Sunday, January 5, 2014

Recap 2013 & Looking Ahead 2014

In last year report (Recap 2012 & Looking Ahead 2013), I cited 2013 to be remained cautiously optimistic, pointed out one of the event of the year, US Fed withdrawing stimulus, and that turned out to be true as apart from US and Japanese market, rest of the stock markets were either ended 2013 in red or just flat.  FTSE STI closed 3,167.43 on 31st Dec 2013, just clocking a +0.01% for the year.  HSI was slightly better with 2%+ gain for the year while SSE and others were mostly in the red.  Nikkei was the better performance coming in strong at more than 50% while US markets recorded at least 25%.

Recap 2013
Global markets started off the year with a bang after US Government did a last minute stance to avoid the fiscal cliff (but pushing the debt ceiling issue later down the year to resolve).  Sentiment was very positive with rally after rally until May.  S-Reits stock prices were hitting never seen before high for most of them compressing the dividend yield to miserable level as everyone were chasing for dividend return given that S-Reits did a stunning performance in 2012.  US economy as indicated by its data were improving, unemployment rate slowly drifting down, Japan with its Abenomic stimulus program was also fighting its way out of recession, Europe finally emerged from recession with the help of ECB keeping its stimulus program and low interest rate.  Money (cheap and easily money to be exact) were flowing into emerging markets leading them to having inflation problem later on.  The only weak spot then was probably China as when it undergoing reform in its economic model, measures being taken in the past has hit the acceleration of its growth.  However, good things never last when in late May US Fed Chairman Ben Bernanke first sounded a possible of US Fed to start tapering of its QE.  That piece of news rocked global markets since them as fear and panic by investors or "no more easy money" caused global stock markets to correct.  There were lot of twist and turn since then as investors and analysts trying hard to second guess when will US Fed exactly start tapering.  Whenever strong economic data emerged most were suggested tapering would be soon and markets were being sold down and whenever any of the US Fed members appeared to calm the market on QE tapering, markets rebounded.  Great volatility exhibited during those periods.  While every eyes were focus on when tapering will commence, China has meanwhile quietly mastered a turnaround in its slowing down in economy as it finally stabilized and rebounded in the second half of the year.

Then came another event in September that shocked everyone, the 2 political parties in US failed to agree on anything even at the last minute with respect to the debt ceiling issue (first started in 2011) and caused US Government to be partial shutdown for the first half of October causing job losses along the way.  While most agreed on that will have impact on US economy recovery but some were "delighted" in a way that event will lead to US Fed delaying in tapering.  Eventually, a compromise was made (delaying the issue to January 2014) and US Government was able to reopen in the middle of the month.  Thereafter, it was all the guessing game again on when US Fed will start taper, November or December or 2014.  That continued to dictate the volatility of global markets in particular emerging markets seeing mass outflow of funds as investors preparing for tapering.  Funds were flown back to US as the tapering signified strong recovery of US economy.  Finally, in the December FOMC meeting, Ben Bernanke for the last time holding the meeting as Chairman before stepping down this January announced US Fed will officially start tapering in January 2014, reducing the monthly bond buying amount from US$85b to US$75b.  That piece of news overall was well received by global investors as US markets rallied to close at least 25% for the day while some emerging markets initially saw knee-jerk reaction but soon stabilize later.  That decision confirmed the consensus that US economy was indeed on recovery which brought optimism to global investors.  In December, the 2 political parties in US also managed to cut a deal on the budget to prevent another possible default or shutdown in January but that did not address the issue of whether the debt ceiling will be raised or not.

Japan, on the other hand, probably was on another planet in 2013 as the Abenomic and BOJ even more aggressive stimulus program than US Fed, pulled Japan out of recession and moving towards the targeted inflation, moving away from the decades long deflation issue.  As a result of that, Nikkei showed one of the best performance in global markets with at least 56% gain for the year.  China though in the later half managed to halt the slowing down of its economy but was not enough to allow SSE to close positive for the day.  Europe also fared better this year will bourses ended in positive region.  2013 probably was one of the quieter year for EU as not much was focus on its debt issue, allowing them to work their way out of recession.  Asia (less China and Japan) was having a roller-coaster ride for 2013 due to the US Fed tapering.  South East Asia market was probably the worst hit as money outflow coupling with Indonesia rising inflation, political unstable in Thailand (still is at this point of time), typhoon disaster hitting The Philippines, and the control measures taking effect in Singapore in term of property and foreign labour inflow.  With no surprise, SE Asia markets registered one of those worst performance for 2013.  Despite, all those events, global markets still manage to close positive for the last day of trading in 2013.

