Market Observations - Jul 2022 - Turning Tide

 The past 6 months could have been a fiction book if we didn't live through it: 

• Crypto currency Luna levitated to godlike levels and crashed to almost 0 (less than 1 cent). At its peak on 5 Apr, it was $119, and newfound wealth led to newly crowned "crypto investors".

• Russia's invasion into Ukraine led to trade sanctions, which led to a supply crunch of almost everything you can name on earth, resulting in prices spiking and then crashing down. It didn't help that it happened at the same time when Luna went to the moon.

• Interest rates doubled in a matter of months. In Jan, Singapore floating mortgage interest rates were still below 1%, and in Jun, it's just under 2%. It's similar in other countries too, as the Federal reserve increased interest rates.

The construction sector resumed work last year, and it caused a worldwide shortage of building materials such as steel, sand, and even small items such as screws, and it was just supply crunch in 1 industry. What we saw with Russia was disruption at a wide scale, not as serious as when China went into lockdown mode, because everyone had started to diversify their supply chains and stockpile critical materials, but it comes in at a close second -- fuel, food, shipping, labour, all increased one after another in a chain reaction. Even nickel prices went to the moon. The only thing that probably won't reach the moon is my income *cold joke*. 

Nickel prices in the past 1 year

Why I believe that the tides have turned?

• I don't hear man-on-the-street talking about buying crypto. Earlier this year, I get to hear such conversations in MRTs, buses, restaurants, hawker centres. I haven't heard anything in the last 1 month.
• I don't see as many advertisements about investing in REITs for retirement. I believe that marketing money is smart, when the baits work, there will be a lot of them laid. So the hype is over.
• I don't see as many advertisements about buying property for investment. I believe this is a sign of increasing market activity -- agents don't have to try so hard to attract buyers.
• It does not feel like we had reached a "blood on the streets" phase after a market wipeout, and we may not even see one because job support has been the #1 priority in the pandemic support budget.

What data points do I look at?

• Pandemic support budget -- All the schemes have tapered off.
• Non Performing Loans -- Local banks financial reports report steady NPL rate of about 1.5%. As new loans are also growing the loan portfolio, proportionally, the increases in NPL (which are past loans) are not obvious. Banks also can be selective with their customers and don't need to fight to increase market share (and get lower credit quality loans as trade off).
• Retail rental and occupancy rates -- Although the pandemic caused many businesses to close, it didn't lead to widespread vacancy. Shopping malls that hit the right notes with location, footfall, amenities, are still commanding high rental and occupancy rates (see Mapletree Commercial, SPH REIT). As long as people are still spending money, the economy is good.
• Debt -- Debt is ever increasing in China and personally I don't have a good feeling about it. The good thing is USA has even bigger debt and they are still alive. The bad thing is no one knows the impact of unwinding debt at a China scale, but when that happens, I definitely want to be holding on to tangible cash flow producing assets.

Valuations

• As the risk free Singapore Saving Bond (SSB) rate is 3% p.a. for 10 years, I am using that as a benchmark to compare the risk premium. Mapletree Commercial REIT's (MCT) current price of $1.80 has a 5.2% dividend yield. for 2.2% more, will you take the risk? Historically, MCT's yields are around 4.5% when risk free rates are 1.5%, so if we apply the same risk premium of 3%, MCT's dividend needs to be 6% to make sense. If we look at DBS/UOB dividend yield, it's 4.6%, and it makes you wonder if buying a bank stock makes more sense than say MCT?
• Price Earning ratios of Singapore companies are not too expensive, and not at bargain ranges either. The STI ETF is at $3.15, which is about 10% below its Apr highs. Historically, there is a higher chance of maintaining at this level, than either moving up or down. Usually bank stocks trade at < 3% yields.

What I will buy

• At current prices, I see the most value in bank stocks, for reasons stated above.
• If I have to make a second choice, I will choose food manufacturing businesses because they have more control over supply side costs.
• All other sectors have their fair share of risks. Air travel hasn't gone back to even 25% of pre-pandemic levels. Tourism and hotel REITs will also have to expect bumpy restarts. Transport companies have have to cope with erratic oil prices with the ongoing "fight" between US and Russia. Energy companies have to cope with high cost of operations and they don't have much pricing power to begin with (personally I feel that another energy crisis will result in energy companies being nationalised again). Telcos still are handicapped without their data roaming and business travel income stream which traditionally forms 20% of their telco revenue. F&B and basically any service industry that is highly dependent on human capital will have to struggle with high rental and manpower costs.

Opportunities that I will look for

• Maximise SSB deposits if rates really continue to increase beyond this month's 3% p.a. to the mystical 4%. 
• If that happens, we almost certainly will have a stock market correction of another -20%.
• Personally, I believe if everybody expects a 4% p.a. FD rates in dec, will it ever happen? If only market timing is this easy... 

Disclaimer: The writer owns shares in DBS, UOB, STI ETF, SPH REIT.