Income Investing and Hong Kong

Personally, for me, I find these past few months and years difficult as an investor. For one, we are currently in the longest bull run in history. In other words, we are entering an unchartered territory so to speak.

Market milestone: This is the longest bull run in history (read here)

I have been contemplating creating a dividend portfolio for some time, and I reckon it is timely that Kyith came up with the post below.

Why Living Off Dividend Income in Retirement is Not Perfect (read here)

The key points below as mentioned by Kyith are:

Bottom line is this:

To earn a higher expected return, you have to take on market risk. You have to put your capital in a position that the capital may go down. This means you need to live with volatility
Cash flow only from fund, stock, bonds payout only is going to be volatile
You can make it work if you are OK with volatile income

Ok, I am not going to sugarcoat the fact that from my personal view, investing at this time when valuations are high (esp. in the US markets), the odds are against me.

And the word “volatility” is a nice way of saying seeing unrealised losses.

It is almost every single day I read about news about the impending recession (and that Singapore has narrowly avoided a recession).

It is no wonder that we are facing inverted yield curves.

Note: Under unusual circumstances, investors will settle for lower yields associated with low-risk long term debt if they think the economy will enter a recession in the near future.

Look, I can continue to mine for stocks and study their valuation. But the possibility of finding value stocks are lower.

I still believe fundamentals of stocks are important. Although I have fallen into traps myself whereby despite the sound fundamentals of the companies’ financial, the stock prices still crashes (often there are other issues such as the industry-wide issues, sudden crisis, or geopolitical risks etc).

With that being said, going forward, there are some ideas which I have been toying with.

Firstly, I do think there is nothing wrong with keeping the majority of your cash in just pure cash (as in, in the bank account) or money market funds or short term bond funds. These are essential dry powder that would come in handy, in times of crisis. This is what I have been doing for the longest time.

I may be wrong, but I do believe that we are heading towards a long protracted downturn (contrary to the crash we had in the Great Financial Crisis of 2007-2009).

The stock market is long overdue for some ‘cleansing’.

To many, we are currently in an ‘everything bubble’, unlike the subprime crisis in the GFC. Government everywhere are using whatever means to prop the economy up (with many having negative interest rates). Ask Howard Marks what he thinks about negative interest rates, and he would say he doesn’t know – in fact, many of us wouldn’t know.

However, as someone might put it, negative interest rates are not a long term solution. And as Howard Marks put it – It is not the Fed’s job to prop up the stock market.

For one, companies may lack the incentives to push forward. Imagine a race, whereby at the end of the race, the future value of cash would be worth less than what it is now (in an inflationary environment)… companies would be motivated to compete and rush forward, to earn more cash as soon as possible. On the other hand, in a deflationary environment whereby there are negative interest rates – whereby the future value of cash is more than what it is now, there is no hurry to push forward. Banks are just pumping cash into the system.

Well, it effectively means that lenders pay borrowers for the pleasure of taking their money. This sounds slightly disingenuous, but in reality, it is a reflection of the economic conditions where there is too much money supply and not enough investment demand.

So with that premise in mind eg. an ‘everything bubble’ and a slow (and some might say painful) decline in stock prices… what am I to do? It is like watching a train wreck (heading towards you) in slow motion. You know it is going to happen, but what can you do? You can’t avoid it, you can’t stop it but have to face it for the longest time…

You can call me a pessimist, but from what I can see – in the best-case scenario, the stock market might just fluctuate along at the current levels (range bound) for years…. there may not be a drastic crash or sort. But at the same time, there won’t be a super bull charge. It is a slow and painful going nowhere sort of market.

For many who lack the patience (like me sometimes), or need the income, it is especially painful.

The game plan which I am talking about here is more psychological rather than fundamental/technical.

“It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.” Charlie Munger

Rule 1 – Have Min. 50% War-Chest Ready

Like I mentioned earlier, there is nothing wrong with keeping lots of dry powder in my war chest. After all, staying invested is not without its worries. And everyone has his or her own risk tolerance (and also depends on your age, how much risk you are willing to take, etc). As mentioned by Kyith, you have to be ready to live with volatility. That is easier said than done. Everyone says they can do it until they get punched in the face.

