Perception Revolutions

If Beta is dead, VaR should be extinct

2010-02-13T21:26:00.002+08:00

It is to my horror that after poring through the notes on what is VaR. It finally dawned upon me that the entire financial industry has embarked down the path of no return. In the academic world, Beta is dead and thus by inference so is VaR. I thought the industry practitioners might be better when it comes to this kind of stuffs so perhaps they might have something more advanced.

Seems like I was dead wrong, allow me to correct myself, they are even more out of touch than the academicians. Financial markets are like the real world, it is much more chaotic than what can be captured by some complex formulation and parameters. The all to familiar gaussian bell curve appeared on the 3rd page to my disgust.

Just how do you model human behaviour? Applying mediocristan laws in a world of extremistan is bound to get you into trouble. The natural tendency of human beings to swing towards extremes. Right down here we still have an entire industry worshipping something that is incorrect and I have a career that is based on bullshit.

Being politically correct emails galore

2010-02-10T00:04:00.004+08:00

Got an email straight from a director in London to change all references of "Proprietary and Prop" to "Arbitrage" in all our reports. Well, yeah as if that is going matter at all. Now the harsh criticism on proprietary trading is coming down from the regulators and politicians. So change the wordings of the title. Presto, we are operating a different business now!!

Please do not use the acronyms PIIGS. Spell them out Portugual, Ireland, Italy, Greece and Spain correctly. Do not say you have short positions, that makes us look like short-sellers. These people gain from the misery of investors. Say you have a short exposure.

Seriously, I totally do not understand what all the fuss is about.

Practical Realities

2010-02-08T01:46:00.002+08:00

It is the distinctive unmistakable feeling that work is starting to suck my lifeforce away. Nowadays, I spend the most of my time looking at practically meaningless data. Delta, Gamma, Vega, Theta and Rho, these Greeks are really meant make to simple things complex.

In reality, risk sensitivities are only meant for trading purposes. They represent no significance at all when it comes to real long term investments. However, trading in a bank is no difference from gambling. Investment banks are just super big glorified casinos. Why do I have to bother with all these nonsense?

Ah...I forgot, because it's my job to do so. It pays very well but I literally hate it, but this is the best I can get to move towards my goals.

Career Advice

2010-02-01T23:35:00.005+08:00

"Would you tell me, please, which way I ought to go from here?"

"That depends a good deal on where you want to get to," said the Cat.

"I don't much care where..."said Alice.

"Then it doesn't matter which way you go," said the Cat.

-Lewis Carroll, Alice in Wonderland

Reigning in the banks

2010-01-24T12:37:00.002+08:00

Though this might mean lower bonuses for everyone but hopefully this will reduce the amount of work I am getting! Simplify the rules and regulations as well. Lower leverage, lower risks and please...lower the amount of new trades. Banking should be boring and I would like to have it that way.

Tiger Airways IPO

2010-01-17T22:10:00.002+08:00

"Investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners."
-Warren Buffet

One of the worst industry ever to invest in, couple this with losses over the past few years and a negative net asset value. This may be the year of the tiger but with numerous global airlines dropping like flies, don't expect a spectacular flight for this one. Main sellers of the stocks, Ryanair. If the kings of LCCs can't turn this company around, I can't see how Temasek and SIA can.

Expectations of future profits due to the IRs is nothing but a hope at best. It might turn out well, it might not. On the otherhand, if this paper tiger were to roar, then it is sure indication that we are entering bubble territory. Caveat Emptor.

What a mess!

2010-01-11T23:32:00.004+08:00

As much as I like the club, its finances are in a mess. Here's what I picked up from soccernet:

The bond will be used to repay the "senior secured notes". It was thought that the Glazers would be looking to finance the £175 million worth of payment-in-kind notes that are currently attracting 14.25% interest. However, this is considered personal debt and will not be refinanced through bonds.

"Manchester United today announced that it will be seeking to raise approximately £500 million aggregate principal amount from an offering of senior secured notes due 2017,'' said a United statement. "The notes, whose proceeds will be used to refinance existing debt secured against the club, will be issued by MU Finance plc.''

But the Glazers will not be selling the club and intend to use the money saved from restructuring the debt to ensure significant money is available to Sir Alex Ferguson to spend in the transfer market.

I have no idea what are in the books. However, from the surface, 14.25% worth of interest is just madness to me. No corporation can ever survive that kind of interest rates on loans. This is the kind of rate you pay for a junk bond, something with a high probability of blowing up within the next few years. Furthermore, isn't issuing new bonds to refinance existing debt a big red flag, a classic robbing Peter to pay Paul syndrome. The Glazers are destroying a great franchise from the inside.

A legend of the past

2010-01-10T13:42:00.004+08:00

" I was taught to work as well as play, My life has been one long, happy holiday; Full of work and full of play- I dropped the worry on the way- And God was good to me everyday."
- John D. Rockefeller

Currently reading Ron Chernow's biography of John D.Rockefeller. This guy is an absolute legend. If Standard Oil were to remain as a company today. It would have consisted of ExxonMobil, Chevron and ConocoPhillips combined, which is 3 of the top 5 companies on the Fortune 500. As a percentage of United States GDP, no other American fortune amassed including those of Sam Walton and Bill Gates combined would even come close. This was probably the greatest amount of absolute wealth that any self-made person could amass by his own hands. A controversial character through and through, extremely philantrophic in terms personal life but ruthlessly efficient when it comes to business. It is not hard to imagine the critical role that he played in propelling America's ascension to supremacy as a world superpower.

Learn, unlearn and re-learn

2010-01-03T11:28:00.005+08:00

The only function of economic forecasting is to make astrology look respectable.
-John Kenneth Galbraith

Here comes the end of 2010 and the start of a brand new decade. There were lessons learnt and re-learnt and for some unfortunately I still do not learn. Putting the past aside, its time to start anew. Going forward, what are the lessons we can learn from the past that can better guide us towards the future?

Here are my top 5 lists:

1. It ain't over till it's over

Never ever pass judgements too quickly. What might seem a wise choice then might not be so wise later. What might seem stupid then might not be stupid later. Whether you are right or wrong in terms of decisions is all time and outcome relative. You can make all the right moves and the most logical decisions but there is always the element of chance that things might not turn out as expected. There's nothing to rejoice when prices go up and nothing to panic when prices go down. If one does not need validation from the markets, then it does not matter what the market does most of the time.

2. Long-lasting competitive advantage is the driver of value

Statistics and past performances matters as much as how relevant they are as a guidepost to the future. In some cases they can be predictive, in others they are as good as a flip of coin. Value is only as good as how much you will get. If all those earnings and cashflows is going to find itself stuck in some machinery and assets, then unless the company is going to liquidate the assets, you are not going to see those cash. Understanding the economics of a business is a much better way of assessment than some esoteric calculations. Porter's 5 forces though not exhaustive is a good framework to start with.

3. The tendency of man is towards extremes.

Humans are like a pendulum that swings from one end to another. That is why we had cycles in the past, we will definitely have them in the future. However, the magnitude and duration is unknown and unforeseeable. A good business per se does not justify an astronomical price and a bad business per se might not mean it is totally worthless. (It neither works the other way round either.) Reality is not as simplistic as what many people think. Except for scientific laws of nature and history, there is no such thing as sure thing.

4. Psychological biases: Try looking into the mirror

People like to look at success stories and forget about the silent evidences of countless failures. Nothing is more inspirational than fighting and overcoming the odds to emerge victorious. However, one usually fails to notice is that to "overcome the odds", by definition means to be the exception. What makes people like to think "this time its different", for everyone else the rule applies, whereas for me, "it's the exception". Therein lies a paradox, without believing we are the exception, we wouldn't try, then there would be no success stories today. In order to be the true exception, one would have to ask himself and find out "What do you have that others don't? What are you doing that others are not?" Food for thought.

5. It's all a matter of perception

Our internal representations or experiences of any event is not precisely what happened but rather a personalized internal re-representations. People interpret things differently. The conscious mind is unable to process all the signals that are being sent to it. The brain filters and stores the information it needs and ignores the rest. The different filters in place are the reasons why two different people might view the same things differently. Those filters are made of beliefs, values, attitudes and metaprograms. Many of these filters are ingrained and stored within our emotional and cognitive system so much so that we are not aware of it. Since we do not know how things really are, but only how we represent them to ourselves, the best we can do is only to represent them in ways that helps us rather than harm us.

The Future of Finance

2009-12-20T14:03:00.004+08:00

It seems clearer and clearer to me that the financial industry is headed for an age of rocket science. An age whereby quantitative and computational finance governed by greeks, complex alogorithms and black boxes would account for an overwhelming majority of trades on exchanges. What would be the future effects of this? Would the traditional investor be disadvantaged? Is it time that all of us should have black boxes of our own?

In this post I would attempt to share my thoughts on this:

What would the future effects of this?
It means that the market will become more and more efficient in such techniques and the profit margin in relation to risks will continue to shrink. The investor will have to on an increasingly frequent basis develop new techniques and ideas, backtest it and roll it out before some hedge fund or large bank comes into the scene. The impact of this on security prices to me is unknown but I guess that prices would become much more volatile as trades become much faster than ever before. Slight changes in economic indicators can have large impact on security prices. More and more people will have to depend on leverage. Then this means there will be counter-techniques whereby institutions with large enough capital to influence prices can front-run or harvest smaller black box players by busting their stop losses or force margin calls. Volume of stocks traded would explode and this would spell well for exchanges.

Would the traditional investor be disadvantaged?
It depends, very much on the whether the investor or trader relies on similar quantitative indicators to make his trades. If he does, then he will surely be outdone by these black boxes and it would be about time he revises his investment framework. Retail investors should keep away from techniques that would pit themselves in direct competition with the big boys out there.

Is it time that we should all have black boxes of our own?
I would say no as a matter of fact. These black boxes will almost wipe out the the arbitrage business of financial securities. It requires strong foundation of financial and programming skills which is not oftenly found in any normal person. However, there is one thing that black box users do not have, that is to have a long time horizon. The quant community by and large do not like to leave themselves exposed to price fluctuations for too long. The buy and hold technique might seem outmoded and dead, but I would say it would depend very much on what you buy and at what price you bought. Blindly buying the indexes, will just allow you to do average. These quant traders would come under increasing stress and pressure to find new techniques and ideas. Whilst true buy and hold investors who have perfected the art would have no such stress.

Debunking the Efficient Market Myth II

2009-12-20T12:17:00.009+08:00

For several decades, there would come a time when the prevailing view that the world is so chaotic and so much beyond our control that even the most prudent of stock investments seemed foolhardy. Yet on hindsight these periods were all of opportunities that seemed almost incredible with the advantages of hindsight.

There were several times in these decades whereby some stocks will become darlings of the market. These were later to prove to be the most dangerous kind of trap for those who blindly followed the crowd than those who really knew what they were doing.

