Xeo's Annual Investment Report 2013

Dear Friends,

2012 has been another uneven year, with one crisis after another. 2012 seems to be a repeat of 2011: US political high drama, overheating in China and the European Financial crisis hogged the limelight for the entire year. Despite all the crisis coming fast and sudden after one and other, the portfolio did held up pretty well during the crisis days and managed to deliver a return of 13.66%  for the entire year. There has also been some changes in my investment management system, in order to deliver a better investing experience to you. In the past, I am unable to accurately give you an idea your portfolio return, due to the diversity in the types of portfolio I am managing. Ever since I have started to merge and consolidate all my client's portfolio into a more standardized one, based on market risk, returns has improved and a monthly tracking of the sample portfolio performance enabled investors to have a better idea of how their portfolio performed. This is also useful for me to analysis my strategies and how they held up in times of crisis and opportunity when compared to the global index. With the tracking system running smoothly for the past year, I can start to move on to more detailed statistics, in order to have better accountability to you. The ultimate aim, is to have the capability to have a monthly report for each and every portfolio that I manage. 

On another note, I have been approached to work on an investment psychology book, which will be published in Malaysia. That is also the main contributing factor why I am pretty behind time with my annual investment report. I spent my Christmas and New Year typing away at the keyboard, trying to meet the publishing dateline which was on 1st Jan 2013. At the end of the day, I was a few weeks behind the dateline, but I finally got that project out of the way.  

2013 looks to be a good year for investing in global equities and shares. The US recovery in the US economy is gaining pace and the US stock market finally managed to break out it's state of stasis of the past few years. The panic in the Eurozone has subsided to a more manageable level and we are seeing more decisive actions from the new leadership in China. The immediate risk to the market is the potential rise in the US interest rates, which will create a shockwave in some of the overheated markets around the world. If we are able to play this liquidity game smartly, we should be able to come out as a winner, in this stage of the market cycle.

Yours Sincerely,

Lye Wen Song Xeo

Performance of Various Markets

The top markets in 2012 based on SGD are Thailand, Singapore and Hongkong. These countries performed extremely well compared to other countries, is not due to the strong fundamentals, but rather, due to the strong SGD. The SGD appreciated around 6% against the USD during the whole of 2012. Given the fact that USD was one of the better performing currencies for year 2012 due to the fears and uncertainties from the Euro financial crisis, the international stock market returns were greatly diluted, due to the extremely strong SGD. Therefore, investing in local stock last year, was the most profitable as the investor will not be affected by the fluctuation in the exchange rate. Property counters in Singapore also received much limelight as they almost doubled, due to the vibrant property market despite attempts by the government to cool down the property market. South East Asia generally performed extremely well, with the exception of Indonesia, and our relatively large allocation into SEA equities have paid off handsomely.

Economic Themes of 2012

At the start of 2012, major economists were worried about the possibility of a breakdown of the financial institutions in Europe, triggering another major recession and financial crisis around the world. The political deadlock in US lead to much uncertainty and investors are reluctant to invest, thanks to uncompromising bickering among US politicians. The China economy slowed down tremendously, as the government strives to control the rampant inflation in the country. The Euro crisis also took a toll on the export oriented China Economy and the Chinese government is reluctant to act, given that a once in a decade leadership change was looming. There were certainly much gloom and doom than, and luckily, things turned out better than expected and must of these concerns in 2012 were resolved, as we marched into 2013. 

Middle East Tension  

At the start of the year, we witnessed the tension in Middle East rose sharply as the Iranian government in the face of western trade sanctions, threatened to close of the Straits of Hormuz, a critical international oil trade route. Oil prices spiked above $100 for the first time since 2007 and the high oil prices threatened the fragile global economic recovery. The oil crisis faded into the background as the European Financial Crisis erupted again.

Euro Financial Crisis

The European Financial Crisis reared its ugly head again as the Greek went to polls in May and is unable to form a majority government. This brought back the fears of the Eurozone dissolving again as the fate of Euro were in the hands of the Greek citizens. The Greek re-election one month later solved the entire issue as a Pro-Euro coalition was voted into power and the Greeks hunkered down and try to weather the desperate situation within the nation. The financial markets were finally calmed in September, as the European Central Bank, unleashed its most powerful weapon in its arsenal: By offering unlimited support for all eurozone countries involved in a sovereign state bailout program. Mario Draghi, the president of the European Central Bank, managed to save the day by flooding the market with liquidity and gave financial markets confidence by supporting the credibility of the troubled Euro nations. 

