Quote
"Shares are not mere pieces of paper. They represent part ownership of a business. So, when contemplating an investment, think like a prospective owner."
- Warren Buffett
Last updated : End Jul 2009
Summary Review
World equity markets were flat in June, suffering a pull-back in the middle of the month but recovering towards the end of the month. Following three months of strong market performance as investor risk appetite increased, markets stalled into the mid-year on concerns over the economy and earnings prospects. Investor optimism was tempered as economic realities became clearer. To be more specific, investors accepted the fact that the global economy is likely to be subjected to a protracted period of below potential growth, corporate profit margins will likely be pressured due to a supply demand mismatch that will adversely impact pricing power until excess capacity can be eliminated, as well as the realisation that mounting fiscal challenges will limit the ability of governments to pump-prime the economy on a sustained basis. The aggressive fiscal stimulus measures that helped stabilise financial markets and restore investor confidence rapidly have themselves become a key concern.
Given that the policy makers face some of the most daunting structural challenges in a generation, we remain defensive in our positioning. While the timing of the recovery remains uncertain, what is clear is that it will be muted at best. The next major signpost that will influence investor behavior are the mid-year earnings reports and subsequent guidance for 2009 performance. We anticipate a mixed picture, with continued challenges and continued differentiation becoming increasingly evident. With the de-leveraging process likely to continue through the balance of the decade, 2009 and 2010 are likely to remain stock pickers markets.
The Japan market remains the weak link. A sharp decline in industrial activity and trade has weighed heavily on the export oriented sectors, which have historically dominated the market. Losses at Toyota Motor, the benchmark in the auto sector, underscores the severity of the challenge faced by the industrial sector. A strong yen and political uncertainty in Japan further add to the already formidable list of challenges.
European markets corrected in June, but are the best performing developed region on a year-to-date basis due to a recovery of their currencies. While the debt overhang is less of an issue for most Eurozone economies, their financial sectors require significant restructuring and de-leveraging. The complexity of the Eurozone, adds to the challenges of policy makers in the implementation of swift stabilisation measures, and accumulated deficits limit their ability to respond though fiscal measures. Add to this the impact from an economically troubled Eastern Europe, and the outlook is far from clear.
Emerging markets remain the bright spot in terms of performance. This is broadly justified as the emerging countries do not face the same challenge to growth and do not have the domestic debt overhang that is evident in the developed world. There is a clear differentiation between developed and developing countries on the issue of both growth and leverage, which is fully warranted. However, there is an underlying need to re-tool the economic models of much of the developing world, to achieve a better balance of growth. Until this happens, growth will remain well below potential and heavily dependent on demand from the developed regions.
In the developed regions, the more recent market recovery has seen a sharp outperformance among more cyclical and growth sensitive sectors and companies. Unlike prior cycles, where the consumer provided the signal of a return to confidence, this time it will be the corporate sector that we have to monitor, especially given the level of excess capacity still evident.
We remain in the midst of a global recession that is on a scale not witnessed in a generation. Earnings visibility remains poor, and corporate profitability is expected to remain under pressure for some time. While valuations do provide some support, we will need to see evidence that corporate profits can hold up for the recovery to become durable. In the interim, our strategy is to continue to focus on the high quality companies that are well positioned to respond to today’s challenges. We are finding good opportunities in virtually all sectors.
Government response to the crisis has been bold and has helped to contain the near-term downside risk to the global economy. However, there are concurrent negative implications embedded in some of the policy responses. First is the rapid build up of debt and aggressive monetary easing, which will likely detract from long term growth prospects and add to financial risk down the road. The second, and perhaps more troubling is the move by Governments to take investment stakes in the private sector in the interest of protecting jobs. This in the long run could increase the temptation of policy makers to adopt protectionist measures under a misguided notion that this will help preserve the value of their investments and will appease voters and to believe under a misguided notion that they need to preserve value for their investments. If implemented without sufficient discipline this policy could represent the thin edge of the wedge towards a swing towards protectionism. If this happens, the recovery process would inevitably be derailed.
US
Expectations in the US have already been lowered significantly. The US Federal Reserve is likely to continue to provide an accommodative monetary stance. Fiscal policy under a new Obama-led administration has been bold and aggressive, with spending targeted in a two-pronged fashion, firstly toward structural objectives of enhancing public infrastructure, and secondly toward enhancing the social safety net, which should stabilise demand.
