Thoughts on Allocation and Effects of Interest Rate Changes…

It has been a slow month basically for me in March. I did not have more ‘powder’ to invest and in addition, I started contributing to my SRS. For my SRS investments, I tend to limit myself to a few stocks for ease of tracking.

Allocations & Markets

These days I spend more time thinking about allocations, while also reading up on individual stocks. There are different ways to slice and dice my portfolio. One way is to classify them as per below (based on where they are listed).

This is not a true reflection of course, as many Singapore-listed stocks have a significant portion of their assets in other countries (be it US or China, etc). Case in point, HongKongLand which is listed in the Singapore stock maket but its assets in Hong Kong, Macau, Chinese Mainland contributed 96% of its revenue in 2023. Likewise, SG-REITs like Mapletree Pan Asia Commercial Trust and Mapletree Logistics Trust have significant portions of their assets in China/HK.

I am still a believer of the China growth story and Hong Kong list stocks in general and yup, I do not think that are un-investable.

The current P/E (TTM) of the Hang Seng Index is at 7.80 on 5 April 2024, which is below the long-term average of P/E ratio of 10.16 suggesting that it is undervalued. Please see the 10-year chart below.

In the case of the Straits Times Index, the average P/E (TTM) over the last 10 years is 13.05. At the current P/E ratio of 11.27 on 5 April 2024, it would be considered undervalued.

On the other hand, the S&P500 led by the magnificent 7 stocks (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla) which account for about 29% of the S&P500, has a P/E TTM of 26.69 on 4 April 2024, which is above its Long Term Average P/E of 23.93. Hence it is considered as overvalued. Please see the 10-year chart below.

For this month (March 2024), I added to my positions in Baidu, Lam Soon, Link Reit, and Mapletree Logistics Trust.

Given the negativity surrounding China and HK-listed stocks due to the myriad of issues there (geo-political risks, aging population, high unemployment rates, property and economic slowdown, etc), it is no surprise that the Hang Seng index is generally undervalued. Consequently, value-wise, the percentage of my HK-listed stocks in my portfolio has shrunk (despite my added investment into HK-listed stocks).

I was watching this recent video by Kelvin Learns Investing which was Streamed live on 23 Mar 2024 (Kelvin and Budget Babe are both in it). I thought it was quite good, and well-thought-out. Rather entertaining as well. In the beginning, Budget Babe was talking about the performance of the various market indexes, and being diversified sort of balance out (the good and bad for your portfolio); and S&P 500 P/E is rather high right now… But somehow subsequently she went on to elaborate about the Apple stock which is listed in the US market (although the Hang Seng index has underperformed relative to other markets for years. Would another comparable tech stock listed in Hang Seng offer better opportunities, despite the myriad of issues faced by Apple now?..if I follow her train of thought correctly). I reckon she is more comfortable investing in the US markets given geopolitical risks factored into HK/Chinese stocks.

Nasdaq and S&P 500 soar to record highs as markets appear unsinkable (read here)

I have yet to add to my Story Fund stocks and have been mainly using them to sell options. At the back of my mind, I have been toying with the idea of creating a much smaller but more speculative portfolio consisting of crypto-currencies, AI-related stocks (or even ETF linked to commodities such as uranium or copper which I feel would be a sunrise sector in tune with the rising need of AI and energy in general).

Now is not the time I feel.

Passive income target: Harder than I think

My financial target of increasing my monthly dividend passive income this year appears to be harder than I thought. Many of my dividend stocks (esp. those non-financial related ones) are lowering their dividend payout. Even Hong Leong Finance.

1) Mapletree Pan Asia Commercial Trust 3rd Quarter (FY 2023/2024) dividend payout is 2.20 cents (vs 2.42 cents a year ago).

2) Golden Agri Resource in Feb 2024, recommended a lower final dividend of S$0.00613 per share, as opposed to the S$0.00991 final dividend paid out in the same period a year ago.

3) CK Asset Holdings Limited in March 2024, announced that it will pay a final dividend of HK$1.62 per share (compared to HK$1.8500 a year ago).

4) Digital Core Reit in Feb 2024, reported a distribution per unit (DPU) of 3.70 US cents for FY2023 ended Dec 31, 2023, 15.9% below forecast and a 7.0% drop from its FY2022 DPU of 3.98 US cents.

5) International Housewares Retail announced in Dec 2023, that they will pay an interim dividend of HKD 0.056 (vs HKD 0.1200 a year ago).

6) Hong Leong Finance on 23 Feb 2024, proposed a final dividend of S$0.09 per share, down from the final dividend of S$0.1325 per share in FY22.

7) Fu Shou Yuan in March 2024, proposed a final dividend of HKD 0.0686 (vs HKD 0.0758 a year ago).

8) Guangdong Investment Ltd in March 2024, proposed a final dividend of HKD 0.1233 (vs HKD 0.4262 a year ago).

While I have been slowly DCA-ing into selected holdings, the anticipated monthly dividend payout as shown in my StocksCafe account did not increase much.