For me, for one, I will be keeping lots of ready dry powder in my war-chest (like more than 50% of my investable money). And in tune with the long protracted slowdown, it is really sort of slowly dripping in and investing – with the knowledge that I will be seeing a lot of my initial investments in the negative territory for a long time (right after I bought them). And that is probably why I am in no hurry to add stocks.

I can be like adding 1% or 2% of my net worth per month… Maybe do 1 or 2 trade per month (or more). Maybe even fewer trades (depends on the situation) at a slower rate (or stopped). Rest of the time doing nothing at all.

Why not wait for the actual crash, then invest? You may ask.

Of course, there is always the other 50% of my dry powder in my war-chest that comes in handy. But let’s be frank, we would never know when is the lowest point (only in hindsight). It can always go lower (even after the slight uptick in the stock prices).

The key is not to lose your guts and keep investing. Do it at a rate that is comfortable for you.

“Everyone has the brainpower to make money in stocks. Not everyone has the stomach.” Peter Lynch.

From another angle, I can be 100% invested now. And frankly, it really depends on the individual.

For me personally, knowing myself, I would probably freak out if I am fully invested and I lose 60% to 80% of the value in a crash. Even in a slow and long crash, I would freak out. Would I stay invested then, would be a big question mark.

I am not trying to be a hero here. There is no prize for being one anyway. I am not saying that others can’t do that (for some – to reach Alpha, that is the way). If you have the risk tolerance, you can do that… in the long run, stock prices would recover, provided that the fundamentals did not deteriorate.

Rule 2 – Adhere to Allocation and Diversification Principle

Allocation and diversification are important when it comes to volatility. There is really a big difference when I am 100% invested in a single stock and that stock crashed 50%, as compared to being just 20% invested in a basket of stocks and some crashed 60% while others dropped 40% (overall maybe just a drop of 10% of my total investable cash).

At the end of the day, it is just not worth it to have sleepless nights worrying if you have made the wrong decision and if your future (or your family’s future) is compromised – no matter what the end profit will be. I would gladly go for low Beta stocks anytime – which might mean lower capital gain.

Rule 3 – Get paid while waiting

Make time your ally.

After all, from the start, it is clear that waiting will be a big part of the strategy.

The beauty of treating the portfolio as a dividend-generating machine is that time is a great ally. The longer the wait, the more income it generates (provided the companies’ fundamental remain ok).

I am not sure I have the tenacity of the Taxi driver as mentioned in the article below though…

A taxi driver retires at 33 after amassing 40,000 HSBC shares (read here)

And it is in line with the long protracted drop… The drop in stock prices, might, in fact, result in a greater yield.

A Recession and a Market Crash are two different things. Stock markets can do well at the start of recessions – and the two might not coincide exactly. So no point getting too excited when we see the word ‘recession’. The crash may be some time away.

To quote the article below: “It’s just that the stock market cycle rarely lines up perfectly with the economic cycle…..The problem with trying to time the stock market by calling a recession is that I could give you the exact start and end date of the next economic contraction and you still may not be able to profit from that information. The stock market is simultaneously forward-looking, backward-looking and maybe even sideways-looking so the fall in GDP is never going to line up perfectly with the decline in stocks.”

Everything You Need to Know About Recessions (read here)

Nevertheless, you get paid while waiting.

And in many cases, a recession spells doom for the stock market.

Nobody like a crash – but if given the choice, I would much rather prefer a slower rate of drop than a sudden drop (but often investors don’t have a choice anyway). And if the sudden crash does happen, the drip rate will just increase.

It might be a rabbit hole (as termed by Kyith). It might even be a value trap. So always keep an open mind. I am always aware that I would pick the wrong stock at some point. Some would be lemons. There are no guarantees. However, in any situations, it is always about the odds.

Rule 4 – Invest when there is Optimum Fear

I think this might be the hardest to do. Like what do I mean by Fear, what do I mean by Optimum…. like defining the impossible.

