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Year-In-Review 2022

Regrettably, it’s been a long while since I’ve written an article. Initially due to NS and subsequently because I had to hit the ground running at my internship. Now that I’m starting to get used to the intensity (hopefully), I am looking to get back into writing because I enjoy sharing what I have learnt and have also found it to be beneficial in terms of helping me collect my thoughts. In fact, this year I am hoping to write more broadly about things I’ve observed/read and learnt that may be useful to you guys. For now, since it’s the start of the year, I thought I’d take the opportunity to do a review and layout my plan for the year ahead money-wise.

Disclaimer! Nothing written in this article should be construed as investment advice.

Where are we headed in 2023?

As I am not a seer, I won’t try to predict where the markets are headed, but I will lay out some facts. From its trough in October 2022, the S&P500 has rebounded by 12%. This rally suggests that investors are optimistic that the worst is behind us – that inflation has peaked and that would prod the Fed to cut interest rates later this year, even as Fed officials insisted that it was too early to think about shifting policy.

However, recent macro economic data seems to suggest otherwise. U.S. job growth accelerated at the start of the year as employers added a robust 517,000 jobs, well above the 2019 pre-pandemic average of 163,000. This pushed the unemployment rate to a 53-year low of 3.4%, raising doubts on whether inflation is under control.

When I first saw these numbers, I couldn’t wrap my head around it. During the same period, big tech companies were announcing massive layoff every other day. How could all the huge layoffs and the talk of recession be reconciled with the strong macro economic data? I did some research and it turns out that these tech companies account for only 2% of the American workforce. The hiring is happening in a much bigger part of the economy, the service sector, which includes all kinds of businesses – everything from restaurants and hotels, to dry cleaners and hospitals. The employees in those sectors account for about 36% of all private sector payrolls.

So while I don’t know where the markets are headed, I would be cautious of declaring that inflation has peaked and I wouldn’t rule out the possibility of the Fed keeping interest rates higher for longer.

Portfolio Review

Since the start of 2022 until today, my portfolio has suffered from a decline of ~9%, slightly better than the S&P500, which is down more than 16%. While a significant portion of my portfolio is in the index, the decline was partially offset by the relatively strong performance of my Singapore investments.

Still, this is nothing to be satisfied with as it is now plain as day that it was much better to hold cash throughout 2022. However, hindsight is 20/20 so I try not to harp on it too much. The bright side is that because I deploy my capital in tranches instead of in a lump sum, I still have dry powder to take advantage of the correction that is still playing out.

After a review, I don’t see any deterioration in the fundamentals of my portfolio companies that warrants selling any of them. As I genuinely don’t know where the markets will be tomorrow, one month or six months from now, I am happy to hold what I already have in my portfolio and continue dollar cost averaging as the year progresses.

Note: This only includes my invested capital and does not include cash

Plan for 2023

As of now, I have no plans to divest any of my holdings and intend to continually invest more throughout the year, no different than what I have been doing last year. I do however, plan to make minor tweaks in allocation as I add to my portfolio.

Broad-based ETFs tracking the S&P500 and the world index will continue to form the foundation of my portfolio and I will continue to DCA throughout the year, maintaining my allocation to ETFs.

One thing that will be different for me this year is that I will be less active in looking for individual businesses to invest in, simply due to limited time and capacity. That being said, I will still continue to monitor those that are already on my watchlist. One of which, I will share more on below.

At the time of writing, I find REITs to be priced at a very attractive level with some of the well established REITs boasting 5-6% yields. The somewhat depressed prices could be attributed to the high interest rates, which translates to increased cost of borrowing for REITs. However, I believe that well-managed REITs with comfortable gearing ratio, high proportion of fixed interest debt and high interest coverage ratio will have no issues delivering satisfactory returns to shareholders. On top of that, REITs remain my only viable mean for exposure to real estate at the moment and their steady dividends can provide stability to my portfolio if markets make a turn for the worse. Thus, I have taken the opportunity to increase my exposure to REITs in the first two months of 2023 and will likely continue to add to my position if prices become even more attractive.