With news about the imminent cutting of interest rates by the Federal Reserve, it may appear that the S&P500 is running ahead of itself. Nevertheless, a few scenarios are playing out in my mind.

Generally, a decreasing interest rate environment will benefit stocks (or as many would put it, a rising tide raises all boats). However, if I am just to consider interest rates alone, I think for some Hong Kong-listed stocks – the effect is more pronounced.

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The Worst Performing Hong Kong Reit

I came across this article by the Fifth Person titled, “Top 3 Hong Kong REITs that made you money if you invested from their IPOs (Updated 2024)”, read here.

To quote the article: ” …since the protests in 2019, investing in Hong Kong’s stock market has proven challenging. Hong Kong Real Estate Investment Trusts (HK-REITs) have suffered in particular and the sector has been on a downward trend since. However, those who invested in these REITs from their initial public offerings might find themselves pleasantly surprised by the outcomes.”

The article talks about David (a fictional character) who invests HK$10,000 in each Hong Kong REIT from the day it listed. Since David is a hard-core income investor, he doesn’t want to come out with any more money to subscribe to rights (if any) and is prepared for any share dilution. Let’s also assume that he neglects to sell his nil-paid rights from which he can make a profit from.

The top 3 performing Reits are Link Reit, Fortune Reit, and Sunlight Reit if David has invested since they were listed.

However, that was not what caught my attention. What caught my attention was Hui Xian Reit which IPO-ed in April 2011. And despite the past almost 13 years, the investor (David) still did not manage to make a profit even after considering dividends.

Perhaps it is the contrarian part of my mind at work, but I am always interested in the ‘fallen’ stocks, although I am well aware that not all fallen stocks will turn around. I typically leave stocks that are performing well alone, but I tend to read more into stocks that are laggards. Nevertheless, there are often deep structural issues with the business models – these, I tend to avoid.

The other reason why I am intrigued is because I am indirectly vested in Hui Xian Reit via one of my holdings – CK Asset Holdings Limited. CK Asset owns 34% of Hui Xian Reit, and the latter contributed HK $55 million in profit to CK Asset in 2023. CK Asset’s total profit contribution in 2023 is HK $1,525 million. So though Hui Xian Reit’s contribution is not a small amount, percentage-wise it is not that significant especially compared to the contributions from Fortune Reit and Prosperity Reit (to CK Asset’s revenue).

Hui Xian Reit appears to be a vehicle for Li Ka Shing to unload his Chinese properties. It is also a real estate investment trust demerged from Cheung Kong Holdings. Perhaps that explains the relatively high percentage holding by CK Asset.

LI KA-SHING SELLS CHONGQING COMPLEX TO OWN REIT FOR $638M (read here)

I have mentioned earlier a list of my stocks with recent YoY declining dividend payout. CK Asset is one of them. Other blue-chip HK property peers in my portfolio such as Sun Hung Kai Property and Link Reit have done better (dividends are increasing). Also, Mapletree Logistics Trust with about 19% of its assets in China, managed to eke out higher DPU recently for its fiscal 2024’s third quarter (3Q FY2024) ending 30 September 2023.

So yes, I am intrigued.

Hui Xian REIT is the first RMB-denominated REIT listed in Hong Kong. Its portfolio spans across retail, office, serviced apartment, and hotel businesses. The properties are all situated in China. i.e. Beijing Oriental Plaza, Chongqing Metropolitan Oriental Plaza, The Westin Shenyang, Hyatt Regency Metropolitan Chongqing, and Sheraton Chengdu Lido Hotel.

It is common knowledge that since the second half of 2022, with the increase of interest rates by the Federal Reserve and subsequently by major banks, one of the hardest hit sectors is the REIT sector due to the elevated borrowing costs.

Just to give some examples from what I have read:

In its 7 Feb 2024 presentation, MPACT stated that the decrease in distribution was due to “Higher net finance costs due to increased interest rates on SGD and HKD borrowings; and Release of a one-off cross currency interest rate swap (“CCIRS”) gain in 3Q FY22/23 that was absent in 3Q FY23/24″.

On 1 Feb 2024, Digital Core Reit mentioned that “they delivered a full-year distribution per unit of 3.70 U.S. cents, down just seven percent year-over-year, as they managed to offset a significant portion of the much higher-than-expected interest expense through accretive investments and proactive cost containment.”

And with regards to the rising interest rates, amongst the REITs, perhaps the hardest hit are REITs such as Hui Xian Reit whereby the revenue is in RMB but the debts are denominated in HKD. Since April 2022 Chinese Yuan Renminbi has been steadily dropping against the Hong Kong dollar.

As the HKD tracks the USD, Hong Kong central bank has to let the interest rates track the moves of the US Federal Reserve (i.e. keeping rates high). While China banks are cutting rates to boost its ailing property sector.

China’s Loan Prime Rate is at 3.45%, compared to 3.45% last month and 3.65% last year. This is lower than the long-term average of 3.77%.

On the other hand, the US federal funds target rate has remained at 5.25% to 5.5% since summer 2023, the highest it’s been in over 20 years. The Fed raised the rate 11 times between March 2022 and July 2023 to combat ongoing inflation.