All these periods resembled the others in that they create opportunities whenever the financial community significantly misjudge the situation. The great waves of optimism and pessimism reflects the unfortuante tendency for humans to go towards extremes. Plus ca change, plus c'est la meme chose (the more things change, the more they stay the same). The idea that we have finally come into an era of prosperity or "Goldilocks" economy (remember Larry Kudlow), whereby severe booms and recessions are a relic of the past should be shelved in the memory as a "new era story".

Now I deem it to be appropriate to touch on the subject of Beta. This is a traditional academic measure of price fluctuations of common stocks against the market index. What bothers me is how the academic authorities equate Beta or price fluctuations whatsoever with the concept of risk. Price variation yes, risk no. Real investment risk is measured not by how much price will decline but the danger from the loss of quality and earning power through economic changes or deterioration in management. The idea of measuring investments via price fluctuations confuses the stock market's opinion and what actually happens to the owner's stake in the business. In the desperate search to quantify risk into a single statistical measure, academics have forgotten to evaluate the conceptual arguments of the theory. As Einstein said, "Make everything as simple as simple as possible but no simpler." This is one such oversimplification.

Beta in its purest form ignores all the qualitative characteristics of the company, what it produces, what is the nature of the business, what kind of people do they have for management. He might not even care what the company is called. What he treasures is the price history of the stock. Then if that is the case, then the concept of beta is of no difference to those who use technical analysis as both derive their validation from price fluctuations.

The true investor welcomes volatility for it means that there will be periods of time whereby irrationally low prices will be attached to outstanding businesses. He would be free to exploit its folly to his liking. What the price history of the company maybe is of no importance to him, he would prefer to further his understanding of the business. He does not seek validation from the markets and would not be disturbed even if nobody traded the stock for a year or two.

Real risk though cannot be judged or calculated with numbers, it can in some cases be judged with a level of accuracy that would be useful. A good framework would be to use Porter's Five forces in the evaluation and understand the nature of the business. Thereafter, would be judging the extent of accuracy these factors allow themselves to be predicted as well as the characteristics of management. Lastly, would be the price that the investor would pay for the business.

All these characteristics might strike an analyst as unbearably ambiguous since they do not come in some form of database by itself. In the parlance of law, this would be called the "reasonable man's test". If you were to unable to apply it with a degree of confidence that would be reassuring. Then, this would be a clear indication you are out of your circle of competence or the subject matter at hand does not render itself to such evaluations.

Obviously, every investor will make mistakes. But by confining oneself to a relatively few easy-to-understand cases, a reasonably intelligent, informed and dilligent person will be able to judge investment risks to a useful degree of accuracy.

Academics built arcane investment and capital allocation theories around price histories with correlations to create optimal portfolios. Laudable attempts but not very useful when the underlying concept is fundamentally flawed. Most of the greatest investors who have earned the highest compounded rate of returns all do not use any "optimal portoflio" of any kind. If a business is worth a dollar and one pays 40 cents for it something good may happen to him.

Debunking the efficient market myth I

2009-12-08T18:58:00.003+08:00

Modern finance has very much based itself on a concept that I believe is quite fallacious. What I am referring to here, is the notion of market efficiency. The concept holds that in a semi-strong effcient market, the "efficient" prices are assumed to reflect fully and realistically all publicly available information. It holds that unless one gains material non-public information, there is no way of unearthing genuine bargains, since the favourable circumstances existing are already reflected in the price of the stock.

Admittedly, there is a certain element of truth in it. Very much like in a pari-mutuel betting system, the odds of a favourable gain has to be weighed against the extent of gains that is already reflected in the price. However, a half-truth doesn't serve the investor well at all.

The efficient market theory grew out of the school of random walkers. These people found out that it was difficult to identify trading strategies that worked well enough after transaction costs over along periods of time relative to the risks undertaken. These trading strategies work well some of the time and fail in others. It becomes very much like flipping a coin to decide whether to buy a stock. I don't disagree with this.

Once again, I set out disqualifiers, because there are always exceptions to the rule but not many. These include high frequnecy alogorithm traders such as Renaissance Technologies and other quantitative funds. This method is gaining alot of attention and competition from large banks and hedge funds. I believe it would become a matter of time before the market starts to arbitrage away these huge profits.

Though I know quite a bit about program trading, I do not know enough to give advices. What I am proposing here is the best method of investing not trading. One should be seeking investment opportunities with unusual prospects over the long term and avoid those that are of poor quality. This would be the central tenet to the proposal that is prescribed here.

I do not believe the markets are efficient in this approach because it is unpopular and many investors have a tendency to learn the wrong lessons. At first glance, it might seem amateurish, inexperienced and sometimes downright dumb to the untrained eye. It is safe to say to assume if you knew something was wrong, you wouldn't believe it in the first place.

Most humans, hate self-questioning and prefer to spend their time convincing themselves and others their beliefs are right. These beliefs persist, particularly when they make sense intuitively and even more so when others around agree to it. To determine the efficiency or the lack of thereof with the investment approach, the investor will have to look at whether approach are scientifically sound and relatively unpopular. The method must not be generally accepted because those that are well accepted do not produce the required results. Ironically, this reflects an unfathomable idea, "Precisely because nobody ever think is going to work, which is why it is going to work wonders."

Be particularly wary of making a decision simply because of something you know others agree with. The reasons why we hold certain false belief is because 1) They make common sense and one is typically not prone to question his common sense. 2) People around you tend to agree with you and one do not have an inclination to challenge widely held views.

By and large, those who have accepted and been influenced by the efficient market theory fall in into 2 groups. One is students, who have had a minimum exposure to practical experience. The otherm strangely enoughm is those managers of large institutional funds. The private investor by and large has paid relatively little attention to this theory.

Also, a large number of studies have shown that variation in portfolio values are 90% caused by asset allocation between the different asset classes. Implying that the greatest gains or losses are to be made by moving in and out of markets. However, it is of my viewpoint that timing the market is extremely diffiicult, simply because you have to get several things right. One will have to select the right stocks, to make sure it can withstand a severe crisis. You have to make sure that the price is right and you are not catching a falling knife. You also will have to get out at a good price with the timing right the next time you sell out.

What I am proposing here, is to choose extremely carefully the stocks you are going to buy. Buy them at a relatively fair price. Then put your hands under your butt for the next few decades, a "buy and sit on your butt" approach to investing. Then you just wait. That is all to it.

It can be easily observed that in a portfolio of a large number of stocks, be it a mutual fund or an index. Countless empirical evidences show that a "small" number of stocks actually drives a large proportion of changes of value within any portfolio. Over a couple of decades, these gains in value can become extremely substantial. The ultimate question then begets "Is it possible for investors to identify them?" My answer is "Yes, you can. However, it is not easy to find such opportunites at all."

The death of one man is a tragedy, the death of millions is a statistic

2009-12-08T03:34:00.008+08:00

Just finished the first level of CFA exams. The questions and concepts per se are not really that difficult. What is harder is finding the time and discipline to study as well as the stamina of going through 6 hours of nerve-wrecking challenge. Whatever happens next, be it good or bad, life still goes on.

I have learnt to adopt a more philosophical attitude towards success and failure. Even if one fails, life still goes on, just pick up the pieces learn from your mistakes and move on. Disasters strike, tragedies happen almost on a daily basis to different people in different parts of the world. One is neither unique nor alone. It maybe harsh but I never gave myself (sometimes even others) much sympathy or excuses to wallow in past failures.

The corporate world has a terminology for the end result of such instances. It is commonly known as BAU (Business As Usual). No matter what happened yesterday, the world continues to revolve, markets continues to open, businesses need to be made and jobs still need to be done. Sometimes, I wonder to myself since when did I ever become such a cold-blooded creature.

After some thought, I could trace the rationalization back to an event couple of years ago. It was the day of Tsunami on 2004, whereby almost 300,000 people killed with the highest number of casualties coming from Indonesia. From a perspective of a normal human being, it was an unprecedented disaster. However, what surprised me even more, was that the JKSE index unflinchingly rose instead, marching unstoppably forward. That very moment, impounded within me a icy-chilling sense of reality that till today still continue to send shivers down my spine.

Compare and contrast this with the events of the September 11 tragedy, whereby 3000 people died and stock markets worldwide fell sharply. Though both are tragic events, but the relative costs in terms of human lives couldn't be more apparent. One is a hundred times more than the other and yet responses by markets couldn't be more inconsistent.

Capitalism has implicitly placed a price on human lives. What the markets are telling us, despite how unsightly it is, is that the world can't be bothered by people whose lives don't matter. As the saying goes, the death of one man is a tragedy, the death of millions is a statistic. It seems Joseph Stalin knows a little more about human nature than we do.

Dubai Bond Default

2009-11-30T00:17:00.003+08:00

More problems at work because of Dubai bond's default. Not because of direct exposure to their bonds and CDS but rather more because of HSBC pulling the HSI down. We are experiencing pretty big VaR moves all over the place due to panic selling. Whether there are more trouble than meets the eye? We still do not know. However, many of my colleagues are keeping their fingers crossed. Apparent from the comments, "Now is already the month of December, I don't want this thing affecting my bonuses!"

My opinion is that the default per se is not a big issue $80-90Billion may be large but not insurmountable. What I think is more important is the health of US consumers who are still in a balance sheet recession. Most probably they are taking the opportunity to stock up hugely on necessities during this Black Friday. The financial media as usual might again want to distort this as a sign of financial strength.

Lucky for me, sold out on my Capitamall Asia positions just before markets closed on Thursday, made some coffee money. Kudos to discipline of not leaving speculative positions over weekends. Experience has taught me that market sentiments can change at the snap of a finger. Didn't expect this Dubai issue to pop out immediately out of nowhere though.

Buying opportunity? Well, depends on the extent of correction that happens later. Given how US and Europe reacted, doubt there will be anything more than a small 3-5% move. As they say, bonuses coming up, thus window dressing season is in, doubt traders will be in the mood to rock the boat now.

Fortune's Formula

2009-11-21T23:15:00.002+08:00

Bought it over at HarbourFront PageOne bookshop. Haven't been able to put it down ever since. Though it's a little pricey for a paperback and probably a book you can get over at the library. However, I still never regretted owning it. That for itself, my friend, speaks volumes.

Relooking History with a new perspective

2009-11-13T23:49:00.015+08:00

I was doing some financial research and came across an interesting phenomena. Unfortunately, I have no rational economic explanations for it. Therefore, it might one of those predictors that performs excellently in backtesting but to fail miserably going forward. Nonetheless, it might lead to something though.

This experiment was conducted under the scenario that if one were to buy the S&P500 and hold it there for the next ten years without selling. How well would the investor fare through companies' earnings and dividends without considering capital appreciation of the stock itself? Earnings risk premium tends to overstate performance (upper bound), whereas dividends risk premium usually understates performance (lower bound). The real performance usually lies in between the two.

It would be interesting to note that backward earnings premium is highly correlated to forward dividends risk premium. It has a correlationship of almost 90%. An astonishing predictor considering the fact that forward dividend risk premium are figures made with hindsight hence impossible to produce at that point in time. However, backward earnings premium is another different story altogether.

