I’m in the midst of completing my updated analysis on King Wan Corporation. It’s been incredibly difficult, as it is one of the worst investments I’ve made thus far. Many lessons are gleaned, and I think this case study is very interesting (for those who are not vested).
I’d say it’s entertaining as well, to read about my interactions with a highly incompetent management.
Like I said before, I plan on being absolutely transparent. Even my failures will get adequate spotlight. In fact, probably more so.
As with all things painful, I’m in no hurry to compile my thoughts and experiences though. Anyway, I’d be going for a holiday next week so it might take some time.
On a separate note, I’ve been looking at the global macro aspect the past week, and correspondingly re-read my personal notes about my macro view that I’ve penned about a year ago.
As mentioned in earlier posts, I’m generally rather bearish currently. At this stage, I’m happy to keep a disproportionately high amount of cash for liquidity, and to capitalize on black swan events (read Brexit)
Regardless of how bearish one is though, I don’t think one can sit out of the markets for too long. Nobody can predict when a major bearish event can occur, and it can and often does, take such a long time to come that it surprises even the most bearish of bears.
What I’d do instead, is to eliminate leverage (both in equities and in my personal properties), demand a wide margin of safety in equities and only invest in equities with a strong investing thesis and a clear stimulative event in the horizon. (For eg.BBR Holdings Investing Thesis)
It’s no secret that the US monetary supply has gone up drastically with the amount of money printing (aka quantitative easing) in recent years. I think most people, especially those in this part of the world, don’t really realise how drastic though.
This chart gives a bird’s eye view:
For the longest time ever, the US monetary supply has grown steadily with a gentle gradient. Since 2009 though, in response to the GFC and the housing crash before that, the gradient has just gone absolutely ballistic.
“Money Supply M0 in the United States decreased to 3836463 USD Million in May from 3872940 USD Million in April of 2016. Money Supply M0 in the United States averaged 634909.99 USD Million from 1959 until 2016, reaching an all time high of 4075024 USD Million in August of 2014 and a record low of 48362 USD Million in March of 1961. “
Mo is the total money supply. That’s all the physical dollar bills and coins in circulation, as well as everything else that is liquid and easily converted to cash.
OK so it dipped just every so slightly in May 2016, but that’s kinda insignificant in the broad scheme of things. We simply know that the amount of money circulating around is ENORMOUS in relation to just less than 10 yrs ago.
The total US money supply has increased by >300% in the past 7 years!
Now imagine all this money is distributed extremely fairly. Every person with a dollar, gets $3 from the government to make it $4. If you have $2, you get $6 and now you have $8. If you have $100, you get $300 to make it $400 etc.
The net effect should then be simply, the real cost of all goods and services, simply increases proportionately, assuming the value people place on these goods and services remain unchanged, the demand remains unchanged etc.
So a $1 cup of coffee, now becomes $4.
Simply put, inflation.
Yet, how does inflation rates look like in the US?
Since 2009, the rates have hardly changed. It certainly doesn’t look like a 300% increase.
So where did all this $$$ go to? The money supply has increased dramatically since 2009.
Using the above example, unless everyone who has $1 and received a corresponding $3 from the US government, has gone on to stuff this $3 under the mattress, all this money printed has to go somewhere. It simply has to.
Here is where it all went
As you can see, the SPY (S&P 500 index ETF) was at a low of 73.93 in Feb 2009. It is now approximately up by 200% or so. The chart since 2009, matches the money supply chart almost to the exact letter.
Of course, not ALL the increased money supply went into the stock market, although the bulk of it did. (measured in real terms)
Some of it went to the US property market too.
The lows in this index was registered sometime in late 2010/early 2011. As expected, housing being a lagging indicator, took some time before all this extra money supply found it’s way into the housing sector.
This makes perfect sense. Imagine this, after a GFC and a prolonged period of job insecurity, of job losses and of pay cuts, your employer/boss suddenly tells you tomorrow that starting next month, you’re going to get a pay raise of nett 10% (not cumulative) EVERY MONTH, such that at the end of the year, you’d get a 120% pay raise.
That’s fantastic, but after getting a pay raise of 10% in the 1st month, you aren’t going to immediately go out and start buying the dream house you’ve always wanted. You’d probably save up the increment, or spend it on little pleasures. More fancy dinners outside perhaps. A nice dress that you’ve been eyeing.
Which is why the retail sectors tend to be the most reactive.
You’d only consider buying a new house, when you feel sufficiently comfortable, perhaps at the end of the year, or maybe even longer, after saving up for the downpayment and doing the relevant math.
That’s how it works. That’s why housing tends to lag by a while, in this case, approximately 18-24 months.
Now, back to the money supply and the S&P 500 ETF charts:
I’d also noted that despite a gradual increase in money supply before 2009, the stock market has always risen steadily until it’s completely divergent from the money supply, reaching a peak, before crashing.
It rose steadily from Jan 1995 – Aug 2000 or so. That’s 5 years.
