Note: For the title of each post, I have now decided to use an article from Bloomberg that describes the current sentiment of the day:
Finding Value In Spin-offs
Some of the best trades during the past few years have been spin-offs. Of course, I'm taking about deals like Kraft Foods Group Inc (NASDAQ:KRFT) / Mondelez International Inc (NASDAQ:MDLZ) and ConocoPhillips (NYSE:COP) / Phillips 66 (NYSE:PSX) both of which have continued to achieve record performances year-to-date. What's more, there are a number of spin-offs Read More
Its a day more before I leave for London, and much has been accomplished. We had an intensive reshuffling of our portfolio, trimming positions of stocks that had appreciated significantly since our purchase, and adding to our current positions.
I am not too keen on portfolio churning, but in this instance, I find it necessary for us to take small losses on our positions given the level of opportunity available in the market. It has not been easy to fight our behavioral biases – the chief one being loss aversion. But we must.
To achieve superior returns, one must act in a way that others are unwilling, or unable to.
With the market falling, and no end in sight, it is sometimes hard to stomach that just by waiting a couple more days, we could have obtained the same position at a cheaper price. But let me make the following observation:
Investors do not become poor by being too early in a market downturn, but because they are too late in a market upturn.
Let us return to objective data. On a CAPE ratio, the South East Asian markets at all time historical lows. On the basis of P/B, markets have only been as cheap three times in history – 1997, 2003, 2008.
The current P/B stands at 1.3x for the MSCI Asia ex-Japan Index, 1.5 s.d. from its mean of 1.9x. Investors who have bought at these levels have always reaped significant rewards.
The markets have priced an economic crisis on the scale of the Great Financial Crisis – where one does not exist. Time will tell if I am right, but there exists no signs of widespread risk taking and hubris that existed in the run-up to 2008.
Investors have been cautious, investing out a lack of necessity instead of greed due to record low interest rates. In particular the Singapore government has been prudent, moving to restrict leverage within the system that has bore fruit, with housing prices coming out their exuberance in 2013.
China is a worry – no doubt. But let us recall that much of the pain that is happening now is because of a deliberate act of policy. Reigning in corruption, liberalizing the market, moving away from government led infrastructure projects to a consumption based economy. These are not easy feats to accomplish, and significant progress has been made.
Rome is not built in a day, and its important to remember even developed financial centers like New York, Hong Kong and Singapore underwent their own tumultuous periods. Thats how society evolves, two steps forward one step back.
This is not to say China will not have problems. But which country that chooses the free markets does not? It is an endless cycle where each boom creates excesses that are cleared out by the ensuing bust, sowing the seeds for the next boom.
It’s not pretty, but its the best system we have.
But enough digression. If China slows down, there is no doubt that many of the businesses we own will be hurt in the short run. But lets keep in mind two things
1. There is no correlation between GDP growth and stock market returns.
2. Winters do not last forever, and spring will eventually come.
Many of our companies are cash rich, with well enough resources to withstand the storm that hits. Belts will be trimmed, budgets cut. But they will emerge as their weaker, over-leveraged competitors are wiped out. Leverage is a two way sword.
Importantly, through our holdings, we now have a part owner-ship of some of the best commercial property in the CBD (and outside it) of Hong Kong, Singapore and China. Financial hubs are not built easily, and the demand of such quality properties will always be there.
Inflation is our friend, and while I cannot forecast the short term price movements, I can say with confidence that 10, 15 years from now, these properties will be worth far more than they are today. Replacement costs will rise with inflation, manpower and the scarcity of land.
It is indeed a weird feeling to be the most optimistic when everyone around me speaks of fear, panic and ruin. And yet, this has always been the way that we have generated significant out-performance against the markets. By moving against the crowd. By buying at the point of maximum pessimism.
I remember the eternal words of Sir John Templeton:
“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.”
We are now at that point of pessimism. All is required of us now is patience, patience, patience.