Monetary Bazooka and Multi-Curves

This post was first published in 25 Mar 2020 but things moved rapidly and my views have changed. The updated parts are in red.

Since we last discussed COVID-19, the world has gone from bad to worse. We now have a global pandemic which is increasingly out of control. It is becoming a crisis in the same order of magnitude as the 2008-2009 Global Financial Crisis. I have been using the original thebaselab website of daily checks. It is depressing. We have exceeded 15,000 100,000 deaths with no end in sight.

Courtesy of thebaselab

To combat the virus, many affected countries have gone into lockdown mode following China's example. But they didn't do it fast enough. Some countries' healthcare systems could not handle the situation and many lives were lost. It is important not to stress the healthcare system because there are only so many ICU beds and only so many respirators. Unfortunately, we don't learn fast enough. The first lesson from Wuhan was not learnt quickly enough to prevent the tragedies in Italy, Span and Iran and New York. Hopefully other countries and cities can still save themselves by working hard now.

Meanwhile, global markets went berserk. It did not help that Opec and Russia decided to shoot themselves by not reaching an agreement on production thereby causing a huge collapse in oil prices. (They finally agreed but the damage was done) The direct link between COVID-19 and crude is not clear. There is reduced demand but it's not 40%. However oil prices fell from the 50s to the 20s. In stressful times, as we had seen during the Great Financial Crisis (GFC), market participants adopt the mentality of "sell first, talk later". Hence the correlation of different asset classes goes to 1. Everything gets sold. Even gold got sold.

So last week (19 Mar) gave us a glimpse of the confusion that took place. As markets collapsed, we saw indiscriminate selling across stocks, bonds and commodities. The USD spiked because investors sold assets in other currencies and revert their holdings to USD cash. But the US Treasuries also got sold off, because that's another way to raise cash for redemption as well. This selling will continue. In Singapore, we have seen many blue chips hitting multi-year lows. As long as the global situation remains dire and fluid, we should not expect any recovery. (Then the market saw one of its sharpest rebound in history)

Why is everything going to hell in the markets?

While some of us in Singapore probably don't feel this way, this crisis could actually be worse than the GFC. The 350,000 1.7m infections had affected hundreds of millions of families directly. They are seeing their loved ones succumbing to the virus. But as the lockdown continues, the livelihoods of billions are are now badly impacted. We are talking about millions of people being laid off. They could be in the service industries, their employers only have days of cash left before going bankrupt. They could be the small suppliers in the airline/aerospace industry and/or the oil and gas industry. The big boys in these sectors are having issues, so what are the chances that the little ones can make it? 

The situation is really, really bad. People cannot pay their bills, their electricity is being cut off. They cannot pay rent, and face eviction. They have no money to buy food. It is literally life and death, even when the virus is not nearby. Some experts have drawn parallels to war. We are at war with the virus. Hence we need the monetary bazooka to come and save the day.

Helicopter Money

Alas, politics get in the way. The politicians cannot agree how this could be done. Can we bailout the corporates with no strings attached? What if these big oils and big aerospace just use the money to prop up share price instead of saving their suppliers? What about helicopter money? This is an interesting notion Milton Friedman coined in 1969 but made really famous by the previous Fed Governor Ben Bernanke. He famously said he would get on the helicopter and throw money on Main Street in order to stop the rout during the GFC. We are now doing it because families really need that $1,000 to tide over this month. Not next month, this month. 

So the politicians need to sort this out. They probably have days. Lives are at stake. (30 Mar update: they got their act together) The saving grace is that they managed it during the GFC, so it can be done. Then we need the virus situation to subside. China managed to contain it. So did South Korea. We need the major affected economies now (US, UK, Italy and Spain) to follow the playbook. Lockdown for a few weeks, things should get better. The situation will be different for many developing countries. Hopefully their leaders are learning fast. If they don't, their healthcare systems will not be able to cope. We will see a lot more deaths. May the Force be with them.

Finally, we come back to the big question, what do we do now? Buy, sell, wait?

Like I have said many times before, it is not possible to predict what happens next. The politicians could get their act together tonight and we are done with the bloodshed. Then we curse and swear that we didn't buy enough. My base case is the selldown continues and things get really cheap. It could be close to or even below GFC levels for some stocks. Then it will be the best time to buy. But we cannot tell in advance. So we buy incrementally. I plan to buy 1/5 of what I intend to deploy fully every week or two, something like that. It is not hard math or science, so you need to figure out what works for you.

Markets have since rebounded sharply but it might be consensus that this is a bear market rally. It is quite unthinkable we will recover and exceed the previous 2019 high any time soon. The upside is capped and given the bounce, the time to buy is not now (10 Apr 2020). If there are things that could be sold to raise cash, maybe we should raise some cash to have some more dry powder. The next selldown will test the 2020 lows.

The worst case is that the COVID-19 pandemic drags on for months and we did not move fast enough. One, two or three large corporates fail and drag down some banks. 100 million or even more jobs are lost globally. Or, we see continuing rise in infections and many more outbreaks. We see waves and waves because different countries are on different curves. Some successfully flatten their curves but not others. 

In Singapore, we see a full blown community spread. The fourth wave gets us. Our healthcare system gets stressed. Then we will fall below GFC levels. It is a doomsday scenario. Maybe we won't be worrying about our portfolios at that point. We must not let this happen. Stay at home. Keep the social distance. Flatten the curve!

In short, there are many scenarios. No one knows which one will pan out. I would wait now but would look out for stocks that becomes too cheap to ignore. For example, DBS at 0.5x book with more than 10% dividend yield looks good (albeit banks may not be able to pay dividend in 2020 given the situation). Sadly, I have bought it way too early at $21. Now the stock is trading at $18. Dairy Farm breaking its all-time low at $3.30 or Ho Bee revisiting $0.90 will be interesting. Genting does look cheap at $0.50 (it has since rebounded to $0.70) but we have to assume its businesses will recover strongly once the virus is defeated. We have discussed these stocks before so click on the links for related posts if interested. 