The results have shown that ever since 1977, investing has become a lot more harder than ever. Earnings risk premiums and dividend risk premiums have virtually collapsed, sometimes even negative. This runs against the prevailing notion that if one had bought stocks in the long bull market of 1990s and they would have earned quite substantially. In fact, most of the time, these people would be much better off if they had bought 10 year treasury bonds instead. This showed that most stocks between the late 1970s till the recent crisis were just plain overvalued.

Good news is that according to this indicator, stocks are fairly cheap even at current prices. This is in direct contrast of my qualitative analytical work. In a way, it could also be a defining moment, for the outcome would allow me to place more weightage on qualitative or quantitative factors in the future.

Human Psychology

2009-10-18T19:49:00.005+08:00

In this post, I shall deviate a little from my normal course of subjects and delve into area of human psychology. I highlight the importance of this is because it is necessary to take note that our biological decision making process which has served us so well in our natural daily lives would become fatal most of the time when it comes to financial markets.

I would first and foremost iterate that when it comes to theology, I remain an agnostic. In other words, when it comes to the supernatural, spiritual or other forms of metaphysical claims, I simply do not know the truth. I believe that such things are simply unknowable and one cannot reach a conclusion without the leap of blind faith.

However, allow me to start with a general observation that helps explain what follows. First of all humans are social primates. It does not matter whether or not evolution is true or not, the fact that we share about 95% of our DNA with chimpanzees is not subject to debate. Therefore, many of our body features and basic drives mirror the behavior those of our hairy cousins.

Our main differences lies in only three millimeters of convoluted gray matter, called the cerebral cortex. That is we are biological machines that operates 95% on a similar basis with only 5% differences. This 5% might be what accounts for our consciousness or self-awareness which has bestowed us with higher order thinking and sparked entire civilizations.

Thus, there are basic human psychological tendencies that we have to be aware of, for these applies to the human species in general.

The first is Pavlovian conditioning, this is quite apparent for one can observe how incentives and disincentives work in the real world. Perhaps the most important rule in management is about "Getting the incentives right". Get them wrong and you will start to witness dysfunctional behaviors that games the system.

However, there is a consequent effect that receives less attention than it warrants, known as the "incentive-caused bias". A pretty decent fellow can be driven both consciously and unconsciously by incentives, into irrational behavior that alters his own reality.

This person gets into a rationalization pattern that vindicates this behavior. The cognitive drift is present in every human being and it can cause incredulity in a perfectly normal human being. Thus the principle "What a man wishes, that also will he believe".

The mis-influence can obviously be seen on televisions, whereby tearful mothers, with heartfelt convictions, declare before national television the innocence of their obviously guilty sons. I have experienced this same psychological self-denial, that such a sane person as myself could not accept the unfortunate death of a dear friend long time ago.

That being said, there is another form of warping one's own self-reality. Coming from an accounting background, there is an old saying in the accounting world, "Whose bread I eat, his song I sing." When corporate management of established institutions ask the accountants to jump, the reply was "How high?" The natural results of incentive caused bias is well-developed in economics. Also well-known as the "Agency Problem".

Although money is the main driver amongst rewards, it is not the only reward that works. People also alter their realities and cognition to avoid pain or to gain identity, friendship, companionship, advancement in status and many other non-monetary items. It is important to recognize one's self incentive-caused bias taking place sub-consciously, for it is the cause that has led to many imprudent behaviors.

The second is a hating/disliking tendency. All humans need at least an object of hate within a group, which is also part of the "us against them" mentality. Whereby people bond together through a commonality of enemies. Consider the fact that the world's most successful religions have successfully garnered irrational hatred towards evils such as "demons or devils". It is usually way easier for a person to blame something for his shortcomings, misfortune or some feelings of guilt, than to take responsibility for them.

The triggering of such a tendency is the feeling of loss. A man ordinarily reacts irrational intensity over a small loss or threatened loss of property, love , friendship, dominated territory, opportunity, status or any other valued tangibles or intangibles. As a natural result, infighting in corporate settings over dominated territories often cause immense damage to an institution as a whole.

This also protects ideological or religious views by the feelings of dislike and hatred directed towards vocal non-believers. This happens in part, because the idea of nonbelievers if they spread will diminish the influence of views that are supported by a comfortable environment including a strong self-belief maintenance system.

This ideology-based group think rejects all conflicting inputs. When the vocal critic is a former believer, hostility is often boosted with a concept of betrayal that triggers hatred because a colleague is lost and fears that conflicting views will have extra persuasive power when they come form a former colleague. The result in history is the accusation of heresy which justified much killing of heretics, frequently over torture or burning the victims alive.

It is almost everywhere the case that extremes of ideology are maintained with great intensity and with great anitpathy to non-believers, causing extremes of cognitive dysfunction. This happens when other psychology tendencies are acting concurrently.

The third is doubt-avoidance tendency. The brain of man is programmed with a tendency to quickly remove doubt by reaching some decision. This doubt-avoidance tendency is well hard-wired into our survival instincts. After all, the one thing that is surely counter-productive for a prey animal is to take a long time in deciding what to do.

So pronounced is this tendency that it is logical to believe that at least some leaps of religious faith are greatly boosted in order to remove self-doubt. Even if one is satisfied that his own faith comes from revelation, one must still account for the inconsistent faith of others. This results in the aggressive evangelism activities to convert others.

What usually triggers doubt-avoidance tendency is some puzzlement and stress. Such as what is the meaning of life? Why do we exist? As we shall see later, this tendency usually works in tandem with social proof tendency and stress influence tendency. Many of these factors, naturally occur when facing religious issues. Thus, the natural state of most men is some form of religion. And this is what we observe.

The fourth is the congruence principle also known as the "status-quo bias". The brain of man conserves programming space by being reluctant to change which is a form of avoiding inconsistency. Anything that is inconsistent, causes a phenomenon known as cognitive dissonance. Cognitive dissonance is an uncomfortable feeling caused by holding two contradictory ideas simultaneously and trust me it is not a pleasant experience at all. The desire to avoid such unpleasant feelings to make a person feel better are what leads to confirmation bias, the denial of evidences that point out to the contradictory or other ego boosting mechanisms.

It is easy to see that a quickly reached conclusion triggered by the doubt avoidance tendency when combined with a tendency to resist any change in that conclusion will naturally cause alot of errors in cognition for the modern man. As it works out in an observable manner, we deal with many people whom we diagnose as imprisoned in poor conclusions that they will rather carry to their graves. So bad is the problem that, radically new ideas are seldom accepted by the old guard. Such events can be recognized by Galileo's persecution by the church. Instead, much progress is made by subsequent new generations who comes along and are less brain-blocked by previous generations.

One corollary of this tendency us that a person who has just made an investment or sacrifice in the course of assuming a new identity will intensify his devotion to the new identity. Afterall, it would be inconsistent behavior to make a large sacrifice for something that was no good. And thus, civilisation has invented many tough and solemn initiation ceremonies, often public in nature that instensify new commitments made. Examples that usually come to mind includes, baptism, blood oaths, pledges and even marriage solemnization.

The human mind works a lot like a human egg, there's an automatic shut-off device that bars any other sperm from getting in.

This tendency will often make humans into a subject of manipulative practitioners that gain advantage from triggering this tendency. So strong is the tendency that it can be manipulated to lead people into behaving horribly as a result. Two famous studies in psychology the Stanford prison experiment and the Milgram experiment are done to prove the existence of such a tendency in perfectly normal human beings. We do not know the horrible acts that we humans are capable of.

Though there are still many others, the last tendency that I will discuss here is the social proof tendency. Also known as the monkey-see monkey-do tendency. It has been proven that social animals possess a mirror gene expression. It is triggered in the puzzlement or stress, and particularly when both exist. Since so many others are doing it and I do not know any better, I must be right in doing it as well.

This social proof tendency interacts in a perverse way with the envy and hatred tendencies. A common expression is when people fight over a single man or woman when they are surrounded by an entire forest of better ones. Political versions becomes dead serious as the Middle East threatens nuclear war just because of some land that can easily be divided arbitrarily.

The important takeaway here is that several powerful psychologies work in tandem that causes us to do what we do. Although in several circumstances, it serves us well. In others, it can be extremely faulty especially when it comes to financial markets or religious beliefs. We may think we are above all these because we are rational humans which think for themselves. Though occasionally logic and reason can be used to determine a course of action, men and women including myself are more persuasively motivated by emotions which are also our psychological tendencies. Often, we simply use our intellects to rationalize those emotional actions after the fact.

How Stock Market Operates (Part II)

2009-10-18T19:27:00.002+08:00

When for a long period of time a particular stock has been selling in a certain price range, say from a low of 25 to a high of 30, there is almost an irresistible tendency to attribute true value to this price range. Giving in to this urge can be very costly. This is because the genuinely worthwhile profits in stock investing come from holding the surprisingly large number of stocks that have gone up many times from its original costs. The only true test of whether a stock is "cheap" or "expensive" is not its current price in relation to some former price, but whether future cashflows realized are significantly more or less favorable than the current appraisal of that stock.

Taking from a Graham parable, the market is not a weighing machine on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather it is more like a voting machine, whereon countless individuals register their choices which are the product partly of reason and partly of emotion.

This is an important principle because despite the laws and regulations in place today, pools of manipulation of shares still exist. The methods of all these pools are fundamentally similar. The members would sell stocks back and forth amongst themselves at gradually rising or constant prices. All this activity on the stock price would attract attention of others who would then start buying shares and take a portion of the shares off these pools' hands at still higher prices. These highly skilled manipulators were quite experienced and able practitioners of this rather questionable art.

The conservative investor must be aware of the nature of the current appraisal by the financial community of any industry he is interested in. Determining whether at that moment the price of a stock is attractive, unattractive or somewhere in between depends on most part how far off these appraisals deviate from reality. However, to the extent that the general level of stock prices affects the total picture, it also depends somewhat on correctly estimating coming changes in purely financial factors, of which interest rates are by far the most important.

Allow me to close this chapter with a simple summary, prices have only one significant meaning for the investor. They provide him with an opportunity to buy wisely when prices fall sharply below its calculated intrinsic value. Throughout the investment process, he will be better off ignoring market prices and pay attention to his calculated range of future cashflows lest he gets anchored by some misleading price conditioned into his mental memory.

How the stock market operates? (Part I)

2009-10-02T03:15:00.007+08:00

Every significant price move of any individual common stock occurs because of a changed appraisals of that stock by the financial community. It should never be forgotten that an appraisal is a subjective matter. It has nothing necessarily to do with what is going on in the real world around us. Rather, it results from what the person doing the appraising believes is going on, no matter how far from the actual facts such a judgment may be.

The key point to note is this, any individual stock does not rise or fall at any particular moment in time because of what is actually happening or will happen to that company. It rises or falls according to the current consensus of the financial community as to what is happening and will happen regardless of how far off this consensus may be from what is really occuring or will occur.

