Feb 1, 2018

Xeo's Annual Investment Review & Outlook 2018

Dear Friends,

2017 was a good year for the global stock market with the Asian stock market doing the best thanks to a combination of low inflation, low interest rates and a recovering Chinese economy after the hiccups suffered in 2016. The geo-political volatility caused by Brexit and Trump winning the US Presidential election was generally absent in 2017. The greatest geo-political risk of 2017 was the confrontation between North Korea and America, but even that fails to rattle the stock market as few people actually believe that a real military confrontation will ignite from the war of words. The most exciting development of 2017 was probably the rise of cryptocurrency as a potentially new asset class, with the prices of top traded cryptocurrencies such as Bitcoin and Ethereum soaring by a few hundred percent. The worst performing asset was surprising, the US dollar which lost 9% in Singapore dollar. Back in 2016, many analysts predicted that the USD will rise, thanks to the trade protectionism and tax friendly policies of the Trump administration and the rising interest rates. Instead, USD fell, in one of the worst routs seen in recent years. The question is, as the Trump administration policies started to be implemented and interest rates continue to rise, will the USD climb back in value?

2018 started off with a bang with January delivering a good performance across all markets. However, as the prices hits new high, global valuations have started to flash warning signs with increasing frequency. The current valuation of stock is even higher than that before the 2007 global financial crisis. On the bright side, inflation is still low across the world which prevents central banks from tightening the global money supply too rapidly. However, the stock markets will probably experience shocks if inflation starts to take whole of the global economy.

On the portfolio strategy side, I will maintain a still maintain a conservative strategy with tactical buys into assets that are beaten down. There are potential profits to be made for a "buy high, sell higher" strategy if we move into equities now but I prefer the more conservative approach of "buying cheap" with a good margin of safety as protecting the capital of the portfolio is still the priority for myself and all of my clients. I will hold off any aggressive portfolio allocation and maintain a target of 3-4% return for the year until valuation comes down to a more reasonable level.

Yours Sincerely
Lye Wen Song Xeo

Economic Themes of 2017

Resurrection of Emerging Market Equities

The Emerging market equities made a come back with China, India, Indonesia and Brazil delivering above 20% returns for 2017. the political and financial problems of 2016 has faded into the background with the lack of any unexpected political or financial problems emboldening investors to chase after returns in riskier regions. China was an oasis of calm with the government not allowing even a single thread of chaos with the 19th National Congress for the Communist Party of China taking place along with a historical change of leadership. The peace will probably be disturbed with the Chinese government putting focusing on deleveraging the China economy now that the congress is out of the way. This will generate volatility in the Asian stock markets. 

Rise of Cryptocurrencies

Within the span of 1 year, the price of Bitcoin jumped from $900 to $19,000, sending the world on a frenzy to find out more about this new millionaire making asset. The financial news channels are flooded with daily news on various cryptocurrency developments with few interest in other asset classes. Governments and financial institutions scrambled to regulate and make sense of how to facilitate the transactions of this new asset class which can potentially cause huge regulatory problems to the financial systems. The prices of cryptocurrencies have come down and while the fever has died down a bit, 2018 will be the year to watch as more governments step in to attempt to regulate the free wheeling cryptocurrency market.

The Fall of USD

The sharp devaluation of USD in 2017 came as a surprise to most analysts who predicted that USD will continue to strengthen due to pro-growth and pro-inflation policies that the Trump administration is advocating. However, a strengthening European economy, a low inflationary environment and scandals within the Trump administration, gave the dollar bears a chance to sell down the USD. The export oriented Asian economy has not been affected by the fall and it actually alleviate the high US denominated debt problems in Asia, allowing Asian businesses who have borrowed heavily to pay less in USD interest. However, on the flip side, export profits will be hit if this continues and may start to reflect in the Asian equities in months to come.

Commodities Reaches New Peak

2017 was a year whereby all regions registered strong economic growth, generating an increasing demand for raw materials. However, thanks to the collapse of commodity prices during 2016, there had been a fall in supply for major commodities and this caused the prices of all the raw materials to increase rapidly during the end of 2017.