It rose steadily from Feb 2003 – Nov 2007 or so. That’s just under 5 years.
The current rise started in Feb 2009 (coincident with the massive monetary expansion), and has shot up since then. That’s 7.5 years. And counting.
In “normal” healthy times, when monetary supply is expansionary but in a gradual fashion, the stock market rises steadily until the values have gone out of sync. It builds up gradually into a bubble that eventually bursts. The stock market crashes, eventually people rebuild, and the entire cycles starts again.
It’s human nature. This cyclical behavior is driven by our innate desire to stick to one another and be influenced by the thoughts and opinions of people around us, in the media etc. Basically, other fellow humans.
However, since 2009, this cycle has been disrupted. There is no bubble bursting. The expanded money supply ensures it. There is no hyperinflation as all this money has not gone into buying or investing in real goods or services. The demand has either stayed constant, or in all likelihood, dropped.
Now, if we correlate this “demand for goods and services” with the money supply, if inflation has not become hyperinflation, whereas the money supply has increased dramatically, the logical conclusion is that the ratio of real demand for goods and services vs the the money supply has actually dropped by approximately 300%.
The “resilient and robust” US recovery is not exactly a recovery in real economic terms. It’s a recovery of the stock market. So if one defines recovery as just looking at the S&P 500, sure, the recovery is “robust”.
In real terms though, in terms of economic activity, even staying the same, is not acceptable in view of the 300% increase in money supply.
To truly “stay the same”, the US economic activity should increase by 300%!
If that’s true, we’d see things like US GDP, company earnings and US trade surpluses going through the roof. One can easily search for these data but suffice to say, it’s nowhere what you’d expect it to look like with a 300% increase in economic activity.
Of course, this is a highly simplistic way to put it. There are tons of other considerations and I’m sure more learned guys would put me to the sword with strong counter arguments.
Still, there is no denying the broad overview I’ve put out.
Considering inflation and corporate earnings, the S&P 500 is simply getting costly.
I’d end this part with a self explanatory chart on the Shiller (inflation adjusted) PE ratio index of the S&P 500:
My thoughts going forward
Now if this strong march upwards (S&P500) is ascertained to be almost completely caused by the expanded money supply, it’s fair for me to postulate that going forward, how the stock market behaves as a whole, correlates closely to, well, the money supply as a whole.
The actual economic activity, the goods and services produced by the US economic machine, becomes less of a factor. The amount of $$$ floating around in the US system and by extension, the world, becomes the main factor.
This leads to my overall bearish stance.
I’d like to imagine that I’m an alien, arriving on Earth for the 1st time. Someone wants to place a bet with me. Without any ability to predict the future, just by looking at the current interest rates and how the S&P 500 has performed since 2009, if I’m a betting man, would I bet my money on the money supply increasing further (S&P rising further)? Or would money supply shrink (S&P fall)?
In reality, there’s another option and that is IMO, currently the most likely one. The money supply stays more or less elevated at this current levels, perhaps even dip so very slightly as the years pass. The S&P does something similar, stay approximately at this level over multiple years to come.
The next most likely scenario after this, is that the S&P tanks and crashes.
The most unlikely scenario, IMHO, is the S&P going on to rise another 400%. In fact, I don’t think 100% is possible. Not even 40%.
To put simply, my opinion on the odds are that it’d either stay relatively constant, or drop. The time frame for this to play out though, is highly variable. It can stay constant, and I can be right, but for how long? 3 years? 5 years? 10 years?
That is something where I think no amount of data and logical thinking can provide any significant advantage in terms of insight.
In this environment, I think one can outperform only by applying rigorous bottom up research to swim against the tide.
It’s kinda like going to the casino. The odds are against ALL the players in the casino. But the players in the casino who are prepared, who have studied the odds, counted the cards, practised at home, identified the quirks and maybe analysed the body language of the couriers, these are the players who would outperform the other players who have done absolutely nothing.
I’d add that although I think the most likely scenario is that the markets will hover up and down around a mean (aka pretty much stay the same over a prolonged period), I do think the volatility would increase greatly.
There’d be sudden big increases and sudden big drops. That’s how it is when there’s a lot of liquidity floating around the system.
With the recent strong recovery following Brexit, I’m really glad to have deployed capital. I’m sitting on a tiny gain from my purchases of Valeant and Chesapeake Energy just a week ago. On a overall basis though, both these positions are in the red.
I’m not worried though, as I’ve done substantial work (that’s not been shared here in detail yet as this is supposed to be SG centric) on these 2 and I think I understand them much better than the typical shareholder.
I’ve also started rebuilding the tiny short position that I sold during the dark days of Brexit. (I currently have 2 puny, long dated, short options on SPY)
It may be premature, but I’m planning to be flexible with the short options, meaning I may trade in and out of them, unlike my equity positions, which are more bottom up, research intensive, and mid-long term deep value plays.
The plan to be flexible and trade in and out is in response to my view (aka intelligent guess) that volatility is likely to be high in the months/years to come.