Because of a financial community appraisal that is at variance with the facts, a stock might well sell for a considerable period for much more or much less than it is intrinsically worth. Furthermore, many segments of the financial community of a habit of playing "following the leader", particularly when that leader is one of the larger New York City banks.

This sometimes means that when an unrealitic appraisal of a stock is already causing it to sell well above what a proper recognition of the facts would justify, the stock may stay at this too high level for a long period of time. Actually, from this already too high a price, it may go even higher. These wide variations between the financial community's appraisal of the stock and the true set of conditions affecting it may last for several years.

However, there will come a time when the bubble bursts. When a stock has been selling too high because of unrealistic expectations, sooner or later a growing number of stockholders grow tired of waiting. Their selling soon more than exhausts the buying power of the small number of additional buyers who still have faith in the old appraisal. The stock then comes tumbling down. Sometimes, the new appraisal is quite realistic. However, this re-examination is frequently evolved under the emotional pressure of falling prices, the negative is over-emphasized, leading to under valuation. It may take quite some time for a more favorable image to supplant the existing one.

It is important to note that in several instances what has shifted was the emphasis not the facts. Though, the facts too can change. A clearer picture develops when an investor ascribes price and intrinsic value to 2 different dimensions. The former is based on perceptions and the latter is based on reality.

For the purposes of clarity, I would define intrinsic value to be the amount that is justified by current facts. The reason I did not choose the absolute future cashflows is because there will be circumstances by which are not even reasonably foreseeable even by the extremely skilled investor.

Under such defintions, both price and instrinsic values are dynamic in nature. Though both are not the equivalent of each other, both can influence each other in several profound and important ways. The characteristics of a business intrinsic value will very much depend on the nature of the underlying business itself. Whereas for the price, much more will be due to behavioral traits of shareholders. With this picture in mind, the investor will have a clearer idea of how the stock market operates.

Thus, from here, arises an old Graham key principle.You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. This principle effectively shows why regressing historical prices against an index does not produce any meaningful results. It is in direct conflict of the the traditional Capital Asset Pricing Model (CAPM).

This can be quite interesting philosophically, because if a huge amount of people is willing to pay $2 for a $1 bill for an extended period of time, does it make that $1 bill to be worth $2? Fuzzy logic but an important thought to hold.

Interesting al-ARM

2009-09-29T00:58:00.003+08:00

In order to enhance cognition, it would be good practice for one to consider all the merits of potential weakness in a belief that one holds. Here, I would like to discuss the effects of the second phase of the mortgage crisis which I personally believe will derive from Option-ARMs, Alt-A and commercial real estate. Counter-arguments include:

1. There is an increasing belief that given how low-interest rates have fallen, it would nullify the effects of recasts.

My view on this point is that low rates will mitigate the effects but not so much because the main problems will be coming instead from negative home equity and the repayment of principal. Interest is just one small portion of the whole payment mechanics.

2. The second and more credible argument is that many of Option ARM homeowners will have defaulted long before the recasts. Payments reset occur after 5 years or when the debt grows to a preset amount typically 110 to 120 percent of the original principal. It is believed that almost 40% of these homeowners are already delinquent and many will start missing payments beforehand.

This is valid point and deserves some attention. If 40% of these homeowners are already delinquent, there's still 60% out there which have yet to go. It would also mean that the heavy blow up is sooner than we think it would be. Perhaps more towards a single peak rather than a double wave. Thus the peak would more probably happen in 2010 rather than 2011.

3. Alt-A comprises of people with better credit rating.

These are very much liar loans and just another nicer name for subprime in any case. These loans were made during a time when people are incentivised to lie about their credit score, have houses as proof of social status and when everyone else is doing the same thing. Nothing much you can argue about that.

4. US Government's effort to rework mortgages.

This is not going to have as much impact as many believe it to have. It is slow, inefficient, bureaucratic and mis-incentivised. In other words, you are not going to have a lot of bang for your buck in this programme.

5. These exotic loans are locality specific with a disproportionate amount coming from California

What these means is that not the entire banking industry and not all consumers will be dramatically affected. A dispropotionate few will be dramatically affected much more than others. This is where it gets scary, if the effects were to be spread out and the pain shared throughout an entire industry or country, it is still not so bad. However, if the effects were to be concentrated on one single area then we might actually see some interesting things.

The Great Depression is not that great after all?

2009-09-24T01:26:00.005+08:00

The economic sentiment and the job market is indeed picking up. For one of the very few times, bullish estimates by Wall Street analysts had failed to keep up with S&P 500 gains. The prevailing feeling though unstated but apparent is that "Prosperity is just around the corner". Though cautious, several company executives through their actions have demonstrated this belief implicitly.

I must say that because of this, I have been fortunate enough to be able to get a good job in such difficult times. I would recommend friends that are graduating soon to secure a job as soon as possible, if they had not already done so. Though the first job is very important, this is no time to get picky. Then work very hard to prove your worth to the company and maintain your job security.

However, allow me to reiterate my stance that I still remain bearish at a time even when several other pessismists are starting to get bullish. I feel sure that the bear market is a long way from over. That is why I chose the statement given by Herbert Hoover as the country sank into the Great Depression of the 1930s.

My point of view is that what had shifted was the emphasis, not the facts. The fact that earnings remain poor, prices of real estate outside of US remains high, financial institutions have not deleveraged, joblessness continuing to rise and problems arising from Option-ARMs, Alt-A loans.
The investment and political community seems behave as though they are oblivious to the problems that continue to persists.

I must say that my focus lies on the average American consumer who have been the key engine and driver of global growth over the past decade or so. The balance sheet of the average American consumer is now broken, rising debt levels, rising unemployment and declining salaries. These are not exactly conditions required for a vigorous recovery. Furthermore, I also believe that there is going to be a dramatic reversal in spending habits.

It is true that human behavior and cultures are extremely difficult to change in a short span of time. However, I believe that this time, the economic shock that was delivered is powerful enough to embed deeply in the psyche of several people. The pain experienced will serve as a strong somatic marker in the brain reigning in the once spendthrift ways of the average American.

There is also an increasingly popular viewpoint that Asian consumers will pick up the slack and become the future engine of global growth. I must say that though I agree that it this will be the case ten or twenty years from now, I totally disagree with that it will happen anytime soon in the near future. If one were to look at the Asian economies, from China, ASEAN and India. All of them have one thing in common, they are all structurally export driven economies. Domestic consumption is nowhere near the kind of levels that the west provides. Without strong demand coming from the US and Europe, to whom exactly is Asia going to export their goods?

Having just learnt from the "sub-prime" phase of the crisis, one might have thought that the investment community would have taken warning against similar adventures in Wall Street. But a prime characteristic of a speculative mania is its complete insulation from all the lessons of history, whether remote or at hand. Though admittedly, the europhia and delusion is currently in its mere infancy stage and is far from bubblelistic proportions.

If prices were to continue rising with such tremendous pace, then it will be a matter of time that we will have to re-learn the same old lessons again. Probably in less than 2 years time! For now, I am pretty sure that I must be one of the very few minority to hold such a view.

Poor Charlie's Almanack

2009-09-23T17:32:00.002+08:00

Boy, boy, boy never did I expect to find this book in Bedok library. I have searched high and low for it in Kinokuniya, in MPH and even in school library. I had very high expectations of it and I am glad to say it didn't disappoint one bit. Charlie Munger has rightfully confirmed my underlying suspicions that successful investing is simply a by product of a carefully organized and focused approach to life. The process is by no means simple or straightforward and it requires a multi-disciplinary approach. The world we live in is a constant interaction between scientific and mathematical laws of the Earth and perceptional beliefs of people. It requires a certain set of values and beliefs in order to see the corroborations between systems. Definitely a page flipper...

"You must know the big ideas in the big disciplines and use them routinely- all of them not just a few. Most people are trained in one model-economics, for example- and try to solve all problems in one way. You know the old saying, "To the man with a hammer, the world looks like a nail." This is a dumb way of handling things.

Just as multiple factors shape almost every system, multiple models from a variety of disciplines, applied with fluency are needed to understand that system. What you need is a latticework of mental models in your head. And with that system, things gradually get to fit together in a way that enhances cognition.

The most important thing to keep in mind is the idea that especially big forces often come out of these hundred models. When several models combine, you get lollapalooza effects. This is when two, three or four forces are all operating in the same direction. And frequently, you don't get a simple addition. It's often like a critical mass in physics where you get a nuclear explosion if you get to a certian point of mass- and don't get anything much worth seeing if you don't reach the mass. Sometimes the forces just add like ordinary quantities and sometimes they combine on a break-point or critical mass basis.

More commonly, the forces coming out of these one hundred models are conflicting to some extent. And you get huge, miserable tradeoffs. But if you can't think of tradeoffs and recognize tradeoffs in what you're dealing with, you're a horse's patoot. You are clearly a danger to the res of the people when serious thinking is being done. You have to recognize how these things combine. 'Life is just one damn relatedness after another.' So you must have the models and you must see the relatedness and the effects of the relatedness.

I'm afraid that's the way it is. If there are 20 factors and they interact some, you'll just have to learn to handle it- because that's the way the world is. But you won't find it hard if you go at it Darwin-like step by step with curious persistence. You'll be amazed at how good you can get."

Investment Philosophy III

2009-09-19T23:52:00.002+08:00

This post deals with the handling of one of those rare years where speculation is rife and skilled investors can be almost certain of the impending bursting of the bubble that is to come. First of all, it would be important for the investor to identify what are the characteristics of such times and what are not.

Ridiculous as it may seem to us today, when we are in a bubble, the majority of the financial community actually believed that we are in a "new era". Perhaps not in an explicit sense, but for years earnings of most companies had been growing with monotonous regularity. Serious business depressions had become a thing of the past. In such circumstances, it seemed to many that it had become virtually impossible to lose by owning stocks. And many who wanted to cash in as much as possible on this sure thing bought on margin to obtain more shares than they could otherwise afford. Even though many felt strongly that the stock market was too high on those dangerous days, people were nevertheless entrapped by the lure of the market. Many would find themselves looking around to find new stocks that "were still cheap" and were worthwhile investments because "they had not gone up yet".

Nearly all bull markets have a well-defined characteristics in common, such as (1) a historically high price level, (2) low earnings yield versus bond yields, (3) much speculation on margin and most importantly (4) record high offerings of new common stock issues.

Contrast this with the situation where business was good and corporate earnings were rising steadily. Neverthelessm almost the entire investment community were mesmerized by a simple but fallacious comparisons to the past. It was remembered that few years after the Civil War, a period of immediate prosperity was followed by the panic of 1873 and almost 6 years of deep depression. A somewhat similar period of prosperity after World War I was followed by the Crash of 1929 and even deeper recession about the same length. In WWII, the costs of war had run on a per diem basis about ten times that of WWI. When the "war stimulus and rebuilding effects" run out all hell would break loose. "Therefore" reasoned the dominant invstment view of this period "current excellent earnings don't mean anything". They will be followed by a horrendous crash and a period of extreme adversity when all would suffer. The recession did come but were overwhelmingly minor as to what was expected.