Hong Kong central bank leaves interest rate unchanged, tracks Fed (read here)

China’s Rate Cuts to Pressure Bank Profits, Provide Slight Economic Boost (read here)

China cuts key interest rate in the latest move to boost its ailing property sector (read here)

Meanwhile the Chinese Yuan has been sliding against the USD and the HKD.

China’s yuan slides near 16-year low as economy struggles (read here)

Hence, despite the YoY increase in Net Property Income to the tune of 68 RMB Million (or +5.3%) by Hui Xian Reit, it is nevertheless, negated by the the increase in interest expenses and a realized exchange loss, leading to a YoY reduction in 2023’s distribution. In the end, amount available for distribution tanked 60.5% YoY.

I am just wondering what the REIT management would be thinking… after all the hard work to turn this around and the hotel portfolio rebounded, actual performance (amount available for distribution) still dropped around 60% YoY and share prices tanked.

The below presentations are extracts from Hui Xian Reit’s Annual Results Presentation for the Period from 1 Jan 2023 to 31 Dec 2023 issued on 8 March 2024.

So in simple terms, their loan interests remain high (or keep increasing), while their profit although technically increases YoY, when converted from RMB to HKD, the increase is diminished.

When the tide changes…

‘My mistake was the complacency to think that this will last forever.’ Joseph Schooling

I am sure there are more factors to consider than just interest rates when evaluating the future prospects of stocks and REITs. However, the general consensus out there is that lower interest rates are good for stocks, be it growth or value stocks. And especially for debt instruments like REITs.

The Federal Reserve has six more chances to cut rates in 2024, starting with its next meeting at the end of April. The Fed sees three rate cuts in 2024. When it happens, all kinds of borrowing will be easier for the average American… and for the Reits, over the long term it will help with the borrowing cost and in some cases reduce the exchange losses although the effect will not be immediate as rates will still stay elevated for some time.

Fed officials say three rate cuts a reasonable baseline for 2024 (read here)

As mentioned earlier, a rising tide raises all boats, but for some, it will rise higher.

Hui Xian Reit is an extreme case. It is literally in the wrong place at the wrong time; like a tiny boat in a perfect storm. Most REITs in my holdings are more diversified with assets in various countries. Yes, there are advantages to diversification when it comes to my own portfolio.

Some thoughts

Yield gap between China and US widens to highest since 2007 after surprise rate cut (read here)

To quote the above article dated 16 Aug 2023: “China remains an outlier among global central banks as it has loosened monetary policy to shore up a stalling recovery whereas others, particularly the United States, have been in tightening cycles as they battle high inflation.”

Firstly, I do not think I am great at anticipating swings in the stock markets, sectors, or individual stock prices. In addition, I am not a policymaker or an economist. I can’t predict how policies in the US or China (especially) will change. Given the recent years’ experience, I would not be surprised by sudden policy changes in China (again). Nor will I be able to predict the shifts in the fundamentals of the domestic economies that will in turn affect (inflation and) interest rates. There are many factors affecting interest rates, factors which I as a small retail investor cannot comprehend or anticipate.

If there is one thing I am certain about the stock market – it is that nothing is certain.

However, I like to use the analogy of probabilities when it comes to the stock market. Like how Howard Marks would describe – opportunities in the stock market i.e. the chances of profiting get better when markets tank lower.

Given that the yield gap between these 2 major economies (the United States and China) is the biggest since 2007, what are the odds of it becoming even bigger?

Is it possible that it will become bigger? Sure.

Is it probable that it will become even bigger? What is the odd to that?

And if the yield gap is getting smaller – how can I profit?

How will it affect stock prices? Well, it is hard to predict stock prices, but earning-wise we can make some calculated guesses.

I always felt that share prices are harder to predict than dividends (especially dividends from REITs since real estate trusts must distribute 90% of their taxable earnings to existing shareholders). This is especially so if we are talking about actual cash returns to shareholders. We could be right about the earnings prediction for multiple quarters or years, but “the stock is not the company, and the company is not the stock” and stock prices may not reflect good earnings performance. In other words, I could be right but still fail. Dealing with multiple factors here and I need to get them all correct at the same time – Tough.

However, when it comes to dividends from a REIT, it is a different story (compared to share prices of REITs).

Jeff Bezos Emphasizes The Core Of Investment Wisdom: ‘The Stock Is Not The Company, And The Company Is Not The Stock’ — Insights From The Amazon Founder On Navigating Market Perceptions (read here)

Yield gap narrowing: For cash-rich tech companies like the magnificent 7, this might not mean much… as compared to REITs such as Hui Xian Reit.

I am just sharing my thoughts. The yield gaps might remain wide for many many years. Please DYODD, before doing any investing.

Ultimately, what do you believe in? Are you more of a growth investor, or a true blue value investor who strongly believes that the focus is on the business fundamentals and not affected by geopolitics/government policies, the economy, interest rates, forex volatilities, etc…

Ray Dalio says now is the time to buy ‘cheap’ Chinese stocks as Beijing works to revive the economy (read here)

Thank you for reading.

Webull

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