Sunday, July 23, 2017

2017 First Half Review - Part 1

This year started with a lot of renewed hope after the disastrous 2016 where we saw markets whipsawing investors. Brexit was supposed to crash the market, but it didn't and Trump wasn't supposed to become President and he did! The markets then reacted by going up 15%, when everyone thought it should go down if Trump ever won. In retrospect, the Trump rally continued into 2017 and we saw the S&P500 hitting all time highs and most markets, following US footsteps, are up for the year.

We have passed the first half of 2017 and hence it might be timely to do a quick review for the half year. Looking at various indicators, it could be said that a large part of the positive moves in the stock markets are done. Most markets had seen positive return for consecutive 6 months which happened very rarely in the past 20 years. Our own STI index (chart below) rallied from 2900 to 3200 in the last 6 months with only 3 down counters out of the 30 components. 

STI 1 year price chart

What had caused the general euphoria in the markets?

For one, the US market is very resilient. It's almost a decade since the Lehman crisis in 2008-09 and the system had been pretty much cleaned up. Multiple rounds of quantitative easing (QE) had created enough liquidity (as well as side effects which we shall discuss) to stabilize the economy. Unemployment rate is now quite low, productivity is getting higher with tech innovation and things are looking so good that the Fed is thinking about finally stopping QE. Then they changed their mind and thought maybe the party should go on. So markets rallied even more!

Meanwhile in Europe, things are also bottoming after the Grexit scare two years ago and China seemed to be okay with the big meeting coming up in October and everyone is trying their best to keep the Goldilocks economy going. Things should be not too cold nor too hot, just right for President Xi to announce his dream team during October's plenum session. Hence, other parts of the world are following this Goldilock's story where everything will be just right until they go wrong.

The other big trend that had really taken off in 2017 was the Second Coming of Tech. 17 years ago, we had the dotcom boom and bust when the internet promised the new future but then everything failed to deliver. Back then, we were not ready but we thought we were. There wasn't enough optics fiber to deliver what the internet promised, there wasn't enough profits generated. But today, things have really changed. 

Nasdaq 17 year price chart

Now, we have more than enough optics fiber in the ground and under the sea, we have the top tech companies generate more profits than the GDP of some big countries and we have lots of money created by QE1, 2, 3 and QE Infinity. In a amazing turn of event, the Nasdaq price today exceeded the peak reached during the dotcom bubble of 2000 (chart above). Statistics show that people spend 4-6 hours online everyday, on their phones, using PCs, shopping, playing games, watching videos. We are not doing work, not watching TV, not sleeping, not going out to eat (since we have Deliveroo) and just living our lives online. 

As such, the combined profits of the global tech companies: Apple, Amazon, Facebook, Google, Netflix, Alibaba, Tencent, Baidu and the rest generated c.$40 trillion in revenue and c.$3 trillion in profits. In terms of profits, tech would rank as the 4th largest economy in the world, behind Japan. With such profits in tech, it had generated positive cash overflow into the real economy, creating more high value added jobs, startups and hence reducing unemployment (somewhat). Hence it could be said that there is this symbiosis between QE and tech. QE flooded the world with money which flowed into tech unicorns (tech startups with more than one billion dollars in market cap) and into the other parts of the tech supply chain.

One huge positive side effect was semiconductors. After the bubble burst, the semiconductor industry and its relatives all died as the huge oversupply created in the aftermath caused prices to fall year after year. NAND prices, DRAM prices, chip prices always went down, until now. The tech revival, driven by big data and A.I. today, required more powerful computing and more storage. Much more than most could imagine. All the big tech are investing in server farms and computing prowess to outdo their competitors and this caused a short squeeze in semiconductor chips. Hence these players benefitted big time as well. Samsung, TSMC, Nvidia are at or near all time high!

The other huge market was the advent of tech gaming.

This industry started in Japan when Nintendo created the first console box called Nintendo 64 back in the 1980s. It spawned a huge market that had grown to become a $100 billion industry today. Gaming including mobile gaming, computer games, Playstation and Xbox is bigger than Hollywood and music combined. Then in 2017, we have a game changer: Overwatch.