In view of the above reasons, the answer that I would produce would be to hold on to existing shares of outstanding companies, cease all buying operations and sell whatever companies that were less than truly outstanding. The underlying reason is that though the investor can be sure about the impending catastrophe, he cannot be sure of the timing and magnitude of the troubles that is to come. Prices of outstanding companies can multiply itself several times during periods of prosperity and the decline in prices is not likely to be as large as those of run-in-the-mill companies. Even at the lowest price in the depths of the recession, one cannot guarantee that it would be lower than the price the investor was so eager to sell.

However, allow me to conclude this post with a practical observation that is based on numerous experience rather than theory. When the general market is high, there are always a number of individual issues that appear definitely undervalued even by objective standards, and consequently even more attractive in contrast to the inflated value of other stocks. The investor may be tempted to think that these are unusual opportunities. But that is a time that calls for especial caution. Not only the "neglected security" continue neglected for the remainder of the bull market, but when the downturn comes, it is likely to decline in price along with the general market and to fully as great an extent. In a word, beware of "bargains" when most stocks seem very high.

Investment Philosophy II

2009-09-17T00:11:00.024+08:00

Should an investor sell a good stock in the face of a potentially bad market? Now more than ever, the actions of the people who invest in stocks appear to reflect the belief that when an investor has achieved a good profit in a stock and fears that the stock might well go down, he should grab his profit and get out.

My view is rather different. Even if the stock of a particular company seems at or near a temporary peak and that a sizable decline may strike in the near future, I will not sell a firm's shares provided that I believe that its longer term future is sufficiently attractive. I prefer to hold.

My belief stems from some rather fundamental considerations about the nature of the investment process. Companies with truly unusual prospects for appreciation are quite hard to find for there are not too many of them. However, for someone who understands and applies sound fundamentals, I believe that a truly outstanding company can be differentiated from a run-of-the-mill company almost 90% of the time.

It is vastly much more difficult to forecast what a particular stock is going to do in the next 6 months. Yet people's forecasting record predicting changes in the business cycle has generally been abysmal. They can seriously misjudge if and when recessions may occur, and are worse in predicting their severity and duration.

Furthermore, neither the stock market as a whole nor the course of any particular stock tends to move in close parallel with the business climate. Changes in mass psychology and in how the financial community as a whole decides to appraise the outlook either for businesses in general or for a particular stock can have overriding importance and can vary almost unpredictably.

For these reasons, I believe that it is hard to be correct in forecasting the short-term movement of stocks more than 60% of the time no matter how dilligently the skill cultivated. On the face of it, it doesn't make good sense to step out of a position where you have a 90% probability of being correct because of influence about which you might have at best a 60% chance of being right.

Moreover, for those seeking major gains through long-term investments, the odds of winning are not the only consideration. If the company is well-run with sufficient financial strength, even the greatest bear market will not erase the value of holding. In contrast, time after time, truly unusual stock have subsequent peaks many hundreds of percent above their previous peaks.

So putting it in the simplest mathematical terms, both the odds and the risk/reward considerations favor holding. There is a much greater chance of being wrong in estimating short-term adverse changes for a good stock than in projecting is strong long-term price appreciation potential. If you stay with the right stocks through even major temporary market drops, you are at most going to be temporarily behind the former peak at the very worst point and will ultimately be ahead.

However, the underlying presumption is that the investor is able to differentiate a truly outstanding company from a stock market darling. Investors who are not able to differentiate between them will not be suited for this strategy at all. One will truly have to be able to tell a MacDonald's and Coca -Cola from a General Motors and AIG.

Whereas if you sell and don't buy back you will have missed long-term profits many times the short-term gains from having sold the stock in anticipation of a short-term reversal. It is so difficult to time correctly the near-term price movements of an attractive stock that the profits made in the few instances when this stock is old and subsequently replaced at significantly lower prices are dwarfed by the profits lost when the timing is wrong. Many will sell too soon and have either never gotten back in or have postponed reinvestment too long to recapture the profits possible.

Therefore, in and out, may be out of money. It is important to note that even if the anticipated big drop were to occur it might still be higher than the price that you were so eager to sell.

After a sharp advance, a stock nearly always looks too high to the financially untrained. This demonstrated the risk to those who follow the practice of selling shares that still have unusual growth prospects simply because they have realized a good gain and the stock appears temporarily overpriced. These investors seldom buy back at higher prices when they are wrong and lose out on further gains which are of dramatic proportions.

At the risk of being repetitious, let me underscore my belief that the short-term price movements are inherently tricky to predict and that I do not believe that it is possible to play the in and out game and still make enormous profits that have accrued again and again to the truly long-term investor in the right stocks.

Then what about those rare years when speculative buying is running riot in the stock market and major economic storm signals are virtually screaming their catastrophic warnings? How do we know that we are not being seduced by the excitement of times into paying unrealistic prices? What should the long-term investor do under such circumstances? This will be the main topic for the subsequent post.

Investment Philosophy I

2009-09-11T01:24:00.004+08:00

Right down here, my intention is not to point out everyway by which money can be made in the financial markets. Rather it is to point out the best way in my opinion. By the best way meant the greatest total profit for the least risk. It is undeniably true that the really big fortunes from common stocks have been garnered by those who have a substantial commitment in the early years of the company in whose future they have had great confidence in. These people held their original shares unwaveringly whilst they increased 100-fold or more in value.

The big fortunes from these investments are almost always realized by persons who have a close relationship with the particular company- through employment, family connection. etc.- which justifies them in placing a huge part of their resources in one medium and holding on to this commitment through all vicissitudes, despite numerous temptations to sell out at apparently high prices along the way.

An investor without such personal contact will constantly be faced with the question whether too large a portio of his wealth are in one medium. Each decline, however temporary it proves in the sequel will accentuate his problem. Internal and external forces are likely to pressure him to take what seems to be a goodly profit but one far less than the ultimate bonaza.

However, this method made far more money and took far less risk. Finding truly outstanding companies and staying them through all fluctuations of a gyrating market proved far more profitable to far more people than did the more colorful practice of trying to buy them cheap and sell them dear. These opportunities did not require purchasing on a particular day at a bottom of a great panic. The shares of these companies where available for fairly long periods that were to make this kind of profits possible, What was required was the ability to distinguish these relatively few companies with outstanding investment possibilities from the much greater number whose future vary all the way from the remotely successful to the complete failure.

Intellectually, there is nothing wrong with this idea, except that it was almost impossible not to carry them too far. Optimism and price level, each justifies the other. With encouragement from the past and rosy prospect in the future, buyers subscribing to such a policy run an extremely high risk of losing their sense of proportion and to pay excessive prices. For there is no clear-cut arithmetic which sets the limit to the present value of the company.

Therefore, it is of paramount importance to dispel the illusion that outstanding common stocks can be bought at any time and at any price, with the assurance not only of ultimate profit but also that any intervening losses would soon be recouped by a renewed advance of the market to new high levels. This was too good to be true. This method encompasses buying outstanding companies, but not at all times and all prices. It is inevitable that all abnormal growth will revert back to normal just because of competition but outstanding companies would take a longer time to do so than otherwise.

The type of accounting and statistical activity that the general public seems to visualize as the heart of succesful investing will, if enough effort to be given will turn up some real bargains. Some of these bargains may be real. In the case of others, there may be such acute business troubles that are lying ahead, not yet discernable from a purely statistical study, that instead of being bargains are actually selling at prices which in a few years will have proven very high.

Therefore, it is proposed that an investment operation is one that must be justified on both qualitative and quantitative grounds. Operations not meeting both requirements should be deemed as speculative.

The Anniversary

2009-09-11T00:33:00.003+08:00

What a difference a year made! About a year ago, who would have known how the entire financial world would change so dramatically. I remember vividly that I was sitting in NTU's Free Access Lab watching the financial world disintegrating before my eyes. It was between classes and I was checking the headlines on CNBC and Bloomberg, Merrill Lynch merged with Bank of America and Lehman Brothers was allowed to go into bankruptcy.

I still remembered Lehman's exquisite recruitment session where students were required to wear suit and tie, hop on a bus to a luxurious hotel for their recruitment talk. The hall was filled with hundreds of people and when they were only hiring less than 4 people for their Singapore office. Lehman's asian employees were definitely high-fliers, their equity department head was from GIC, others came from very established names as well.

Nonetheless all this came to naught with a tumbling crash that virtually sent the global economy into cardiac arrest. Money market funds broke the buck and froze the entire repo market. Countries after countries were forced to guarantee all deposits of banks. All trade and economic indicators went into a virtual freefall. Undoubtedly, we were facing a meltdown. Many of my classmates were still in a world of their own, oblivious about the rampage that was going on.

Then later AIG got into trouble and people were queueing up outside AIA building wanting to pull out of their investment policies. AIG's CEO for Asia jumped ship the just barely a week after he was being interviewed on Businesstimes for "view from the top". The claim was that he was disillusioned by management in the US.

To be honest, I knew of the magnitude and severity of the problems beforehand but I did not expect it to unfold the way it did. Not a chance at all. I did went into the markets, to buy, but I went in too early. The pain was massive, as the asset values were cut by more than half in less than a week. I was spooked and did not have the emotional capacity, there I stood rooted in fear of what more unimaginable was to come.

Fast forward a year later, having being a participant to witness one of the worst financial bloodbath in history, I have definitely grown. My investment philosophies were being redefined and is now taking clear definite shape. It has now encompassed way more dimensions and understanding that I would ever dreamed of previously. In a way, it felt like growing up. Previously, I was a new kid to the block. Now, I am ready to move on to the next stage.

Is Humpty Dumpty Back Together Again?

2009-09-06T19:05:00.001+08:00

In Singapore, equity and real estate prices are soaring. My parents are constantly being harassed by countless calls of over-eager and irritating real estate agents. "Would you like to sell your apartments?" Which was greeted by the resolute "No, thank you very much."

In a world whereby governments all over the world are engaged in quatitative easing and massive fiscal stimulus, inflation will become the inevitable. Though we think that prices have somewhat gone ahead of themselves, we have no intention to sell whatsoever. The simple reason is this, "If we were to sell, where are we going to put our money then?" Banks are out of the question, for interest rates are meager, commodities are way too speculative, equity and property prices are likely to be overpriced. Finding a safe place to put your money is increasingly difficult.

I have been through the torturous process of trying to find a decent job in an indecent time. Trust me, the job market is still bad as ever. Corporations are not churning out the kind of profits that they used to, sales have collapsed and thus likewise for profits. Companies which are turning out profits have done so only because they have cut costs dramatically, at the expense of countless jobs. The average consumer are not spending the way that they used to. Therefore, not only this is a jobless recovery, it is also a profitless recovery when we are talking about the financial markets. Is this really possible?