China Cooldown and Political Scandal

The China stock market reached its lowest point as investors are worried about the cooling Chinese economy, the impact of the Euro financial crisis on China and the upcoming China leadership transition. The Bo Xilai Scandal created more uncertainty as global investors were getting increasingly worried if the Scandal will lead to something bigger, like a coup or political struggle which may tear the political leadership of China apart. The scandal was swiftly dealt with and a rapid investigation and trial took place, just before the leadership transition in November. All the rumors died down as the new leadership took over with Xi JingPing as the new CPC general secretary and is expected to be named the President later in 2013. The Chinese stock market rallied subsequently, as investors were encouraged by the directions set by the new leadership. 

US Political & Economic Woes

The US economy spent the first half of the year treading water and the attention of the world was turned towards the US Presidential Elections which took place in the last quarter of 2012. Despite much urging from the central banks and prominent economists, the political deadlock between the Democrats and Republicans led to nothing concrete, being implemented, in order to help the stagnant US Economy. Housing prices and employment gradually got better in the first half of the year, and came to a halt in the face of the renewed Euro financial crisis. Faced with increasing discontent with its citizens due to the high unemployment rate, President Obama faced the threat of being ousted from his position. Numerous blunders made by the Republican party and a favorable demographic composition helped the President to clinch his second term, by a large margin. The Republican party, faced with the probability of becoming irrelevant due to the ideology they pursued, in the face of a changing US population profile, soften their stand towards the critical "fiscal cliff" issue. The employment rate started to gain momentum shortly after the election and the data from various sectors of the US Economy indicated that the US recovery is accelerating. The US stock market appreciated quickly towards the end of the year.

Mario Daghi, The President of European Central Bank

Review of 2012 Strategy

In my last annual report, I made 4 points on how I would go about managing the portfolio in 2012.

Take profit frequently so that we can take advantage of the dip due to any crisis

This strategy was carried out with precision as I took profits from the more aggressive funds and moved 20% of the portfolio to Singapore government bonds during Feb-Mar. The market took a sharp dip in April and May due to the renewed concerns of the Euro financial crisis, and the portfolio is able to weather the downturn much better than if I left them in place. Taking advantage of the low prices, I moved into Malaysia equities in July and Korea in August. Both trades have been very profitable.

Increased allocation to US

I have doubled the allocation to the US stock market as the US economy is in the best sweet spot among all the developed economies in the world. The US stock market proved to be resilient during the Euro Financial crisis and Emerging markets feel much more dramatically as compared to US equities during the worst period in May. However, the uncertainty of the neck to neck US Presidential election caused the US stock market to lagged behind other markets. The US stock market corrected sharply when Obama was elected as the next US President as his promises to tax the rich through capital gains tax will be unfavorable to the stock market. The US stock market became one of the best performing markets in January 2013, as economic recovery accelerated in that part of the world. This is one of the good decision I made in the allocation.

Maintain allocation to SEA, especially Thailand

I wrote in my last year annual report that Thailand, will be ripe market to invest in as they recover from a devastating flood at the end of 2011. It is unfortunate, that I did not enter Thailand but chose Malaysia instead for its more stable and less volatile nature. The SEA fund do have some exposure in Thailand, but most of the allocation are still maintained in Singapore. This made us missed out the best performing market of 2012 due to my concerns of its volatile nature in the face of the uncertainty of the European financial crisis. I did not regret the decision too much as my priority lies in the preservation of the capital rather than chasing returns. That said, I should pay more attention to future similar cases as history, will always repeat itself. 

Take profit on Gold shares once the convergence of spot prices and gold mining shares occurs

The convergence of gold mining shares and gold spot prices did not emerge in 2012, despite gold prices have a decent run. The commodity funds were among some of the worst performers in 2012 as the slowdown in the global economy gave rise to concerns that commodity demand will slow down. The 10-20% allocation towards commodities remained a drag on the portfolio.