Europe
We keep an underweight position in Europe as the valuation argument is not strong enough to mitigate the growing risk to earnings. We see significant need for deleveraging across many of the largest financial institutions in Europe. This will likely be accompanied by an extended period of upward re-pricing of risk for borrowers, which will exert a drag on growth. A sharp deterioration in financial and economic conditions will increase the risk that earning expectations are lowered further. While competitive realities had resulted in a favourable shift in policy direction the majority of the Eurozone economies entered the crisis with large legacy obligations and challenges. The current crisis represents the greatest challenge to the concept of a single currency and single economic block since it was first conceived. Leaders facing pressing domestic challenges at home and the need to be re-elected means they are unlikely to defer to Brussels. More importantly, the current crisis is likely to test the willingness of stronger nations to support the weaker, when they too face unprecedented challenges at home.
Asia Pacific ex Japan
We remain overweighed in Asia-ex-Japan but remain defensively focused on the beneficiaries of domestic demand. Growth had moderated faster than previously feared as the region’s sensitivity to a decline in external demand was under estimated. Despite this, equity markets and real estate prices have recovered sharply, discounting a rapid return to the prior demand environment. On this score, we remain cautious as companies adjust to the new economic realities and as financial institutions re-calibrate their credit practices to factor in greater risk due to slower growth. While we continue to like the region’s prospects, our focus is increasingly defensive and underpinned by sustained growth in domestic demand.
Japan
We remain more cautious on the outlook for Japan. Corporate sector profits remain under pressure, particularly among export sectors that are more exposed to discretionary consumer spending. We see significant risk to earnings into 2010 as capping future expectations. Add to this the uncertainty associated with a major political transition, and it is difficult to see the Japan market leading the recovery.
Conclusion
Markets were clearly oversold in the early part of the year, when financing concerns were adversely impacting even sound businesses. Now that financial market conditions have become more normal, and markets have re-rated, fundamentals will become the key focus. The reality that the global economy will remain in an environment of sub-trend growth for some time will influence our investment approach and continue to underpin our focus on quality. The rising tide that lifted all ships is not expected to return for the foreseeable future. It will be increasingly important to pick the right ship to navigate the choppy waters of what will prove to be a protracted and moderate recovery. We continue to focus on high-quality bottom-up investments which will perform better in an environment of heightened uncertainty and risk. We continue to sow the seeds today to benefit from recovery in the years ahead.
Source(s): Fidelity Investments (Singapore) Pte Ltd, Aberdeen Asset Management Asia Limited, Societe Generale Asset Management (Singapore), Prudential Asset Management (Singapore), Lion Capital Management Ltd, Schroders Investment Management (Singapore) Ltd, UOB Asset Management and iFast Financial Pte Ltd.
Please note that this article is meant for information only and not a substitute for comprehensive professional investment advice.
Three Lessons From Warren Buffett That We Can Apply
The world's richest man has been finding value lately in falling markets. We can too, if we apply three lessons from Warren Buffett.
Warren Buffett has been in the news a lot more these days. The world’s richest man – according to Forbes – has been doing his Christmas shopping a little earlier than usual.
Goldman Sachs made it into his shopping list on 24 September 2008. Buffett’s company, Berkshire Hathaway, paid US$5 billion for Goldman Sachs’ preferred shares for a 10% dividend and an additional US$5 billion worth of warrants to buy the financial firm’s common stock at US$115 per share (over a period of five years).
Shortly after the Goldman Sachs purchase, Berkshire Hathaway invested US$3 billion in US blue chip General Electric. And it appears that his shopping spree still has some way to go.
Recently, Buffett wrote in The New York Times on 17 October 2008 that he is considering switching 100% of his non-Berkshire fortune from US bonds to US stocks, as stocks have been bashed and value has been emerging.
What can we learn from the world’s greatest value investor? Three Lessons from the Sage of Omaha.
1) Market fluctuations present opportunities
“Be fearful when others are greedy and greedy when others are fearful,” says Buffett.
Buffett’s advice is simple enough: buy when pessimism reigns and don’t buy (or sell to take profits) when investors are exuberant.