I have an uneasy feeling that we are all living in a bubble of false hope. We try hard to convinvce ourselves that with all the king's horses and all the king's men, we still might be able to put humpty dumpty back together again.

The Prophecy Business

2009-08-29T13:49:00.005+08:00

The card dealer at a casino doesn't claim that he knows something about the order in which the cards will come up. He just makes sure that the bets are properly paid and the house isn't being ripped off.

However, it is hard to find a market participant from the almighty CEOs to the lowliest of clerks who is willing to be just a card dealer. For one thing, customers have an unfortunate tendency of asking about what markets will do in the future. The self-glorificating mentality prevalent in the market will forbid any participant to give the simple answer of "I don't know". For then, one will surely be laughed upon, sniggered and despised. That in itself, is bad for business.

Some people have made the prophecy business their very livelihood and there is no denying that in general, their accuracy were as good as that of a simple toss of a coin. Either it goes up or goes down (very rarely does a stock stays at a single fixed price for long). These professional coin tossers are neither mean nor devious. They do not come to office everyday and think what cock-and-bull story shall I invent today. These people are genuinely much more innocent, they only tell others only after they have genuinely influenced themselves about what they think of the future. The worst that can be said of these people is that they wanted so badly to convince themselves that they generally succeed in fooling themselves.

Then again, there will always be an upward bias for all these recommendations especially from investment houses. The general rule of thumb is to not say anything about anybody unless you have something nice to say. Unless one has the kind of incontrovertible evidence to the contrary, any public expression in the negative form will only attract unwanted lawsuits or ill feelings.

Every now and then comes "the era of wonderful nonsense", a delusional theme that is comparable to the fervent belief that the Earth was flat. Few years ago, the theme was that every IT company was a future money-printing machine even if it was burning through tons of cash at that time. Today, the theme was that real-estate prices for the US as a whole never came down ever since the Great Depression, implying that real estate prices are going nowhere but up. I do not profess to know what the next wonderful nonsense will be, but I do know that there will be a next wonderful nonsense in time to come. More likely than not, it is going to be so wonderful that I may fall for it myself.

Clues from the Past: Philip Fisher

2009-08-23T19:23:00.003+08:00

Prior to 1932 there would have been serious question from the responsible leadership as to there was any moral justification or even political wisdom in deliberately running a huge deficit in order to buttress ailing segments of business. Now conventional wisdom has changed. If business should really turn down, they would not hesitate to lower taxes or make whatever other deficit-producing moves necessary to restore prosperity and eliminate unemployment.

Deficits of this type would produce further inflation in much the same way that the deficits resulting fom wartime expenditures produced the major price spirals of the postwar period. This means that when a depression does occur it is apt to be shorter than some of the great depressions of the past. It is almost bound to be followed by enough further inflation to produce the type of general price rise that in the past has helped certain industries and hurt others.

It seems to me that if this whole inflation mechanism is studied carefully it becomes clear that major inflationary spurts arise out of wholesale expansions of credit, which in turn results from large government deficits greatly enlarging the monetary base of the credit system. The huge deficit incurred in winning World War II laid such a base.

It is almost certain that a depression will produce further major inflation; the extreme difficulty of determining when in such a disturbing period bonds should be sold makes me believe that securities of this type are, in our complex economy primarily suited for institutions who have dollar obligations to offset against them or to individuals with short-term objectives. They do not provide for sufficient gain to the long-term investor to offset this probability of further depreciation in purchasing power.

The Reappointment

2009-08-22T14:46:00.003+08:00

Ben Bernanke's term expires on 31st January and President Obama is going to have to decide whether to replace him with somebody else. If one were to look at past reappointment history such events are more influenced by political rather than economic reasons. It was about whether the Fed Chairman is willing to do the president's bidding and coordinate monetary policies to aid him in the next elections. Though the Federal Reserve is supposed to be a political independent party, nobody really believed that.

Such was the reason why Paul Volcker, a former Fed Chairman whom I highly respect was made to give way to Mr. Greenspan. With the benefit of hindsight, Greenspan was severely over-rated, his era of prosperity was built on a bubble. He was more of a master politician and bubble blower than an economist or regulator. As the way things work in Washington, there is no point in doing the right things if the people are not going to get re-elected for it. Nothing can be worse than doing the right things, laying the foundations for the future, only to see your arch-nemesis getting elected and reaping the benefits of it. George Bush Senior can attest to it and that is also why you can witness the dramatic change in the way how his son handled politics.

Mr Bernanke's dovish approach to the markets is one that would be welcomed by market participants. The "Greenspan Put" analogy is now being replaced with "Helicopter Ben". An assurance that Ben will fly over in his helicopter to release huge amounts of cash and liquidity should the financial system ever get into trouble. Given his dovish approach, experience and now fame for acting early to help relieve the effects of this financial crisis he is highly likely to be re-elected again. Now it depends on whether Obama and his advisers trust him well enough to do the things that they need him to do. If all things were to happen according to the path of least resistance, then we might risk awakening the timeless evil of inflation in the future. Of course, to Obama and company, that is something for the next president to worry about.

House of Cards

2009-08-22T13:23:00.005+08:00

A book that I am reading at the moment that depicts a detailed description of how the fifth largest investment bank on Wall Street went under. Truly gripping stuff, feels like having a front-seat experience of how the entire financial system could have collapsed. The author did really portrayed the emotions and thoughts of the insiders. A good read especially for outsiders who want to know how Wall Street operates. From the rumours on the net, to the credit default spreads, to the calls by the OCC, how people with inside information were shorting the stock using options and customers pulling out to materialize into what was a full scale bank run. It highlights the dangers of overnight repo, it can happen very suddenly. It detailed how even the best efforts by the Fed and treasury could not keep a franchise that was more than a century old from collapsing. It detailed how the downgrades by Moody's and S&P could deliver such a devastating blow. The alpha-male culture that is prevalent in Wall Street, never admitting to any weakness or whatsoever.

The baiting and stringing by JPMorgan's Jamie Dimon who successfully acquired the company on the cheap and risk free. Then the ultimate humiliation of Bear Stearns of having to sell itself for $2 a share. I'm still midway of reliving the experience and remembering it in my mind so as to make sure that I recognize these signs when the next one occurs. It happened to Drexel Burnham Lambert and Kidder Peabody in the past, now it happened to Bear Stearns, Lehman Brothers and Merrill Lynch. I am sure it will happen again, another time in the future when the pain has been long forgotten. History never truly repeats itself in the same identical manner, but there are some things about human behavior that can never change.

Thoughts on Technical Analysis

2009-08-20T22:51:00.003+08:00

"It will fluctuate." -John Pierpont Morgan

Yes, this is the memorable quote from the legendary banker himself when asked what the stock market will do. Filled with lingos such as head and shoulders, resistance points and support levels. Buy a stock because it has gone up and sell it because it has gone down. This is the exact opposite of sound business sense everywhere else and it is highly unlikely to lead to success in the financial markets.

In my own experience and observation, looking all over the world, never have I known a single person who has become consistently and lastingly rich by "momentum trading". The downside of capitalism is that when people want to hear snakeoil such as a shortcut to lasting wealth, they will get it.

Beware of those, who tell you that one can make money effortlessly by following some sort of arcane technique that some guru has constructed. Though there were legendary speculators like Jesse Livermore that lived through numerous moments of ultimate riches and bankruptcies, it would be interesting to note how he ended his life. Apparently, he shot himself in the head. Whether or not he was playing a game of russian roulette in his own bathtub would be an interesting thought to hold.

I do not hesitate to declare my belief that technical analysis is fallacious as it is popular. Professor Mandelbrot in his book "The (mis)behavior of markets", has successfully replicated the stockmarket movements using unbiased random number generators that are indistinguishable from real market data. A same technical analysis person would look at such datas and start drawing lines, moving averages and MACDs which holds no true meaning or whatsoever. These witchdoctors of finance
have an ulterior motive when they promote such techniques.

The answer comes from the exhorbitant learning fees and voluminous trading which generates huge revenues for the brokerage firms. Little wonder that these techniques are hugely supported by such firms. If their techniques were to be so easy and effortless, why aren't these guys sitting at home replicating money. Why do they even bother to teach in the first place?

This brings me to the next point as well, a technique that actually works in the market once made popular ceases to work. Get enough people to learn about your money-making scheme, the market then starts to be become efficient in it. Which explains why markets are becoming pretty efficient in traditional valuation methodologies. To beat the market consistently, one will have to a higher order level of skill that is extremely unpopular. It is of high likelihood such techniques are ones which goes against the basic human psychological tendencies. Therefore, they are the very reasons why it will work.

Being Emotionally Firm

2009-08-18T22:09:00.002+08:00

"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right." -Benjamin Graham

A golden piece of advice, easy to say, very hard to do. When people all around you thinks that you are wrong, any normal person would start wondering if he is really the one with the delusion. Staying emotionally firm can sometimes feel like you are driving on the wrong side of the road. When does one really decide whether his principles are right or wrong irregardless of the crowd? The answer is not as simplisitic as it seems to be. Unfortunately the answer can only be obtained by keeping an open mind and learning through experience.

I still hold firm to my belief that markets are currently overvalued, this does not mean it cannot go higher, neither does it mean it should start going lower either. Historically speaking, overvaluation or undervaluations can go on for decades at times. To be someone who to hold strong beliefs against the crowd for that long a period of time must be someone who is truly extraordinary. It seems that there is certain element of truth that most investment carries an element of speculation. There are times when faced with a formidable opponent, even a chess grand master would have to take his chances.

Often we hear stories about people placing a huge bet which ended up to be a life changing event by which they go on to be hugely successful stories. What we don't hear often though, are the stories of those who made the bet but lost.

We humans are genetically programmed to be seek out the success stories and disregard the warnings of the failures. Unconsciously, we avoid and despise the "losers" as we do not want to be associated with them. Any idiot can take the plunge and make huge amounts of money just because of luck. That same idiot will be wiped out when his luck turns. Blessed is the one stupid enough to fancy his chances and realizes his mistake whilst he is on a winning streak.

Even extremely shrewd businessmen and investors like Oei Hong Leong can fall into such traps. When he was winning, people call him the man with golden touch. Now, I bet many are sniggering behind his back, silently celebrating his fall from grace. My opinion is that he maybe down but certainly not out, I do not think we have seen the last of him just yet.

Speculation with high leverage is just like playing a game of russian roulette maybe one with a hundred barrels. I tell you that this gun is loaded with five live bullets which are totally random. For each time you pull the trigger, you will be rewarded a million dollars. How many times would you like to play this game?

Fear drives human behaviour more than greed

2009-08-18T21:39:00.000+08:00

Singapore's real estate market has been pretty resilient thus far. Just when the financial crisis is barely over, investors are running head over heels for apartments once again. This time the prices have broken through previous highs and there are even signs of speculation as well.