Overwatch poster

Overwatch was created by a company called Activision Blizzard which also gave us a few of the best games ever created. Most people would have heard of them even if they are not gamers. Games like Call of Duty, Warcraft, Diablo, Starcraft and now, Overwatch. For the uninitiated, Overwatch is a team-based player vs player (PvP) game where gamers band together as different characters to defeat the other teams. It was made possible in today's era again because optic fiber now have ample capacity and chip computing power can handle multiple player gameplay without lags. This was not possible just a few years ago which was why games were always single or double player only.

Overwatch redefined PvP with a few ingenious concepts such as having a "replay" moment (like soccer) where the game automatically replays the significant moments during the match and also introduce a very huge variety of different characters (currently 25) having different strengths and weaknesses so as to keep interest high amongst players as they have to study these strengths and weaknesses well to win. Since Overwatch, this concept had been used in many other gaming platforms including Minecraft (Bedwars) as well as Honour of Kings (Tencent's huge hit in China right now) and Clash Royale (which also belongs to Tencent since they own Supercell).

But what's more significant about Overwatch is the creation of Overwatch League. I believe this marks the turning point of e-sports, a new genre in sports where people go to stadiums to see professionals play computer games. Overwatch will have teams from different countries (or states in the US) fighting one another much like World Cup or Premium League. Teams train together (online) professionally to win and most believe this would be as big as soccer someday where players earn multi-millions with worldwide fan base as well as lucrative sponsorships. So, it may not be bad thing to play games and not study today! Well if your kids are so good at it.

Since the creation of Overwatch League, we have seen e-sports taking off with talks of e-sports being included in 2022 Asian Games or a creation of an Olympic style gaming franchise with the past top games from all genres: Tetris, Street Fighter, Halo, Mario Kart and needless to say Overwatch. E-sports will also spawn other industries such as goods, merchandise and gaming peripherals (mouse/mice, headsets, keyboards) where Singapore's own company is the global leader - Razer!

Okay, so much about tech, in short, QE helped the tech industry to revive and the markets are seeing new trends which got investors excited, but there's are risks that the party might just end soon. Next post we talk more about the outlook for the later half of 2017 and 2018.

Overwatch this space!

Friday, July 07, 2017

Return on Investment for 38 Oxley Road

With the whole Singapore intrigued with the 38 Oxley Road saga, it is hard to avoid the discussion, be it during lunch, on Facebook and Instagram and worst of all with international friends. This saga could be a watershed moment, marking the downfall of a little red dot, if it is not resolved amicably asap. But since this is an investment knowledge infosite, let's leave the politics to others to comment. Today we shall focus on the investment aspect.

The investment story of 38 Oxley Road is also quite intriguing for those who would be interested in investment returns. In this post, we hope to capture the no.s and paint some scenarios, some very rosy, hopefully to make people forget the disgust and disgrace of the whole situation. Oxley Road was named after a certain Thomas Oxley, a Brit who owned a nutmeg plantation in the 1890s. It was then sold to a Jewish merchant which presumably then rented the house to Mr Lee Kuan Yew's family during WWII. In his memoir, Mr Lee Kuan Yew wrote that he rented the place for $80 a month in c.1944. After the war ended he and his wife went to London to further their studies and got married. They officially moved into the house in 1950. 

38 Oxley Road: front gate and the famous basement

It was not clear when he bought the house but based on circumstantial evidence, one could conclude it could be somewhere between 1945 to 1955. For our calculation purposes later, let's put it down as 1950. The value of the house is much harder to determine. In his memoir, he did mention that back then a decent house could be bought for 12 bottles of Johnnie Walkers towards the end of the war as families ran out of things to sell, like jewellery, the motobike or car, or even family heirlooms, so finally they would sell their houses. This anecdote itself probably deserves another post as it is not with zero probability that we would not revisit those days.

