds into equity funds, I shift 20% instead. This then allows me more leeway to shift more of my bond funds into equities if markets happen to fall further.

The more likely scenario is that markets will soon stabilise, and as the global recovery continues to take hold, start to move north again. In this case, I would probably regret not having shifted everything in bonds into equities, but having a lessor return is something I can live with. You can’t get everything exactly right. I am not trying to predict we are at a bottom for this year. If I knew for sure, I would shift everything into equity funds straight away.

The whole concept of rebalancing, and having some allocation into both equity and bond funds is about managing risk. Hence, my actions over the last two weeks. So, while I would take opportunity to make some shifts like I have done, I recognize that if markets do recover and move back into a bullish mode, then it would be wiser to shift back to my original allocation at the start of the year then. Just in case people are curious, I shifted $3,000 from the Fidelity High Yield Bond Fund into Aberdeen Pacific Equity, and I shifted $8,000 from INF EF Emerging Market Bond Fund into Aberdeen Asian Smaller Companies fund

Certainly though, I will be watching markets closely at this point. Do I think we are at the bottom for this year? I wouldn’t know, since short term sentiment can change very quickly. However, I don’t believe the fundamentals have changed in any major way over the last two weeks, so, the correction has made me more aggressive in my portfolio positioning.