Even now, one may ask – where is the fear now? When the US markets are still near their all-time high. Irrespective of the Trade Wars and Brexit.

In fact, we don’t have to look very far. Sometimes ‘Fear’ just come to you.

Hong Kong itself seems to have self-created their own recession, and stock market crash (and in some countries in Europe like Germany- recessionary fears are already there).

Hong Kong enters recession as protests show no sign of relenting (read here)
Hong Kong chief Carrie Lam says city is in ‘technical recession’ (read here)
Hong Kong is sinking into a recession with no recovery in sight (read here)
Hong Kong Markets Are Calm as Protests Linger and a Recession Looms (read here)
Germany tumbles into recession as economy hit harder by Brexit than Britain (read here)
German recession looms as industrial orders drop more than expected (read here)
Germany may have entered recession in September, says central bank (read here)
Germany’s economy may have already slumped into recession, its central bank says (read here)

As per my previous article on being Anti-Fragile (read here), my antenna kind of go up when I see the word recession. I go towards it rather than run away from it.

Here Are The Countries On The Brink Of Recession Going Into 2020 (read here)

Actually, I thought my wait would be longer.

“Typically these inversions occur 12 to 18 months before a recession,” (read here)

Let’s get back to Hong Kong. I think a single post here would not be enough.

Whether is it the right time to invest in HK is a great debate. There is no right or wrong. Lots of articles have been written on this. Many bloggers have written about it as well. Many are against investing in HK stocks now and for good reasons.

However, if you believe in the long term viability of this financial hub which is a gateway to China, then the 5 months-long (and likely longer) protests will just be a blip. There are no guarantees in investing. But one thing is for sure – FEAR is very high there now. Optimum? Close.

If one has no time to study on HK stocks – investing in ETFs will do as well.

In the history of Hong Kong, this is without a doubt one of its ‘high point’. Or shall I say “low point”?

When will the protests die down? I do not know. Will it be over soon? I don’t think so (which I feel from my investing strategy point of view – does not really matter also). It might even drag on until the whole world is in a recession, the perfect storm. Or not … and one’s wait might be in vain.

The economic downdraft caused by Hong Kong’s protests is worse than that during the SARS epidemic and the 2008 global financial crisis, Chief Executive Carrie Lam said. (read here)

However, for one thing, I know for sure, by the time people say it is safe to invest – then it is too late. In investing, you only have yourself to trust.

I like to think that I am early in the game… Actually, for many HK stocks, they are already off the Aug 2019 lows. The protest is already more than five months old. The articles below are more than 2 months back. To many, it may be already too late.

China can’t get enough of Hong Kong’s sinking stocks (read here)
Hong Kong stocks at ‘compelling’ lows and could be a buying opportunity, strategist says (read here)

However, on a much longer horizon… I do believe we are still early in the armageddon. No point going crazy at this time. Technically, the Hang Seng has been holding up quite well – despite the upheaval. Trending down yes, Crash? (eg. steep double-digit drop) – not in my opinion.

Anyway, all these do not matter much, it is the average valuation over the long term. Are you buying on average at a low valuation or high valuation historically…

Rule 5 – Invest in Quality Companies that pay a consistent dividend (with not too high payout ratio)

I think we all know utility, banks, REITs, Property counters often give good dividends.

5 Reasons Why Warren Buffett Is Investing in Banks (read here)

To quote the above article: “Investors’ fears of another collapse of banks in the next downturn are likely overblown, which is something Buffett might have already figured out. This has led to billion-dollar investments in banks over the last decade.”

Numerous articles are written about banks – as often reported, banks unlike during the previous GFC are now more sound, and financially stronger these days. How true is that is anyone’s guess (I take many articles with a pinch of salt). However, we have been through more than a decade of low-interest rates environment (and for a bank to generate a decent profit is not easy, and many banks did just that).

This is my personal view, and I could be wrong. With many countries already in negative interest rate zone, I don’t see how much lower rates can go. The possibility of rates staying constant or even going higher is always there (odds are high).