Back then, paper money (which was issued as banana money by the Japanese) was worthless and the economy degenerated and people resorted to barter trade in order to survive. So what became more valuable and could be used as currencies were cigarettes, liquor and usable stuff. Of course gold was on a class of its own. While it cannot be used in daily life, its value had been determined and recognized over the centuries which is why I believe all investors should have some physical gold in their portfolios. It need not be a huge chunk, maybe just 3% but in the improbable event that the modern financial system breaks down, the only asset that will hold its value and sustain daily life is gold.

Ok let's get back 38 Oxley Road. Where were we?

Yes, we were trying to determine its value back in 1950. We have a few numbers to work with. 12 bottles of Johnnie Walkers and $80 of rent per month. Today, 12 bottles of Johnnie Walker would cost between $2,000 to $4,000 depending on which label we are talking about. The Blue Label in some kind of limited edition would cost even more. Anyways, translating these numbers back to the value in 1950, based on an inflation of 3%, we get to $300 to $600. Geez, imagine getting a bungalow at $300! That's probably not too accurate. It could be as low as $1,000 but $300 seemed like too much a stretch. Next let's work with the rent. We know today that rent in emerging markets could be a high single digit or low double digit. A quick check on the rental yield in Africa today points towards that as well.

Courtesy of Global Property Guide

So let's assume that 38 Oxley Road also had a rental yield of c.10% back then. This meant that the value of the house would be $9,600 (8x12x10=9,600). That's probably a more reasonable number to work with. But in order to triangulate better. We can pull in other no.s. Based on what was told about the old days, the first HDB built in the late 1960s cost around $8,000 which meant that extrapolating a hypothetical HDB valuation in the 1950s, we get roughly $5,000. This meant that a house like the one at 38 Oxley probably cost twice or maybe 3x more. So we might get to $15,000, nice. Not forgetting the Johnnie Walker number, perhaps we can put a range on the value of 38 Oxley Road at say between $5,000 to $15,000.

Now that we got the value of the house back then. Let's determine the value of the house today. It was reported in the Straits Times that the valuation of the house is $24m in 2015 but developers, wanting to re-develop the whole area, the house could be bought for much more, like multiples of that number. So what's the right multiple? Again we try to extrapolate/triangulate that number with other numbers.

In a recent transaction, we knew that a Chinese developer bought a piece of land in Stirling Road, paying over a billion dollars for 21,000 sqm of land. That's over $1,000 psf for Stirling Road, near Queenstown MRT. Based on just the psf and land size, we can then know that Oxley should be worth at least $50 million since it's around 1,000 sqm of land. Of course, Oxley is not Queenstown and again the right number should probably be multiples of $50m. If it is 3x, then it's $150m. So there we have it, 38 Oxley Road today could be worth $24-150m. 

So based on these numbers, the return on investment for 38 Oxley Road after compounding for 65 years (1950 to 2015) ranges from 12 to 18%. That's a very decent number. Its at least 50% more for this site namesake! It definitely beats 95% of all professional fund managers out there and almost on par with the world's greatest investor, Warren Buffett's record of 20%.

Ok so here's the kicker.

38 Oxley on Google Map

If you look at the map of Oxley Road above. The plot ratio of the whole area is very low because when one of Asia's most important person was living there, we couldn't risk a sniper in a tall building assassinating him. So it was kept incredibly low at 1.4 whereas the surrounding is at 2.8 to 4.9. So if Oxley's plot ratio is relaxed, we are talking about 2 to 4x increase in plot ratio. This meant that a developer would be happy to fork out even more to acquire the hardest-to-acquire land in that whole area. Audaciously, let's say that 38 Oxley Road could be worth 2x of that $150 million number, at $300 million. Also, since we were never quite sure exactly how much Mr Lee Kuan Yew actually paid for Oxley Road, if we assume it's really closer to 12 bottles of Johnnie Walker, say $1,000 back in 1950, we get a new ROI of 21.4%, beating Warren Buffett's record. Furthermore, it compounded for almost 15 years longer than Buffett's reign hitherto. That's never been done before. 

In conclusion, if that turned out to be the true scenario, Mr Lee Kuan Yew, is Singapore's best investor and our answer to Warren Buffett.