I would say that the outlook for Singapore's real estate still remains bright for the long term future. However, very much like the equity markets, I think prices have gone ahead of itself. I was pondering about what could have been the key driving factor. What was it that really pushed people through the line to place hundreds of thousands and sometimes even millions betting on real estate? After some thoughts, I find that the answer is more psychological than rational.

I am inclined to believe that it is fear. The fear that when prices skyrocket, people are afraid that they can no longer afford to buy such houses in the future. They are afraid that they would be left behind as they missed the great bullish bandwagon.

As for greed, sure there are people who are in it to make a quick buck. However, emotionally speaking, what human beings really can't stand is the sight of their peers faring better than them. We despise and look down on people around us, thinking that we are all high and mighty. The sight of someone inferior making more money than we are pushes us to take uncharacteristic actions. I see this all the time and I find it to be a far more convincing reason than greed alone.

The world is way more chaotic than one can imagine. I wouldn't dare say that people who jump in right now aren't making an astute decision. When governments of the world are undertaking the path of least resistance, implementing massive fiscal and monetary stimulus. They try their very best to inflate away the troubles with paper money. Though we might not see the effects right now due to rampant deflationary pressures, we might witness later on the future when true recovery comes.

However, I have experienced my own fare share of setbacks to declare anything about the future. I have seen my own opinions gone wrong on more occasions than I can count.

Market Sentiments

2009-08-18T00:00:00.003+08:00

"I can calculate the motions of heavenly bodies, but not the madness of people."
-Isaac Newton

Today, the ST Index slid by a significant 85.53 points. Looking at the headlines, it seems that Bloomberg and CNBC have been pretty oblivious as to the real cause of concern for investors. These are perhaps signs of media manipulation by the US government. Every bad news has been twisted and deformed to sound like a green shoot to drive up market sentiment. If you noticed, they all come with a positive tinge. Every good news is given headline space. Investors might have realized that they have been taken for a ride by the conventional media for quite some time.

The selloff orginated from China. Perhaps, investors have realized that the massive monetary and fiscal stimulus by the Chinese government is temporary at best. Increasing real private consumption is going to take some time. Behavioural change of Chinese consumers is not going to happen overnight and it takes more than just credit expansion to drive sustainable growth. This would require a developing of a proper social safety net, whereby people need not worry about old age. Robust bank lending standards are needed to prevent speculators from needlessly driving up asset prices. The old economic model of being the world's manufacturing factory is not going to work if nobody is buying the goods. In other words, China will have to reinvent itself and start acting like a world economic superpower.

Then again, though its future is immensely bright, this is something that is not going to happen over a short period of time. It is a multi-year process and still very much a work in progress. I must admit that I am not willing to stick my head out to declare that this is a start of a correction or a double-dip as anticipated by many other forecasters. For all you know that markets might rocket even higher soon, but is the market way too far ahead of itself?

The intellectually honest answer is that I do not know. The long-term forecasted earnings of the S&P 500 is going to be 50-60 and the question will be what multiple does it deserve. The unbiased long-term average of the S&P500 history is around 16X which leads to a fair value of 800-960 points. So the market seems to be pretty pricey at this point in time. Coupled with the fact that there are several underlying problems that have yet to be solved, I do not believe the recovery is going to be v-shaped.

What are the problems that I have in mind:
- Collapse in corporate earnings
- Commercial Real Estate
- Credit Cards
- Financial institutions that refuse to delever
- UK house prices
- Option ARMs

I believe that all these problems are going to have an impact one way or another at least in the short run. If there is going to be any recovery it is going to be subdued. The US governmental policy seems to be blowing one bubble to another, always kicking the problems down the road to the next administration. Never wanting to do the right thing and purge the corruption as well as rotten practices out of the system.

At this moment, they are now trying to blow another bubble by allowing financial insitutions to have a free rein. They have changed the accounting standards to let zombie insitutions continue roaming on this earth, lending money at extremely cheap rates. Many of these insitutions are still living in a world of more than 20X leverage. When these institutions get the money, they gamble and toss the coin once again. Heads I win and keep the money, tail the government bails me out again. Therefore, there can be little doubt about who are driving up these asset prices.

Then we have a problem to ponder about, when is it going to end? When is the fed going to stop giving these institutions unlimited amounts of cheap money? The plan was to provide these insitutions with liquidity while they slowly claw back their equity and delever without causing financial chaos. However, instead they are now taking the money to drive up asset prices.

Is this experiment going to work? Will animal spirits and the rise in asset prices generate the positive wealth effect that is sorely needed? Will they succeed in blowing another bubble? I seriously doubt so. The largest asset of the American consumer is real estate not equity or any other asset classes. If you don't turn housing around, you have not solved the single largest underlying problem. As long as it is not resolved, the American consumer cannot spend again.

Then again, these are only opinions, I have yet to attain the kind of expertise or experience to know for sure what will happen.

Thoughts on National Day Rally 2009

2009-08-17T16:05:00.001+08:00

My thoughts of what goes on in the minds of the typical Singaporean

- Economy: Alamak no bonus, tax rebates or ang pows ah?

- Healthcare: Everyday work so hard for so long where got time to exercise?

- Race and religion: Yah lor, Singaporeans become more active in religious groups, now must pray harder then can dio 4D or Toto.

From the looks of it, we are not going to have an election anytime soon.

The New Paradigm for Financial Markets

2009-08-17T15:10:00.003+08:00

"Living in London was a comedown. I had no money and no friends. After my adventurous life, I was full of myself, but the people in London was not interested. I was an outsider looking in, and I discovered lonliness. There was a moment when I ran out of money. I was having a snack at a Lyons Corner House, and after paying for my food I had no money left. "I have touched bottom," I told myself, "and I am bound to rise, This will be a valuable experience."
-George Soros

I was reading this book for the second time ever since I bought it. But what really caught my eye this time wasn't the Theory of Reflexitivity or the predictions that Mr. Soros made that turned out to be right or wrong. Rather, what caught my attention was the fact that I could sense his determination in the face of extreme adversity. The intense emotions that were described by a mere few words that made the read all worth while.

Though readers with mindset of a higher order should dwell into the abstractions of Reflexitivity, the idea is pretty simple but difficult to prove. However, this economic rally can potentially verify his ideas. The equity market rebound began in March way before other economic inidicators turned positive. Later several indicators did in fact turned positive whilst others continued to languish. An empirical observer would say that economic signals are more mixed rather than unidirectional. The euphoria driven by "animal spirits" could be said to be, a product of successful propaganda and media control. Perception is not reality, but perception drives reality.

If this rally were to be sustainable and rise in the various asset classes were to successfully generate a cumulative wealth effect. Then it would give us a better insights into how financial markets operate. Fundamentals drive sentiment or is it sentiment that drives fundamentals?

Students of financial literature, myself included, are educated and trained to place much more weight on underlying fundamentals. However, before the crisis came upon us, I could still remember several analysts declaring that the sub-prime crisis would be contained and have minimal impact if any at all. They pointed out to figures of earnings which justifiably show that the fundamentals of several companies continue to hold strong. Record earnings, record sales and strong financial positions, the fundamentals could never been better. What a difference a year has made!

Now fundamentals are down substantially and the future from my point of view remains rather bleak. There could be 2 explanations to such a phenomenon:

1) Our perception of what constitutes to be "strong fundamentals" are flawed and investors forgot to ask themselves "How much?";
2) Fundamentals are really driven by sentiments or "animal spirits" which should really be an essential part of economic theory.

Though I was inclined to believe the former, but with each passing day I find myself swayed towards the latter. However, all is not set in stone yet for the definitive answer could only be determined by the future.

The Centris

2009-08-17T14:42:00.005+08:00

Investing in Real Estate is tough business, as Mum and Dad can attest to it. Though the potential rewards are great, so are the pitfalls that you can get into. Numerous days of travelling across the country. Looking for suitable lights, furnishings and furniture. Making sure that the defects are corrected. Looking out for good tenants and trust-worthy agents. Most importantly, you need to do your due dilligence and have lots of good old luck. Fortunately, experience here would pave the way for others as well. Anyway this one is situated above Jurong Point 2, right beside Boon Lay MRT. And yes, it's near NTU.

Does prices eventually catch up with value?

2009-08-15T04:11:00.004+08:00

"That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realized it in one way or another." - Benjamin Graham

Lately, I have been disillusioned by the notion that markets will eventually revert back to the true value of any common stock. People who have done valuations before would understand, that to do a proper valuation of any stock is not easy as it seems. For equity valuation is indeed a truly complex business.

Intellectually speaking, the true value of common stocks of course should not be found by reference to the price movements but rather by the discounted cashflows of the future without the depending on the vagaries of the markets. However, there are several problems with this conventional valuation technique. The most apparent ones would be the measurement of risk and forecasting.

In terms of risk, current financial literature seems to be moving in the wrong direction. Be it the single-factor CAPM or Fama and French's three-factor model, what most of models attempt to do is simply to explain price fluctuations. What matters the most instead should be the downside risks of the company's future cashflows. My view is that most academics are missing the whole point here. However, I can understand where they are coming from. Few investors have the emotional capacity or ever saw themselves holding a stock for more than five years much less even ten, twenty or thirty years. Moreover, when you sell your stock, your terminal cashflow will still ultimately depend on the market price itself at that time.

Secondly, there is a problem of developing good forecasting techniques. In many instances, variations in historical key ratios are too large to create anything that offers good predictive value. The result leads to the creation of an unbelievably large range of prices for any stock, which would be useless in most instances. Most of the time, these ranges would be useless perhaps save for a few rare extreme occasions.

Coupled with ethical and incentive problems prevalent throughout the entire financial industry. It would be extremely rare for anyone to come across insightful, independent and objective valuations. Even if there are, it would be difficult to filter it out from the rest of the noise. Thus, logically speaking there is no way the market as a whole can actually figure out where true value of companies lie. If this were to be the case, then there should be no time limit by which the mispricing of securities can last.

Target Asia Fund Performance Report

2009-08-15T03:27:00.001+08:00

As the economy improves, the Asian stock market continued its rally. China’s rapid loan growth, strong property and stock market performance have raised concern that its economy may be over-heating. We believe that such concern is premature. The Chinese government has been monitoring the situation closely and has signaled that it will soon slow down the loan growth. Loan quality is also being checked constantly.

As the world economy recovers, Asia should again outperform. We monitor stock valuation closely and continue to top slice those outperformed stocks where valuation has become too rich too quickly.

Option ARM: The second wave of this crisis or just fear-mongering?

2009-08-15T02:58:00.005+08:00

I once saw this graph before in early 2007 when Bear Stearns got into the first signs of trouble. Despite the recent massive rally in asset prices ever since the lows of March, the thought that a comparable second wave might come is just too much to stomach. That is why I have yet to buy into this rally. Perhaps the situation has changed and this graph is no longer valid. Maybe through loan modifications the impact might not be as great as imagined. It is also possible that the market might have already taken this into account. However, this graph has proven its mettle once and I'm not about to bet against it a second time.

