Xeo's Annual Investment Review & Outlook 2014

Dear Friends,

2013 was another difficult year to invest in, as the stock market appreciation around the world gave drastically different returns. The western analysts were out there, trumpeting on the fantastic returns of the US and European stock market, yet at the start of 2013, they were pessimistic on the US economy due to the sequencer, debt ceiling and potential Euro crisis. On the other hand, Asia and Emerging Markets ended the year mostly flat or bleeding even though, many Asian analysts, were absolutely positive on Emerging Market equities at the start of the year, thanks to the outstanding performance of 2012.On hindsight, we should have allocated everything into the western developed markets, but at the start of 2013, US and Europe were generally not favored by many analysts. How ironic!

We did pretty well this year considering that we were almost 80% allocated into Asian equities and Commodities at the start of 2013 and pushed into the unfavored western economies, which rewarded us extremely well by the end of  2013. The portfolio returned 9.25% for cash investment and approximately 10.4% for CPF-OA investment. It could have been a lot worse if we have maintained our portfolio mainly in the Emerging Markets.

Dismal Performance for the Emerging Markets

Some of the new initiatives for taken this year includes: A simplified fund fact sheet for all the time strapped investors who do not have time to read through my investment reports; Tracking of CPF-OA portfolio returns; The Market Correction Promotion in July, which many of you took advantage of and generated 5% return within a 5 months period. Congratulations to those who dared!

Many analysts are positive for the year of 2014 but I am getting more cautious as a result of the huge run-up of the western stock markets and the debt situation in Asia and Emerging Market. I will not hesitant to say that 2014 will be a even more hazardous year for global equities as the opportunities for value are disappearing fast.

That said, the portfolio, if managed properly and timely by picking the right sector and country, can still produce a positive result this year. I will share my strategy in my detail at the later sections of this report.

Lastly, I wish everyone a Happy and Prosperous 2014!

Yours Sincerely,

Lye Wen Song Xeo

 Economic themes of 2013

2013 was another eventful year, but the two main themes that dominated the stock market are politics and the central banks. As a result of the actions of the political leaders and the central bankers, the financial markets of 2013 went through another roller coaster ride. Thankfully, the crisis over at Europe seems to have quieten down quite a bit, else, the roller coaster rider would have gotten a lot more exciting.

Source: Cartoon by Marshall Ramsey of Creators Syndicate.

Politics

The fate of the stock markets in 2013 were greatly affected by the politics around the world. The US budget and debt limits shook global markets, as a small faction of the US Republican Party threatened to bring US on the brink of defaulting their debts, potentially unleashing a financial tsunami around the world and shutting down the government for more than 2 weeks.

In Germany, the re-election of the Christian democratic CDU-CSU alliance and it's leader, Angela Merkel, validated the support of the German people on the bailing out of the distressed European nations using tax payers funds. The support of Germany on the reform program in Europe is absolutely necessary and this lead to a resurgence of investors confidence on the euro markets, helping to stabilize the Euro crisis.

On the emerging market end, two of the most promising emerging markets, Thailand and Turkey, whose stock market has outperformed in the last few years, were bashed down quickly in a matter of months. Both countries are embroiled in a potentially prolonged political crisis which started as a small blunder by their leaders and the issues snowballed into movements which threaten the country's political stability. 

Abenomics saved Japan?
Source: The Economist

Central Banks

The central banks of US, Europe and Japan played a prominent role in the fate of the global stock markets in 2013. The prospect of the US central bank rolling back the quantitative easing, also known as tapering led to the first major market correction around the world. After much speculation throughout the entire year, the tapering finally took place in Dec, resulting in a chain of effects that could be felt around the world.

Currencies of some of the major emerging markets such as the Thai baht, Indonesia Rupiah and India Rupee lost more than 10% of their value against the USD as an indirect result of the tapering. The central banks of these country had to intervene to stabilize the volatility, and trying to keep the hot money within the country. Gold took a beating in 2013, partially as a result of the tapering, lost around 30% of its value. 

The Chinese banking sector faced a cash crunch,when the Chinese interbank prime rates jumped 3 folds overnight as a result of the news of US tapering and the Chinese Government moved in to curb the over-investment of property and capital goods, trying to prevent the country from engulfing into a debt crisis. 

Taking a book from the US central bank, the Japanese central bank also started their own quantitative easing. The Japanese quantitative easing, also known as "Abenomics" (Named after the Japanese prime minister) pushed the Japanese stock market up by 50%, but at the same time, pushing the yen down by 17% against SGD. 

Emerging and Asia Markets grossly underperformed Western Markets

Review of 2013 Strategy 

The portfolio movement was pretty dramatic last year, with a turnover of 70% of the portfolio. Here is a breakdown of the Golds & Duds for 2013.

Jan 2013: Took Profit Malaysia, Bought China

Thinking that investors will react favorably with the installation of the new Chinese government which is keen in reforms, the Chinese stock market will start to run. It didn't happen. By the end of March, that position took a small loss of 6%.

Verdict: Dud

Mar 2013: Took Profit on South East Asia Fund & Korea Fund

The SEA fund and Korean fund was up 30% & 10% respectively and judging from the "heatiness" of the stock and property market, I decided to get out and not to look back. The SEA stock market and Korean Stock Market lost more than 10% in the June correction and were among the worst performers for 2013.