Fundamental Shift in Global Economy
Before going into analysis for 2014, there is a point that need to be emphasized again which I have been mentioned since 2012.  Global economy is undergoing a fundamental shift and when completed, the economy model then will no longer be the same as in now or in the past and that will have great impact on global stock markets as a whole.  Years ago, the global economic model was BRICS (Brazil, Russia, India, China and South Africa) in which analysts and investors singled out the 5 emerging markets as the leading factor for global economy growth.  BRICS bubble has burst, that is a true hard fact now and with China having a 10 years reformed plan in 2012 (changing its economic model to consumer and services based) and being a world number 2 economy, it will have impact on how global economy will be shaped in the future.  There are couple of factors that pointing towards this fundamental shift in global economy.

1. China and Japan are aggressively trying to venture trades partnership with SE Asia.
2. Europe is "courting" China in economic link
3. China Yuan is gaining momentum as one of the world recognized currency
4. Inflation was seen rising in Asia but in general not the commodity prices (this is very abnormal)
5. China and Japan though still in political differences (in particular the disrupt of the isle) very well knew the fact that forging good economic link is the priority
6. Japan planning to legalize casino

This fundamental shift in global economy will result in nations building up buffer for themselves against any external shock (like the US subprime crisis) and hence relying less on US economy.  US will still be world number 1 as long as the USD has not become banana note and its supreme in military strength is not challenged.  By knowing this fact, one can then determine or decide where to find the next gem to investment in.

Looking Ahead 2014
What to expect in 2014 ?  Those positive views need not to be further elaborate as most can be found on analysts' reports, newspaper, etc.  The general consensus was 2014 will be a year for developed market in particular US as US economy is recovering finally (especially the unemployment situation) following US Fed decision to start tapering in January.  EU will continue its recovery from recession, most believed North Asia (China, Japan, South Korea and Taiwan) will benefit most from US economy while SE Asia market might have another muted year in 2014 as funds are focusing on the developed market.  Whether that will be true or not, it is too early to tell but there are couples of unanswered questions that made me beg to be differ from those consensus views.

US, Strong economic data pointing to recovery but still under "life support" system (US Fed QE) despite the reduction of bond buying by US$10b.  Furthermore, US still in virtually 0% interest rate environment and there will come a time interest rate will hike and how that will impact its economy.  Can US economy really back to its past glory days when without any QE supporting it and in the norm interest rate environment ?  As long as that question cannot get any answer, there is no reason to be overly optimistic in US economy.  Apple, probably the world number 1 brand internationally now, last month announced deal with China Mobile to break into China market.  Why China market is so important to Apple ? Apple without China market could be just an ordinary apple !.  Even an US company is placing focus not on its home soil that spells something already.  That is another cue to the fundamental shift in global economy.  If that is so true, then US economy recovery will have impact on global economy but the impact will no longer be the same as in the past.  While in last October when US was fighting internally to resolve the debt issue, President Obama has to skip the SE Asia summit then and that could prove vital as US missed out the opportunity to countries like China and Japan to forge deeper trade partnership with SE Asia (SE Asia has a population of more than 600M, the second highest from China of more than 1B).  The new consumer and services based economic model need population and that was the reason why China and SE Asia were key markets for it.  Secondly, though US Government has no worry about its debt problem until 2015 (with the last month budget deal), the unanswered question will be what happen to the debt ceiling ? They have raised it in 2011 and now do nothing about it.  Technically, the latest budget deal allows US Government to cut spending to avoid hitting the debt ceiling again but that does not address the debt ceiling.  What is the real purpose of having a debt ceiling when it can only raise and not reduce ?  As long as US debt ceiling is not reduced, there is every single opportunity that US debt will getting bigger and bigger.  Lastly, US still a nett deficit nation despite all those recovery talks !  Having more questions than answers definitely bring no overly optimism and as long as those questions remained unanswered, every rally in the US stock markets will create nothing but bubbles and increase the risks.

China, though managed to stabilize its slowing economy in the second half of 2013 but can expect to be occasionally volatile in its stock market as long as it is still undergoing reform in its economic model.  China GDP for 2013 was targeted to be 7.5% and should China successfully reformed its economic model to the consumer and services based, its economy should be in the range of between 2.5% to 4.5%.  If every year due to progress in reformation, its targeted economy shrink by 0.5%, that will probably take another 6 years to reach 4.5% and 9 years to reach 2.5%.  During these periods, one can expect cans of worms slowly one by one popping out (like the property overheating, shadow banking, rising local Government debts, corruption, pollution, etc) and with the Chinese Government putting in measures to resolve those issues, one can expect its economy to be on a "move 2 steps, retract 1 step" type of movement.  This will result in volatile stock market as funds moving in and outInvesting in China will need to have that extra high tolerant to stomach those risks while waiting for China to successfully reform its economic model.  China is a big country (in term of land space) with huge population (over 1B of people) and it is never easy to govern such a large scale nation even with its one-party system.  There could be problems that remain unsolved due to no solution or problems appear to be resolve but later on side-effect kicks in.  China could overtake US to be world number 1 economy decade later and the very bright prospect by analysts on China is definitely not something without any risks (unknown risks to be exact).  It is again not something to be overly optimistic either.

Japan, the Abenomic is working as Japan emerged out of recent recession and decades long of deflation.  Prospect is good leading some analysts to be very very positive in Nikkei.  Should Japan really manage to finally emerge from its lost decades it will be very good to Japanese and global as a whole but again there still remain couples of unanswered questions.  Japan is currently under the BOJ (more aggressive than US Fed) stimulus program, what will happen will BOJ decide to taper or withdraw stimulus like US Fed ?  Japan has one of the highest debt to GDP ratio in the world (unlike EU nations, its debt is owing to its people) and what will happen if the debt bubble burst like those in Greece, Spain and Italy ?  That damage is definitely not something one can be imagined of, it is a time bomb to be exact.  Japan economy has a strong reliant on its export (Toyota, Honda, Sony, Panasonic, etc) and weak Japanese Yen will help those companies but can the Japanese Yen be forever weak ?  This is something to ponder about.  Hence, as in the case of US, there should not be overly optimistic in Japan either.

Europe, pretty much quiet in 2013 as investors left the EU nations to restructure their debts and economy.  EU finally managed to emerge from recession with the help of tight fiscal policies and ECB's stimulus program (again low interest rate environment) but if one followed closely, EU inflation is heading towards deflation level.  This is something very worrying as if it really developed into deflation level, it will become another Japan in its lost decades and that is definitely no good for EU as a whole.  This is something probably the priority task for ECB in 2014, to ensure EU will not go into deflation stage.  This is something any investors in EU must monitor closely.  Spain, Greece and Eurozone as a whole still have high unemployment due to the restructuring of their economy in the past years and that still remain a hard issue for EU as a whole to tackle even if they are out of recession and that is another event that must closely watch in 2014.  Should EU economy finally be strong enough to allow ECB to taper or withdraw its stimulus (or even raise interest rate) what will happen to the stock markets and how that will impact rest of the world ?

South East Asia, the beaten one in second half of 2013 and with many expect another muted year, that might not be true.  Like mentioned before, SE Asia is the second largest consumer market after China, that is not something one can easily ignored.  Japan Prime Minister Shinzo Abe when elected in 2012 made his first overseas trip to SE Asia, why ?  China leaders have been frequently doing trade talks with SE Asia, why ? Myanmar thought short-term wise might be overheating (might even need a burst in the bubble) but still have lot of room to expand.  Vietnam, the previous hot market after bubble bursting seems to be getting the attention back again.  For Indonesia (rising inflation, deficit issue), Thailand (political stability) and Malaysia (sign of overheating in its property market), they need to sort out their own domestic issue immediately in order to re-attract back all the foreign investment.  Singapore though in the better shape than rest of SE Asia is not free of problems and worries too.  A nation with limited land space, no natural resources all along relying on foreign influx has to put up measures to slow that down due to great dissatisfaction from the citizens.  Furthermore, the several cooling measures placed on property market are showing effect presently and all these will have impact on its economic growth.  As a whole, from the surface as long as SE Asia nations do not iron out their respective domestic issues, it will difficult to attract foreign investment in the short-term and this is where the stock markets are showing now.  However, there is no all doom and gloom as most have overlooked the fact that US will be playing catch up in term of trade partnership with SE Asia and for US economy continues to sustain the growth, they have to do it if not they will be fallen behind China and Japan.  This is where when SE Asia was beaten down in 2013, cheap bargain can be found.

Singapore, faring better than other SE Asia nations in 2013 and with mixed forecast from analysts in 2014; some believe like other SE Asia it will be another muted and uninteresting year and the other half believe as a safer heaven (compared with other SE Asia nations) and due to its open economy model it will benefit from US economy recovery should perform better in 2014.  There is no right or wrong from each view.  Should most still believe in pouring money into developed nations, no matter how safe heaven Singapore is, it will still unable to perform (funds only target a year of return and not long-term basis).  For those who stick to the negative view will not be getting right either.  Singapore, one of the better developed nation among SE Asia could be seen as a "center" for business opportunity in SE Asia and with countries like US, China, Japan and maybe even Europe all eying a pie in SE Asia consumer market, how can it not benefit from it.  Early last year Singapore Government released a white paper on its population stating a projected population size of 6.9m in 2030 (which caused a stir in the nation but eventually the white paper was passed in parliament).  That population size is it just plainly to resolve the low fertility issue or it meant something more ?  Keep an option open that the decision could be part of change in Singapore economic model in the future (a shift to rely more on consumer and services based, in line with what China is doing and slowly moving away to the very much export oriented model).  There is this point need to bring up in 2014.  S-Reit, most still very negative on it given that fact that now that US Fed tapering has started and interest rate could be up next, the business prospect of S-Reits will get hit.  This is because S-Reits in general do not have much retained earning as 90% or more of their earning are distributed back to unitholders as dividend to get tax exemption.  As such, in order to growth they need acquisition which in turn need cash.  Without much retained earning, most borrow from banks and with potential rising interest rate, that will hurt their earning as a whole.  There is to certain degree true to that but not totally true.  The main priority of S-Reits is to sustain and maintain their current earning and it is not mandatory that they must make acquisition.  There is no absolute that even with higher interest rate environment they are not able to maintain their present earning.  Singapore inflation is at 2% latest, bank interest on average 0.1%, CPF special account (risk-free) interest is at 4% and S-Reits at present average dividend yield is 6.5%.  Inflation will be going up in 2014, even if bank raise interest rate (due to US Fed doing a hike), do you think it will still able to hedge against inflation ?  S-Reits is having a premium of about 2.5% over CPF special account (it is cater for long-term hedge against inflation, if they don't nobody would want to allow the Government to take away portion of their hard-earn money and place it there and the Government will risk of being voted out next), if that is not consider a good hedge to inflation, what is then ?  Trying to be negative or even to the extreme of negative without looking at the bigger picture is never ever a wise move.

Summary
General consensus is developed nations will have a better 2014 than emerging markets but think of all those unanswered questions listed above, that might not be true after all.  Most of the developed nations (US, Japan and Europe) are still under "life supporting" system (ie stimulus program and low interest rate environment), can they really back to their old glory days without any stimulus and normal interest rate environment ?  There is a chance that they can't and they will have to forever rely on stimulus to sustain their growth, so it is a 50-50 thing at the moment.  When having this 50-50 case, there is no reason to really get very optimistic about it and should stock markets over-react and when reality hit, they will have much to fall and that risk will be more than one can imagine.  Emerging market (in particular SE Asia) might be losing flavourism in 2014 as they have been badly sold down in 2013 but that doesn't mean they will continue to be so in 2014.  Most of them are still fundamentally sound (nett surplus at least) and with prices already being sold down, the risk has already been minimized, will be no surprise if they are the better bargain you can get in 2014.  One of the thing one need to look out for in 2014 is :-

Inflation (deflation for the case of Europe unfortunately).  With most Central Banks having low interest rate, they will not be stingy to hike interest rate to curb inflation.  Rising inflation or rising interest rate will have impact on economy and in turn stock markets.

For 2014, unless the intention is to invest to hedge against inflation else there is no reason for one to really pour money into the stock market unnecessary.  On the other hand, for those who still holding investment from 2009, consider slowly to unwind their positions as markets rally up.  Investment should just keep to those which can hedge against inflation and at most only 50% of the capital to be in stocks.  Holding the remaining 50% cash and wait in patience to bargain hunt in bear market. 

Never ever have views that go to the extreme (positive or negative) as from Newton's Third Law of Motion (For every action, there is an equal and opposite reaction), taking a stand at the extreme will always end up at the wrong ends.  If most of the views are correct (in stock markets) then there will be no poor people in this world.

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