With a difference two years makes. The Chinese stock market was truly something to behold. I recall vividly watching on CNBC one particular segment where farmers remarked that trading the stock markets was far easier than farming.
Warning signs don’t come more vividly than that.
As always, the party in China soon ended as markets deflated. I was a value investing seminar in Italy where a fellow investor asked me just what was going on in China. After all, trading activity had dropped dramatically with a multitude of the largest companies being suspended for falling too much.
I was relatively unscathed from the fallout initially. Unfortunately, the fallout from the unwinding of the Chinese bubble affected regional bourses in Asia.
Let me just add in a word here.
Its always easy to talk about how fundamental values and stock market values don’t move in sync, and that as a value investor, you should ignore the markets. In reality, this is much much harder than it sounds.
Understanding something on an intellectual level and actually understanding it when the shit hits the fan are completely different things. Reading about the great market crashes from the comfort of your home and living in one are completely different things.
Fall-Out From China
The second half of 2015 was a relatively turbulent time with all major Asian bourses falling. Still, we had a relatively good first half of the year and had cash sitting on the sidelines so we were able to make some good investments.
What really threw me off was 2016.
Valuations at the end of 2015 in both Singapore and Hong Kong were already cheap by any measure of valuation.
Unfortunately, a combination of a Chinese stock market (from a failed circuit breaker – an event that continues to amuse me), and plummeting oil prices led to the indexes falling to levels not seen since the Great Financial Crisis of 2008.
The hysteria regarding oil was interesting, to say the least. It seemed at one point that oil had no intrinsic value judging by the endless wave of pundits predicting ever falling prices.
The only reference point I had were the months of 2011 where the US got downgraded for the first time. I never forgot the reaction of investors to this – they ended up driving bond yields lower in a flight to safety to even more US Sovereign Debt! The Dow Jones was moving by a couple of hundred points daily.
As a new investor, this was a baptism of fire I never forgot.
Different Kinds of Sell-Offs
There are by my own categorization two types of sell-offs.
You have your single stock sell-offs (events specific to the company), or if it’s bad enough, a sector-wide sell-off. Every now and then, you have a country wide sell off which is unique to the country.
These aren’t particularly noteworthy in my view as they don’t have a dramatic impact on overall stock market values globally (will come back to this in a later post).
Every now and then, however, you have a global market wide sell off. The telltale signs are always the same:
- Correlations among all asset classes converge
- Non-financial publications suddenly feature front page headlines of market-wide sell-offs
- High yield bond spreads widen dramatically
- IPO and debt issuance (especially high yielding bonds) drop dramatically globally
The last time we had such a major event was a two-pronged crisis emanating from the Eurozone Crisis and the US Government shutdown (combined with a downgrading of their debt for the first time in history).
Ever since then, markets had been relatively benign.
It was psychologically much easier to handle back then too. In 2011, I was investing very small sums of money, and it digesting paper losses was hard. Fast forward to 2016, this was no longer the case.
When I find something very compelling, I spend as much time focused on looking at the risk of the permanent loss of capital, as well as trying to understand the potential optionality and upside.
The best and easiest investment ideas are in my view buying companies trading at huge discounts to their net cash values, especially if they are acutely conscious of their cash flow and working hard at reducing their expenses.
After all, what can be easier than buying cash at a discount?
Well, it turns out that buying 50 cents on the dollar is a lot harder than it seems.
It’s an odd feeling adding a position which you think is an incredible bargain, only to see it drop further. Things were not made easier with the overwhelming deluge of bad news and negative sentiment. I hung around quite a few business people back then, and most people probably thought I was crazy for being as bullish as I was back then.
It was an exhilarating experience, but intensely exhausting. There’s no sense when everything is falling as to where potential bargains may appear. I remember vividly wondering whether I had missed out anything in my analysis.