Rates cannot stay negative for long, yes, it does give a boost initially to the economy but it is not a long term solution. It does more harm long term than good. Short term rates might go lower, but long term (and since I view investing as long term) – rates will go higher from what we have now.

Banks thrive in an increasing interest rate environment.

On the other hand, in a recession, banks without a doubt would get hit badly upfront. There are no two ways about it, but there are always exceptions. HSBC wasn’t that badly hit in the last GFC. And given that HK (unlike Singapore) has China.

“It’s the start of the end of an era of super profitability in Hong Kong,” global head of bank research at Citigroup Ronit Ghose told the Wall Street Journal.

To make matters worse for Hong Kong’s banking industry, the city must match interest-rate cuts made by the U.S. Federal Reserve, causing lending to become a less profitable venture due to the city’s fixed exchange rate with the U.S. dollar. (read here)

However, on a long horizon, the risks have been priced in (if not priced much more than expected).

So when you combine HK + Banks (double pessimism), there is a myriad of stocks which one can pick now (or even for the months ahead).

One can pick up quality banks at a discount now.

Of course, there could a bigger crisis or crash ahead – a global recession or worldwide market crash — and the stock prices you see now could go even be lower.

I haven’t invested in HK banks before but I have invested in Sun Hung Kai properties before and did invest when its stock price was around HKD 80+… now it is in the range of HKD 112 to 115. Kind of shows how elevated property prices are now in HK.

Seldom we see stocks of quality companies trading down… will it get lower – why not? Should you buy? Your decision – depends on your circumstances.

As mentioned, there are many good dividend companies in HK exchange (utility, banks, REITs, Property counters) – it might be more worthwhile ‘mining’ there.

I am also not adverse to Utility, REITs or Property counters – I think there are gems in each class (irrespective of the interest rates environment). The keyword here is Quality – that would be a topic for another post.

On another note – when you invest in giants like BOC, HSBC, Standard Chartered, Sun Hung Kai, Hong Kong Land- there are already certain levels of diversifications. They don’t just operate in HK. Having said that, I am not going to sugarcoat – the HK risk will still be there. Prices might stay depressed for years and there could be opportunity costs. Various factors to consider.

I am not trying to get high dividend yield stocks that have already been trending down prior to the geopolitical crisis. Always go for minimally decent companies.

Companies everywhere face headwinds. Banks have to deal with the digital transformation, and fintech, etc… Nevertheless, banks have been proactive in cutting cost, and yes some have started to cut their head-counts (such as HSBC – On Monday, Quinn said the bank would accelerate its efforts to cut costs, which included previously announced plans to eliminate less than 2 per cent of its workforce and reduce the bank’s wage costs by 4 per cent over the course of the year. Read here).

Go low, go small, go slow, go long- Super long…

The next quarter financial reports for many of these companies would not be pretty (but I reckon these have been priced in). And for property / REIT counters, the results would not be out immediately since many tenants have signed lease agreements. Outlook nevertheless will not be pretty.

HSBC is first of the major banks in Hong Kong to report their quarterly results.

HSBC misses third-quarter estimates, but Hong Kong business ‘resilient’ despite protests (read here)

Didn’t I say, Rule 4 might be the hardest rule to adhere to. But before I start pumping cash into the portfolio – just remember Rule 1 (No hurry).

The worst maybe 1 or 2 years later. And deterioration will not be evident so early.

Hong Kong bank profits seen falling 67% in JPMorgan’s worst case (read here)

If all else ‘fails’ – like I mentioned earlier – nothing wrong with keeping 100% of your investable cash in your war-chest. There are really times when it is more worthwhile not being invested at all. Having the majority of your cash in the war-chest. In fact, the time to invest is often short and few in between.

As someone once mentioned, as you scale up – you see all these simply as asset allocations. Moving funds from cash to bonds to equities. At times it makes sense to be more in cash, at times it makes sense to be more in stocks or bonds, etc. Ultimately it is about the cost – reward equation.

Often, it is the situations that favour those that are prepared… You don’t know when. Just be ready when it comes knocking.