RGE: Singapore Economic Outlook

2009-08-15T02:17:00.010+08:00

• Exports will decline sharply due to global electronics downturn but industrial production has bottomed out.

• Consumer spending and investment will contract. Asset market rally might be temporary due to weak domestic fundamentals and global volatility.

• Fiscal and monetary policies will be accommodative until 2010 due to sluggish recovery in exports and domestic demand.

A high dependence on exports and financial services has pushed Singapore’s economy into a severe recession that is much worse than the 1997‐98 or 2001 downturn. The yearover‐year contraction in GDP growth that began in Q4 2008 will extend through all four quarters of 2009. But the pace of contraction in GDP growth and exports might ease in H2 2009.RGE Monitor expects GDP to contract 5.5% in 2009 after growing 1.1% in 2008. A small consumption base and strong export linkages of investment and industrial production imply these indicators will see a deep U‐shaped recovery. GDP growth will remain sluggish in 2010 at an estimated 1.4%, depending on the pace of recovery in U.S. and China, the savings rate in the U.S. and EU, and improvement in global credit conditions and financial activities. However, accommodative fiscal and monetary policies are a positive amid large job losses and risks of workers' aversion to the political system. Large foreign exchange reserves, strong external positions and credit ratings will cushion Singapore from any revival in global risk aversion.

Export Recession Far From Over

The pace of export contraction has eased since March 2009 but volatility on a month‐to‐month basis implies that export improvement is largely being driven by inventory restocking in export destinations. Improvement in exports is mainly driven by pharmaceuticals while electronics and petrochemicals continue to contract at a sharp pace. Given that demand in the U.S. and EU are unlikely to show a marked improvement at least until late 2009, exports will continue to contract through 2009. Since a large share of exports to other Asian economies (Hong Kong, Malaysia and China) is re‐exported to the U.S. and EU, exports to Asia will also contract. Any recovery in 2010 will largely depend on the revival of global demand and electronics cycle, both of which are expected to be sluggish.

Imports have been contracting sharply since most of the imports are for re‐exports. But trade and current account surpluses have been easing due to Singapore's import dependence. If commodity prices pick up temporarily, external surpluses could come under further pressure. But this will be largely contained as commodity prices will be lower than their 2008 levels and consumer spending will contract.

Investment Takes a Beating

Due to a low domestic consumption base, industrial activity and investment are strongly driven by exports. There has been some improvement in industrial production in late Q2 2009, but mostly due to strengths in sectors such as pharmaceuticals and biomedical. Other sectors such as electronics and chemicals will continue to contract sharply through 2009 due to the global electronics downturn. These exports will also witness a very weak recovery in 2010. The Purchasing Manager's Index (PMI) moved into expansion territory in Q2 2009. But given that a sustained recovery in domestic and export demand is still distant, any improvement in PMI and manufacturing output going forward will be slow. The pace of manufacturing recovery in 2010 will depend on the strength of export growth.

The service sector will continue to contract, led by financial services and a slowdown in retail, tourism and real estate as consumer are aggressively cutting down spending. Consumer spending and exports are expected to recover at a sluggish pace in 2010. Inventories are still high, taking into account demand forecasts for 2009 and 2010. So firms need to aggressively cut down inventories in the coming months. Firms also face tight credit access in capital markets while corporate earnings in 2009 will remain dismal. Therefore, investment is expected to fall sharply in 2009 with a sluggish recovery in 2010 depending on the pace of improvement in global trade and credit conditions.

Labor Market Downturn Hits Consumption

The export manufacturing sector and financial services will continue to shed jobs sharply through 2009 amid demand slack and tight credit conditions. Government stimulus measures have somewhat helped contain lay‐offs but any improvement in hiring prospects will be driven by improvement in global conditions in 2010. Layoffs are expected to continue through most of 2009 so that the total jobs lost in this cycle will exceed the jobs lost during the 1997‐98 or 2001 downturn. The unemployment rate is expected to rise from 2.25% in 2008 to close to 5% by 2010. As most of the immigrants who are laid‐off leave the country, Singapore’s already low consumption base is shrinking. Due to this, the sharp contraction in retail sales and consumer spending is expected to continue through 2009, notwithstanding government tax stimulus measures. This will be exacerbated by negative wealth effects from 2008's correction in equity and real estate markets and tight bank lending standards. Given high import dependence, any taxbenefits spent by households might be leaked via imports.

Asset Market Correction Continues

Singapore's equities have rallied since March 2009, buoyed by capital inflows and surging liquidity. Valuations are some of the most attractive in Asia, especially in sectors most affected by the recession such as exports and real estate. However, another market correction cannot be ruled out given the possibility of revival of global risk aversion and domestic risks. The bleak corporate earnings witnessed in Q1 2009 will continue through 2009 making the export and real estate sectors vulnerable again. A sluggish recovery in exports and domestic consumption will raise investor concerns about the health of the corporate sector.

Low interest rates in the U.S. and EU until 2010 will keep Singapore's short‐end yields low at least until 2010. This will be supported by capital inflows, improving liquidity, deflationary pressures and the central bank’s bias for an undervalued currency. Financing the fiscal deficit and fiscal stimulus package with past fiscal surpluses and foreign exchange reserves implies that fiscal pressures during 2009 and 2010 will not put any upward pressure on yields.

The Singapore dollar (SGD) has been trading above the mid‐point of the exchange rate band set by the central bank in the April 2009 monetary policy meeting. This has been led by capital inflows and U.S. dollar weakness recently. However, there are risks to the SGD in H2 2009, including revival of risk aversion and investor concerns about the weak economy and corporate earnings. Further devaluation of SGD by the central bank is unlikely in 2009. But the central bank will nevertheless intervene to keep the SGD in the lower end of the exchange rate band to support growth. The SGD might get a boost in 2010 as the central bank begins to tighten the monetary policy. Strong external surpluses and foreign exchange reserves will cushion the SGD in the event of any risk aversion.

The housing sector has witnessed sharp price correction but starting Q2 2009 there has been some improvement in home sales and prices. However, this has been led by rise in home resales, in lower end sections and in sections where prices are now attractive. The entry of buyers has been mostly due to improving sentiment, speculation, rise in capital inflows, liquidity surge and the stock market rally. But all these trends might be unsustainable in H2 2009 and even in 2010 given weak fundamentals for home demand.

Job losses will continue through 2009 with weak hiring in 2010 leading several immigrants to leave the country. Households continue to face wage pressures and wealth erosion. As a result, demand will fail to keep up with the supply of homes leading to further price correction. Commercial real estate may face further downturn in H2 2009 due to bleak corporate earnings, falling business spending and plunging retail sales. Rising vacancy amid oncoming supply of commercial real estate space will cause rentals to follow sharp downward trend.

Bank credit growth has slowed sharply during the current downturn. But there has been some improvement in loan growth in Q2 2009 led by consumer loans and loans to small and medium enterprises under the government guaranteed loan scheme. However, credit to the corporate sector remains under pressure. Declining investment implies that corporate lending will remain subdued. But there are some positives for banks. Interest margins are rising and local banks have the scope to take over lending activity left by retreating foreign banks. Strong capital‐adequacy ratios are helping banks to withstand some deterioration in asset quality from rising nonperforming loans from households, corporates and the real estate sector.

Room for Fiscal Measures

The $13.7 billion fiscal stimulus package was implemented in early 2009, financed in part by drawing from over $3 billion of the country's foreign exchange reserves. The stimulus package includes credit incentives for firms to retain workers, ease taxes and credit access for firms, credit transfers for the poor and unemployed and spending on public services. These measures have somewhat contained lay‐offs and improved credit access for small and medium enterprises. Despite being aggressive, the stimulus will be insufficient to boost growth in 2009 and 2010 as firms face slack demand and households have low propensity to consume. Despite the expected sluggish economic recovery in 2010, there might not be another stimulus package.

High spending and tax cuts in the stimulus package and slowing tax revenues from individuals, corporates and financial activities will push the fiscal balance from a surplus of 1.8% of GDP in 2008 to a deficit of over 4% of GDP in 2009 and 2010. But fiscal discipline, large foreign exchange reserves and external surpluses during boom years will give enough room to maintain loose fiscal policy.

Monetary Policy Takes Cues from Exports and Inflation

Singapore has been in technical deflation since April 2009. Deflationary pressures might continue until early 2010 amid contracting domestic demand, large excess capacity and labor market slack. Inflation in 2010 is expected to remain subdued and will be driven by the pace of recovery in domestic demand. While commodity prices will be lower than the 2008 levels, some strengthening in commodity prices might raise the risk of import inflation.

In April 2009, the central bank moved the exchange rate band to a lower level without changing the width or slope of the band, leading to a devaluation of the SGD. The SGD has actually been trading in the lower end of the exchange rate band since late 2008 due to the central bank's intervention in the foreign exchange market to support exports.

If the sharp contraction in GDP growth and exports witnessed in H1 2009 extends into H2 2009, which seems unlikely, the central bank may further ease the monetary policy by devaluing the SGD. However, this might be limited by the risk of import inflation, especially if commodity prices strengthen. Moreover, the central bank's devaluation bias will make investors averse to Singapore bonds. The central bank's move will also be limited if any revival of risk aversion going forward causes the SGD to depreciate. The central bank has in the past emphasized the limited impact of exchange rate depreciation in boosting exports in the short‐term. But in any case, monetary easing bias will be maintained until sometime in 2010 due to sluggish recovery in exports, economic growth and inflation.

The Way Forward for Economic Policy

Singapore’s ruling party, the People's Action Party (PAP) faces pressure to maintain its popularity amidst the severe recession. As a result, in May 2009 the government proposed reforming the parliamentary system by allowing non‐PAP members to control up to 20% of parliamentary seats in the next elections. Doing so could be seen to give non‐PAP members more say and to promote a debate on the political system and economic policies. In early 2009, the government also implemented a fiscal stimulus package giving transfers to households and unemployed workers and tax and credit incentives to companies. Given that the economy will recover at a sluggish pace in 2010, the government will face pressure to maintain loose fiscal policy and contain public aversion to the political system.

However, the government will limit the extent of voting powers to the non‐PAP members who sit in the opposition. So the government will continue to have a strong hold on the political system, whether in reforming the political or legal structure or voting on economic policies, irrespective of its dwindling popularity among voters in the recent years. The government also recently passed a law to restrict public demonstrations indicating that restrictions on civil liberties will continue.

The government also plans to hold elections before the constitutional deadline of 2010. However, elections in the immediate term might be ruled out as fighting the recession occupies most of the government's time. Moreover, there are risks of calling for an election as voters face rising job losses and reduced spending and aversion to the present political structure grows.

But the biggest challenge for the government will be carving out an economic model for Singapore. This is imperative as de‐leveraging in the U.S. and EU reduce demand for Singapore's exports and competition from Hong Kong and Shanghai and greater financial regulation pose risk to Singapore's edge as an Asian financial center. The government will also have to address high income inequality and Singapore's shrinking population as immigrants leave the country during the recession.