Verdict: Gold
 

Mar 2013: Cut Loss on Commodity and Gold Funds

The promised inflation due to the massive money printing exercise around the world did not materialized and Gold prices started to drift down from $1700 to $1600 in March 2013. Although I wrote in my 2013 annual report that I will maintain this position, I decided to cut losses as the macro environment became more and more hostile towards gold. Gold prices plunged $200 shortly after I switched out, and Gold prices ended the year at $1200. The gold funds are also the worst performing funds in the Singapore fund universe, losing investors around 50% for 2013. 

Verdict: Gold

 

Gold Price Took a Plunge
Source: kitco

Mar 2013: Increased US equity exposure from 10% to 40%

The US stock market became one of the best performing market in the developed world, boasting an annual return not seen since 1995 delivering an astounding 39% return for the year. I wished I had allocated more to this region, but hindsight is always 50/50.

Verdict: Gold

Mar 2013: Took Cover in "Safe Haven" Singapore Government Bonds

The call was correct as the global stock market corrected more than 10% in May but the Singapore Government Bond did not prove to be a safe haven afterall, as global investors choose to ditch Singapore Bonds as a result of the looming threat of the US tapering. Singapore is seen as a proxy to the SEA market, which leads to global investors believing that our credit worthiness will be affected should the our SEA neighbors collapse as a result of a tightening of global liquidity. The fund lost 3% and did not perform as well as expected as a safe haven position. It could have been worse if I have stayed in Asian equities and lost more than 10%, which is the reason why I will give it a Neutral verdict. 

Verdict: Neutral

Jun 2013: Bought into "Undervalued" Turkey and Thailand

July was the month when the global stock market was at the bottom and I was hunting around to see which sector was potentially the most undervalued as a result of the over reaction to the tapering news. Turkey and Thailand caught my eyes. Both markets were the worst performing in the world at that time, falling 18% & 13% respectively. Both countries have huge market potential and I believe that their stock market should shoot through the roof, once global investors realize that the selling was overdone as a result of the tapering concerns. Just as the stock markets of these two countries were about to fly, they were hit by domestic political crisis almost at the same time. Judging that there will be no resolution in the short term, I decided to cut the losses at -14% at the start of December. This position cost the portfolio more than 2% of its annual performance. 

Verdict: Dud

Jul 2013: Bought into US Small and Medium Enterprise Stock

The US Blue Chips did well. The smaller companies did even better! This position returned around 12% effectively offsetting the losses caused by the Turkey/Thailand position.

Verdict: Gold

Final Verdict: 4 Gold,  2 Duds, 1 Neutral  

.............Pretty Good, But Can be Better!
 

2014 Opportunities and Threats

Overheated US & Japanese Markets

The US and the Japanese stock markets were the best performing stock markets in 2013 and I do believe that they are overheated at this moment in time with a major correction in the making. The magnitude of the correction could be more than 10%, given how much they have rallied in 2013 and the rest of the world will similarly be affected when they correct. Preventive action will be taken to preserve the hard earned profits that we have made in 2013.

Possible Debt Crisis from China

The first signs of a possible debt crisis in China came in June when the interbank interest rates shot up from 3% to 13% after the news of a probable US Fed tapering came to light. It happened again in December. Both times, the government intervened and forcefully pushed the rates down to prevent a possible credit crunch. It was also revealed in December, that the Chinese local debt jumped 70% to $3 trillion dollars over a short span of 3 years and the percentage, of which is attributed to Shadow Banking, also soared. The Chinese Government is now walking on a tight rope to ensure that the credit problem do not tip over and yet keep the economy going. Failure to do that, will lead to disastrous results for the entire Asian stock market and commodity prices.  

The Rapid Rise of China's Local Debt.

 The Emerging Markets Credit Crunch

As the US tapering starts to kick in this year, the currencies and financial markets of emerging markets will continue to face pressure as global investors flee to the Western markets due to the rising yield and strengthening USD. However, a possible rally may occur during the interval between the end of the US tapering and the rise of the US interest rates. All eyes to the US central bank and US inflation data for clues of this rally. This is assuming that we are not pulled down by a possible China financial crisis which will turn this possibility into naught. 

Strengthening US Dollar & Economy

Given that the US economy is the best kid in a lousy neighborhood, the USD and the US stock market should perform well after the downwards market correction and should be featured prominently in the portfolio. US Money Market funds will also be attractive and will be a better safe haven than the Singapore Government Bonds. Oh wait! CPF-OA funds doesn't allow investors to invest in US money market funds as they perceive currency movement to be more risky than the China stock market. Great logic there CPF! 

Europe: Wild Card

The European economies are still trying to claw their way out from the depths of recession, even though some light can be seen. This is similar to how the US economy looked 2 years ago. There might be some hiccups here and there, making investing in the European Markets a wild ride, but judging from how the US stock market performed from 2 years ago till now, the value proposition of Europe is too good to pass up.

The Strategy for 2014

I strongly believe that a major correction will take place soon and the portfolio will see a major movement towards safer assets such as money market funds in a month or two. This year, I will also try to avoid emerging market equities, unless they offer a compelling story, while under the looming threat of a possible China debt crisis. Most of the asset allocation will be devoted to US and European equities. I might explore technology and small & medium enterprise as a tactical play as the they will be some of the first beneficiaries of a US and European economic recovery. 2014 will be another difficult year to invest in and I plan on being flexible and nimble as what I have done in the past 2 years. I will like to end this report with an interesting paragraph from the Blackrock Investment Outlook for year 2004, which perfectly sums up my investment strategy.

"One is of particular interest to us as money managers: the potential for markets to overheat. Are we there yet? We do not think so. Irrational exuberance can last a long time. but much policy powder has already been spent, and we will be on bubble watch. 2014 is the year to squeeze out more juice from markets—and be ready to discard the fruit when it starts running dry."