Finally, T-bills remain a good place to park short term cash, with the latest issue yielding 3.9%. As I’ve mentioned on my telegram channel multiple times, I have been adding to my T-bills position throughout 2022. However, they are more of a short term investment and I hope to recycle the capital into equities and REITs should prices become more attractive in the later part of this year.

Biggest Mistake of 2022

No doubt, I have made many mistakes in 2022. None, however, is as costly as this one of omission. In mid 2022, I had my eye on LVMH, and conducted due diligence on the business and its various brands. Even without owning any of their products, I appreciated the ubiquity of their brands and how they are synonymous with wealth and status. The brilliance of Bernard Arnault has also been something I have read about and admired for quite some time. The world’s largest fashion house thus checks all the right boxes. Ultimately, I chose to hold off on buying any LVMH shares because the market levels looked frothy.

Fast forward to today, the share price has increased by more than 40% while my portfolio has slumped along with the markets and I still don’t own a single LVMH share, so I am literally slapping myself for that mistake.

At today’s prices, I am calling it over-priced, so check back in a year to see whether I am right about that… Nonetheless, LVMH is one of the companies that I will be watching closely this year.

I must admit, it’s great to be writing again and I really hope the stuff I share is beneficial to you guys. In view of my commitments, I am looking to publish less often but dive into greater detail each time and hopefully provide greater value in each article. I already have a couple of exciting ideas, so stay tuned!

Posted on by CTKS

Inflation, Interest Rates and Time Value of Money

Given the recent jitters in the markets driven by inflation data, talks about tapering and rising interest rates, I thought I’d write an article discussing the issue at hand. Don’t get me wrong, I have previously shared about the futility of attempting to predict macroeconomic trends and my view has not changed. However, it is still important to understand these fundamental concepts and what they mean for investors.

Inflation

Inflation in layman terms is an increase in prices. This phenomenon is caused by an imbalance between supply and demand. As the pandemic threatened to force the global economic machine to a grinding halt in 2020, governments around the world rushed to prop up demand by flooding the markets with liquidity. However, the production of goods could not keep up with surging demand, driving prices up.

In other words, inflation results from efforts to get something for nothing. If the governments gave away money by taking away an equal amount through taxation, no inflation would result as the balance between supply and demand would be unchanged.

Consensus amongst most economist seems to be that a low and stable inflation is desirable for economic growth while deflation and persistently high inflation are both detrimental to economic growth.

Interest

Interest is the price of time. It measures the cost of having or doing now what we hope to be able to pay for later. Anything bought with borrowed money will cost more than buying with cash upfront. The difference is the price of time. This is true whether the borrower is an individual, a company, a city or country.

The buyer of time takes on an obligation to return the borrowed money and pay for the right to use the money now. In other words, debt.

There is nothing inherently good or bad about debt and interest. Debt is a merely a tool. Whether it is beneficial or detrimental depends on how one uses it. Many people have been ruined by debt. Many others have made their fortunes with borrowed money. The difference is whether the time borrowed is used profitably so that it is worth it.

Time value of money

This is a concept that is central to investing. Simply put, a dollar today is worth more than a dollar tomorrow. This is true for the following reasons

  1. Inflation means that a dollar can buy more today than the same dollar can tomorrow
  2. The ability to invest means that you may incur a opportunity cost
  3. The risk of not being paid back as the entity that owes you money may go bankrupt means that you would want to be paid as soon as possible

These three factors have similar effects. The promise of being paid $1,000 ten years later is worth less than $1,000 today. In fact, you will likely accept $800 if you believe that you are able to get a fair rate of return by investing your money elsewhere.

When we invest, we are forgoing spending that sum of money today. In order for this to be worthwhile, we must receive the same amount of money in face value plus some as compensation for the erosion of purchasing power, opportunity cost and the risk that we are undertaking.

Tying it all together

The relationship between interest rates and inflation is as such.

Nominal interest rates = Inflation + Real interest rates

The higher the rate of inflation the greater the cost of buying time – in other words, the higher the interest rate.

One of the greatest delusions is that the government can keep interest rates low while continuing to inflate the money supply. