Jan 22, 2016

Xeo's Annual Investment Review & Outlook 2016

EU Parliament
Brussels, Belgium

Dear Friends,

2015 was known as the "the hardest year to make money in 78 years" by CNBC and the year is marked by intense central banks and government interventions. The dominant themes of 2015 were an indecisive US Federal Reserve on the issue of an interest rate liftoff, the political Greek drama over at EU, the amazing rally and crash of the Chinese stock market followed by numerous market intervention by the Chinese government. The energy war between major new and old energy producers escalated in 2015, pushing oil prices to a new low and major commodity producing countries saw their currencies being punished against the USD.

I made a couple of risk and opportunity forecasts in my 2015 investment report and I got most of the forecasts correct with the exception of a potential Russian financial crisis which I got wrong. Russia was contended to stay low in 2015 and consolidated the gains that they made in 2015. Our strategy of staying in USD for the majority of the year and ride on the EU Quantitative Easing inspired stock market yield us a decent 4.32% for Cash and 2.71% for CPF-OA. The returns are nothing spectacular but given the difficult conditions of the financial markets and the extremely low volatility of the portfolio, we have performed remarkably from a risk/return point of view.

2016 will probably be one of the turning point of the financial markets as the strains and cracks of the Chinese economy continues to grow and spread. A divergence in the global monetary policies between US, EU, Japan and China will exert strains on currency and fix-income markets which may potentially result in a currency and debt crisis in smaller economies with strong trade links with China. The commodity market will continue to come under pressure due a a combination of a stronger USD, slowing demand and over supply. In fact, the year started off badly with the Chinese stock market leading a sell-off, hitting the daily stop trading market of the Shanghai Stock Exchange of 7% and burying the global financial markets in deep freezing snow.

I will advocate a strategy similar to 2015 by allocating the majority of the portfolio into USD money market funds or short duration bonds with a small allocation into US and European equities with the priority on preserving the capital of the portfolio, and opportunistically squeezing out gains whenever possible. With great Risk comes great Opportunity and should we survive this winter with most of the capital intact, we will be able to take advantage of the blooming returns of spring time.     

Yours Sincerely
Xeo Lye

Economic Themes of 2015

China Stock Market Super Rally and Crash
The spectacular 100% rally of the Chinese stock market and the subsequent 40% crash is probably the greatest highlight among all of the financial events in 2015. The crash of the Chinese stock market led a fall in global equities, resulting in the first ever market correction in the US stock exchange in years. The slew of panicky market supporting measures implemented by the Chinese government to arrest the fall of the stock market exposes the lack of experience the Chinese government has in managing a stock exchange. This also brings about the question if the Chinese government can competently manage the Chinese economy into a soft landing.

Greek EU Exit Drama
Once again, the Greek political high drama came into the spotlight at the mid of 2015 with the Greek government calling for a shock national referendum on whether Greece should stomach the austerity that comes with the fund infusion from EU central bank. The Greek voted "Nay" and the Greek government went back to the bargaining table threatening to destabilize the EU by pulling Greece out of EU. EU ignored the threats and Greece decided to stay inside EU anyway. 

Indecisive US Federal Reserve
The US Federal Reserve has been hinting of a interest rise for the entire of 2015 but the the world lurched from one potential financial crisis to another, resulting in a delay in the liftoff of the interest rates until December 2015. The indecisiveness contributed much to the confusion of the financial markets around the world leading to heightened volatility in the currency and fix income markets around the world. 

The Collapse of Oil and Commodity Prices

Oil price fell by 50% from $100 to $50 in 2014 and 2015 saw the value of oil prices continuing to fall to the $30 price zone. Prices of industrial metals also continued their down trend and emerging markets depending on commodity export revenues saw their currencies being sold down against the USD. There had been much speculation that some of the oil producers, especially the shale oil companies in US, will wave the white flag in surrender in the face of a price war. However, the oil war continued through out the year with nobody closing the oil tap and oil prices continued to fall further as the over supply of oil continues and the demand of oil from China starts to slow down.

Review of 2015 Strategy

I took a cautious stance at the start of the year and continued to take profit on the portfolio as stock market advanced throughout the year. By the time the market experienced the first major market correction in years during August, we have taken most of the profit with most of the portfolio parked in short term SGD and USD bonds. We took advantage of the depressed stock marketing during the third quarter of the year and put our cash to work, netting a decent profit over the next two months. However, an underwhelming EU QE and the continued fall in oil prices took away some of the profits we accrued during December and we ended the year in a positive territory as compared to the negative returns of the majority of the stock markets around the world.

January 2015: Took profit and moved 60% of portfolio to USD Money Market and Global Short Duration Bond Fund

Learning from 2014 mistake of moving too much of the asset into defensive position too soon, I adopted a gradual profit taking strategy this time and we managed to capture a portion of the market appreciation from Jan to May.

May 2015: Moved 80% of portfolio to USD Money Market and Global Short Duration Bond Fund

The China stock market rallied strongly, reflecting a mania of a potential stock market bubble. Concerned with the potential collapse of the Chinese stock market, I moved most of the portfolio into a conservative stance.

August 2015: Moved 30% of portfolio from Global Bonds into US and Europe Equities

A combination of a China stock market crash, Greece crisis and falling oil prices resulted in the first major market correction in US since 2011. Taking advantage of the fear in the market, we moved the portfolio to a more balance approach to capture any potential surge in the stock market.
Verdict: Gold

October 2015: Moved 30% of portfolio from Bonds into European Equities

With the stock market on firmer footing, I moved another portion of the conservative portion into the European markets as the monetary policies are extremely favorable to the European stock market. The European stock market rallied 15% before hitting a peak and lost ground to an underwhelming QE program announced by the EU central bank. On hindsight, I did not consider the possibility of an underwhelming QE program and should have ventured less aggressively into European equities. 

Final Verdict: 3 Gold, 1 Neutral

The Outlook & Strategy for 2016

There are many concerns and risks which I foresee in 2016 and here is a short list of some of the most important risks which I see will threaten the stability of the financial markets.

China Yuan depreciation, property and debt bubble

With the collapse of the stock market bubble, the question we need to pose next is if whether that the slow-down of the Chinese economy will lead to the pricking of other bubbles which the Chinese economy has been inflating in the past few years. This concern has been around for the past 3 years on every annual investment report which I wrote, but the probability of a bubble bursting in this year seems to be higher than the previous 2 years as the Chinese government is embattled with multiple fronts to try to stabilize the crashing stock market. In my opinion, the Yuan is also over valued and the Chinese government need to manage a controlled descent of the Yuan to prevent any sudden capital outflow from the country. The theme of 2016 will be focused on China and how China manage the slow-down in the economy as well as how well China coordinate it's various financial instrument to prevent a mass panic and flight of capital. I will personally avoid any China related holdings or countries and companies that derives a huge part of their income from the Chinese market.

Oil and Emerging Markets

The continued descent of oil and commodity prices is actually a positive to consumers in many countries which has been suffering from the effects of high oil prices for the past decade. The wealth of these net oil importing nation has been flowing to the oil exporting nation and the reverse is happening right now. Markets such as Russia, Malaysia, Middle Eastern and certain Latin American countries will suffer as oil prices maintain at the current low prices. In my opinion, the sell-down of the oil prices have been over exaggerated by speculators who are fueling the over supply fear. If you think logically, for oil prices to crash from $100 to $30 in a year, the world supply of oil must have tripled or the demand must have fallen by one-third to the $30 price range to make sense, which are both not the case.There is currently a strong speculative downward pressure by traders on oil and any news that will lead to a possible reversal will have oil price shooting back up as traders unwind their positions.  Oil will no doubt be under pressure for 2016 but this opens up an interesting investing opportunity in this battered asset class.

Divergence in Monetary Policies in the Developed Nations

With the US raising interest rates and the EU and Japan with their ongoing QE program, it is not hard to see a simple strategy base on this current trend. Buy aggressive assets in EU and Japan to benefit from asset inflation due to an influx of capital and buy conservative asset in US to benefit from the raise in US dollar. However, the recent 2016 new year crash and on-going downward trend in commodity prices may have the US central bank concerned about possible deflation pressures and a slow-down in the US economy, resulting in them slowing down the rate of interest rates increment. This will give a big jolt in the global financial markets leading to a possible rally around the world. A slow-down in the rate of increase of interest rates will lower the financial strain of the foreign debt servicing in emerging markets resulting in an overall improvement in the fiscal health of emerging markets. History has also shown that US equities typically will do positively in a rising interest rate environment but with an increase volatility in the stock market, so I will hold on to positions in the US stock market for 2016 even with the heightened about of volatility which we will see. Between Japan and EU which are still engaged in aggressive monetary loosening, I will prefer EU as the impact of a slow-down in the Chinese economy will have a lesser impact on EU than on Japan.

Bursting of Global Tech Bubble?

One of the best performing sector in 2015 has been the technology stocks and there has been many privately valued tech unicorns in which the valuation is far higher than that of profitable businesses which are generating decent profits. In 2015 Facebook gained 34%, Amazon Inc. was up 118%  Netflix Inc.  returned 135%, and Google was up 47%. By comparison, the SNP 500 declined 0.7%. Although the mobile tech bubble of today has not reached the stage of the bubble frenzied years of 2000, investors are recognizing that the prices of these companies are becoming unsustainable. The recent market downturn has trimmed the prices of these stocks by quite a bit, leading to a temporary deflation of another potential bubble. Although the tech bubble does not pose a risk as of now, but this trend needs to be monitored.

Elections in US

With one of the most important election in the world schedule to be in Nov 2016, it will have a significant impact on the financial markets going forward. At the moment in time, there has not been a clear leader in the Republican nominee with Donald Trump and Ted Cruz running neck to neck. Over at the Democrat side, Hilary Clinton will probably be the nominee. Should Donald Trump and the Republican wins the US presidential elections, we will see a spike in the US stock market as pro-capitalistic, pro-American Trump will result in deregulation and lowered tax rate and at the same time, be more hostile to foreign markets that "threatened" the jobs of Americans.  


2016 will be an extremely tricky year to manage the portfolio as there will be extreme volatility going in both direction and it may be impossible to navigate the waters of 2016 without encountering any waves. Having said that selective asset allocation into regions and asset classes which is the most under valued or relatively protected from the potential flash points of the world will be the best strategy going forward. There may be cases whereby we move in to take action on an asset class which is battered down already, and to see it being double KO by another round of selling that takes it down by another 10%. There is simply no way to tell when a market bottom will be and the portfolio may take short term losses due to the volatility market but we will want to be in the position for the lift-off when the next market rally comes along.

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