China switch in December

I have been contemplating moving back into the Chinese market for the past 1 year and only took the plunge in December. The Chinese stock market bottomed out at the start of December and rapidly appreciated more then 20% since than. Due to the time delay of the fund switching mechanism with unit trust, we did not manage to catch the full benefit of the rapid run. We made some decent profit from it and the switch out from Malaysia was a blessing too. The Malaysian stock market underwent a sharp correction shortly after we switched out as the prospect of the upcoming Malaysian general elections gave jitters to the investors.

Overall, 2012 was a very challenging year for the global stock market and some of the events have caught many of the economists and portfolio managers off guard. Many of these analysts were caught off guard due to their focus on numbers and economic data. However, the theme of 2012 is on how the few individuals in the world, who were able to reverse the trend and fortune of their nations, in the face of adversity. Barrack Obama, Mario Draghi and Xin Jingping changed the sentiments of the markets and engineered a stock market revival in their perspective economies. One lesson that we can learn from 2012, is the need to factor in the influence of human nature and their resilience towards adversities. Judging the market and the economy just by numbers, will never be sufficient. Afterall, the financial market is a living thing, made up of millions of investors, each with their own moods, worries and hopes.

2013 Opportunities and Threats

The outlook at the start of January 2013 is an optimistic one. The US economy is on the mend and is recovering strongly. The European financial crisis seems to be under control as this moment in time. The China government is trying to reignite the China growth engine, hoping to keep a lid on the spiraling property prices. Here are some of the themes that I see in 2013 and what are some of my strategies:

1) Overheated South East Asian Markets

The SEA financial markets are some of the best performing markets in the past 4 years. We are relatively untouched by the turmoil that riled the majority of the global stock market and have put up impressive returns. However, The SEA markets risked an overheated economy as US, Europe and China economies regain their footing. SEA markets also have some of the best performing currencies in the world at this point of the time. Throw in the possibilities of laggard investors who finally caught on to the SEA story, there will be a sharp inflow of foreign funds to take advantage of the historically high stock market and rising currency. The sharp inflow of foreign capital will prompt the government to implement harsh cooling measures, in order to control the spiraling inflation and to prevent another episode of the 1997 Asian currency crisis. I will start to decrease the allocation of the SEA markets in general and invest in selective SEA markets, like Indonesia, which has been a laggard in the 2012. 

2) Maintain exposure in North Asia

With the improving Chinese economy, the immediate beneficiaries of this trend will be Japan, Korea, Taiwan and Hong Kong. One note of caution is that, the basic problems of the China economy is still there: An overheated property market and a spiraling increase in cost of living. Juggling between inflationary pressures and economic growth is a thin line to thread, and there is a high chance that sometime down the road, the Chinese government will start to roll-in harsh cool down measures to slow down inflation, which will be a direct hit on the stock market again. We will stay invested in North Asia for the immediate term, but we will not overstay our welcome.

3)Huge opportunities in Europe

There will be a mini European financial crisis occurring again in the 2nd quarter. The European financial crisis is akin to an Earthquake. A huge destructive tremor at the beginning and minor aftershocks years after. The concerns of Spain, Italy and Greece will crop up again, leading to a correction, but the severity of the crisis will be smaller as compared to 2011 and 2012. Europe in recession, proves to be a very tempting fruit, as the potential rise in both the stock markets and currency can bring about very significant profits.

4) Maintain allocation in US and commodities

The US economy is still in the recovery mode. Although the potential of the market this year is not as great as last year, the chances of a very good rally is still there. A survey in US has shown that most of the retail investors are still skeptical of the stock market and has not jumped into the bandwagon yet. That is very good news as the first signs of a potential market collapse, is when the Main Street starts jumping into the stock market and trying to make easy money. Commodities will start to pick up as the global economy grind into the growth mode again. The amount of easy money has made potential inflation in developed economies in the future a real threat. I do not intend to cut my commodity allocation, unless there is a real threat of another global economic crisis again.

Conclusion

2013 will be a pretty good year for equities. However, the more optimistic the world become of its financial markets, the more worried I became. This contrarian view of the global financial market has served me well. in predicting trends and opportunities around the world. However, it is in the human nature, to be slow, to catch on the good things, and fast in digesting bad news. Right now, the general public has not caught on the potential which the stock market has to offer. Once you see queues for IPO at the Central Business District, you will know that the end is near. For now, we shall enjoy the ride while we can.