Meanwhile, hang in there. This is a marathon. WFH is here to stay. Don't scold the kids. Avoid the spouse. Flatten the belly curve on top of the other curve. 

Huat Ah!

Happy CNY! Let's talk about Money!

Wishing all readers a very happy Chinese New Year! Happy CNY, Huat Ah!

Sapiens: A Brief History of Humankind by Yuval Noah Harari was a book published in 2014 that became a New York Times Bestseller and has been translated into 30 more languages. I have read the book twice and found it intriguing enough to discuss it here as some of the concepts were not just refreshing but relevant to investing. The author Harari cited that the inspiration for his book came from Guns, Germs and Steel by Jared Diamond, which was also a New York Times Bestseller which I had also read and was also another eye-opening book for those interested in the history of the human species.

Book Cover of Sapiens

Both books talked about how humans managed to achieve what we achieved today looking back in time from the Stone Age, exploring social cooperation, the advent of verbal communication, the genesis of writing, domestication of animals and other important technologies and concepts. In this post, we shall explore one of the most important concepts that humans came up with and its implication on investing - the concept of money. According to Harari, money does not exist in the real world beyond humanity. Harari introduced this concept from an interesting angle. He implored us to think not as humans but as other species on this planet such as giraffes, rabbits, octopuses and when we think as animals, we then realize money doesn't matter. Giving $1,000 to a monkey means nothing to him. He would be happier with a banana!

Hence money is a concept that doesn't exist in the real world beyond our collective human consciousness. This is very much like imaginary country borders ie countries themselves and imaginary lines such as the Equator or the Greenwich Meridian.

Money is a concept that has been refined by humans over the ages. Cavemen started with barter trade, then used stones and sea shells, which then evolved into gold, then bank notes, then electronic ones and zeros today. It works only because it is based on a communal trust that humans created. The trust that these stones, or gold, or notes represent claim checks on the society which other humans can swap for goods and services. It works only because all humans believe in the same concept. It is a collective myth we invented to facilitate transactions. It didn't work all the time. In the Stone Age, when the currency medium didn't register, money didn't work. For instance when another tribe didn't value exotic sea shells, the transaction broke down. Similarly, when hyperinflation exploded in Germany in the 1920s, bank notes became worthless. Perhaps gold is the only universal transactable currency that could transcend time and all other currency mediums. 

During the Great Financial Crisis when Lehman went bust, we were quite close to the moment that the whole global monetary system and this whole concept of money might break down. If that happened, then all our monies, all the bank notes, all the zeroes in our bank accounts meant nothing. So, if we think deeply about this, we have to be more holistic in the way we handle our finances. As astute investors, we need to think at a more fundamental level.

Family bonding

One perspective would mean following true fundamental concepts like reciprocity, value add, being healthy and able, helping and bonding with others. These are concepts that resonate with all living things, not just homo sapiens. If we treat animals like dogs and horses well, they will reciprocate in kind. If we make ourselves useful, able, we can always extend help and bond with anyone. Bacteria can exist as they too are playing useful roles in the world, like decomposing waste. During this CNY festive season, we are also rekindling family bonds, reconnecting with people that had made a difference in our lives. Reciprocity, being useful, bonding with others, these are the true fundamentals in life.

When we start thinking at this basic level, it then make sense to link these values back to buying companies that are applying these concepts. Facebook and Tencent create huge value add by trying to bond people digitally, making connections using technologies. Tiffany provides true value when the little blue box is presented by the giver to his significant other, which will become a testimony of their love for each other - you are my only one true love. 

Tiffany's ad and slogan

Expanding on this theme, perhaps it is worth asking these few questions when we want to invest in a company that we had researched well:

1. Does the company help improve the well-being of its customers?

2. Does the company add value fundamentally in ways that make all lives better?

3. If the company did not exist, would the world cease to functional properly in some ways?

Framing the questions in such basic terms can really give us another perspective on our investments. Take the Dairy Farm Group as an example. The Group operates Cold Storage, Guardian Pharmacy (Mannings in Hong Kong), Giant, Seven Eleven, Ikea and GNC amongst others retail big brands in South and East Asia. Does the company improve the well-being of its customers. Well, more or less, yes. We buy daily necessities, medicine, even furniture from the Group. Even though online e-commerce had taken over some of its share, we still pretty much need to shop at some of the outlets of the Dairy Farm Group.

Dairy Farm Brands

Does the company add value fundamentally to make all lives better? Well, this is harder to answer. Obviously all the chicken and fish on sale in Cold Storage wouldn't agree. But for most humans, perhaps yes again. So I would half check this box. The last question would always be the most interesting: so if Dairy Farm disappears tomorrow, how is the world affected? So imagine, there's no more 7-11, Giant, Guardian tomorrow. Well, there might be some impact, some inconvenience to some people. Yes, there is still Cheers, NTUC Fairprice and Watsons but I guess some neighbourhood might find it really disrupting. Perhaps the disruption would create havoc for some people for a month or so as people scramble to do shopping at other locations until Dairy Farm's competitors come in the fill the gaps. So, yes, for some, the world do cease to function properly, at least temporarily. 

So in all, I would say that Dairy Farm scores a 2 to 2.5 out of 3 here. This is a company that fundamentally adds value. Alas, valuation is a big hurdle with PE at more than 20x and EV/EBITDA at mid to high teens. With the stock jumping a good 15+% in the last month, value investors would think twice buying now. 

Next post, we look at companies that would fail this test and also explore other concepts related to universally true fundamentals!

Next post is out!