The Outlook & Strategy for 2017

There are many concerns and risks which I foresee in 2018 and here is a short list of some of the most important risks which I see will threaten the stability of the financial markets.

Rising Inflation

Many analysts expected that inflation will start to pick up in 2017 but it failed to materialized. Given that the global economy is firing its engines on all fronts, given that even laggards such as Japan is experiencing good growth, the threat of inflation resulting in a global tightening of money supply. This may be the main catalyst for a stock market correction the threat of higher rates will make risk taking less attractive.The low USD and accelerating inflation in emerging markets will push prices up as US imports more and more expensive goods. The tax holiday proposed by the Trump administration will give incentive for global MNC to repatriate their money back to US and one company which has indicated interest is Apple, which has USD250 billion cash parked outside of US. Lastly, the rising commodity prices will further put pressure on the inflationary front and all these factors coming together will probably lead to inflationary pressure and pushing interest rates up on faster rate in US.

Deleveraging in China

With President Xi firmly in power, the focus on deleveraging the USD4.1 trillion debt will come back into focus again. Given the strong control which the government has over all aspects of the economic system, the government will take slow stable steps to ensure that they do not destabilize the financial system while working off the excess. Growth in China will probably slow down even further but will still provide a good engine of growth in the Asia Pacific region.

Trump Policies take effect

With so many scandals and chaos within Trump administration, it is not surprising that not much is being done in the first year of his administration. However, with the tax reform bill being passed, the impact of his policies will be more keenly felt in 2018. The Trump administration are also putting in trade protection policies with him putting up solar panels, steel and aluminum tariffs in an attempt to protect US workers from those industries. The other agendas on the Trump administration includes cutting regulations and improve infrastructure spending, which will probably benefit the financial and material sectors.

Global Stock Valuation at Danger zone

Investors have poured most amount of funds into equity based instruments since 2013 and this has driven the equity market into the danger zone. While we have not approached the crazy days of the dot com bubble in 2000, but we have definitely seen similar echos of such mania in the cryptocurrency market, which is often seen during the peaks of market cycles. The cycle of such mania will always persist and it is during such periods, that investors should sit up and take note of the dangers of sharks, which are swimming all around the unwary investor.

Investment Strategy for 2018

The bull market is now on it's 10th year of the bull market whereby the average bull market is on average, 4 years between 1937 to 2013. Thanks to the good run of 2017, valuation of stocks has moved from risky to dangerous. The global stock market also has not had a correction since the US presidential election in 2016 and that is an unhealthy development for the stock market. It is highly likely that we will encounter a market correction in 2018 of at least a double digit magnitude, in order to put global stock valuation.

As we approach the end of the cycle, it is prudent to take a more conservative stance on the market, but with the absence of inflation and still relatively low interest rates, what is expensive may become more expensive. With interest rates still on the rise, putting too much stakes into bonds will be detrimental to the portfolio as longer dated bonds will lose money in such an environment. That is the reason why I am reluctant to move the entire portfolio into bonds as planned on the business cycle portfolio and still maintain a big proportion in the equity market, in order to generate the necessary returns to beat inflation. As such, it is still prudent to keep a healthy proportion of the portfolio in stock but in more defensive sector and late stage cycle equities such as healthcare and material stocks. In terms of regional allocation, I am extremely reluctant to allocate any allocation to Asia and Europe as of now, given that their valuations are stretched after the good run in 2017 but I am keen to move some allocation into these regions should a reasonable correction take place, bringing their value down to a more comfortable zone.

In conclusion, 2018 should be a year with much more ups and downs given the fact that stock valuations are dangerously high, along with rising inflationary pressures and tightening of monetary policies around the globe. The economic realities will clash with the optimism of the investors which is at the highest since the 2008 crisis and this will create much waves in the stock market, bringing much chaos, but at the same time, much opportunities.

Marco Economic Outlook and Talk

I will be delivering a macro economic talk on 8th of Feb and if you will like to check in with me on some of my views, do drop by for a chat! I will be happy to share. Click here to sign up!

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