Sure, it is important to find if a market is plummeting because of some drastic deterioration in its economic fundamentals; if that is the case, a lower price earnings (PE) ratio, a widely-used indicator of valuation, does not spell good news.
But in a market downturn, investments may be oversold because of poor sentiment or other factors which are unrelated to their actual fundamentals. There is indiscriminate selling, as investors seek safety in low-risk instruments.
Take, for example, the Asian economies. Their foreign exchange reserves have grown to over US$3 trillion, enough for most of the governments to fall back on if they need to boost their economies. Corporate transparency has improved since the bleak days of the Asian Financial Crisis. Most fund managers continue to find companies which show strong balance sheets and healthy cash flows. On a more individual level, Asians, unlike the Americans, save a lot more too. Despite all these positives, Asian markets have fallen even more than US markets – and we know the economic situation in the US is bleak.
This shows that the markets go through times of irrationality. It happens during a bull run when markets skyrocket, and it also happens during a bear run when they plummet.
So, clearly we find good opportunities among Asian equities now. We continue to advocate investing regularly to benefit from dollar cost averaging.
2) Long-term and short-term goals
Buffett advocates long-term investing. He admits he has no clue on whether the market will rise or fall in the next one month or next one year.
So in the short term, markets may continue to fall, but that has not stopped Buffett to invest in US equities. He may not be buying them at their bottom, but then again, who can? Timing the markets is out of Buffett’s league, so what makes us think we can do it confidently? If you believe in the prospects of a company or economy to do well in the next few years, you will not be as worried over its outlook for the next few quarters.
It is also crucial to distinguish between how we use our short-term and long-term monies.
The short-term pot will take care of our daily expenses, potential emergencies and the big ticket items we intend to splash on within the next two to three years. These could include the exotic holiday to Machu Picchu or the down payment for the home you have been eyeing. To meet our short-term financial needs, leaving the money in safe, low-risk vehicles such as a savings account or a fixed deposit makes sense.
The next pot of money is really meant for our long-term goals. We can afford to give more time for our long-term investments to perform as we do not intend to touch that money for the next three years or more.
So, the point is, each one of us will have a different definition of short term and long term. Make sure we know our goals and divide the money into the different pots accordingly.
For our long-term pot, don’t panic and sell out when our investments fall. Don’t stay on the sidelines either, waiting for the markets to bottom. By the time the market really bottoms and starts rising, you may still be holding cash because you assume the bottom is not over yet.
3) Beware of inflation
Markets are plummeting and we are worried about our portfolios, our year-end bonuses or salary increments; for some of us, our jobs could very well be on the chopping board. But there is one big risk that has taken a backseat lately: inflation.
Buffett has also mentioned inflation as a key risk. "The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our (United States) legislature," he wrote in a Fortune article titled "How Inflation Swindles the Investor".
Inflation may be seen as a lesser concern, with commodity prices dropping sharply. But it remains at a high level: Singapore’s Consumer Price Index rose by 6.7% year-on-year in September 2008. While this is lower than the CPI increase of 7.5% for a period of three months from April to June 2008, the CPI numbers show that the interest rate from our savings account and fixed deposits is way too measly to be able to generate a positive real return.
We need our investments in the long-term pot to deliver a return higher that the inflation rate. Inflation has been hovering at relatively higher levels in the last few months. This makes our long-term investment decisions even more crucial – and cash is clearly not king when it comes to our long-term pot of money.
Buffett’s lessons
This investment guru has gone through some of the more momentous periods in the last four decades: oil price shocks in the 1970s, the competition between the US and Japan in the 1980s, both vying for the world’s number one economy; the savings and loans crisis of the late 1980s and early 1990s; the technology bubble at the start of this century; and now, the credit crisis in the US.
But here’s a man who notes that we often make use of complex analysis to invest, but in actual fact, investing is no rocket science.
During times of crises, it is easy and understandable if we lose track of the big picture. Emotions often lead us to make our investment decisions, instead of sound fundamental analysis. This analysis need not be reliant on complex equations or tools; looking at the PE and PB ratios shows that the markets are being irrational at this point of time.
And remember, when most investors avoid entering the markets, which is the time value investors such as Warren Buffett are busy shopping.
Proposed Actions
In the wake of the recent volatile markets' movements, we understand the anxiety you are having with your investments and thus we would like to recommend: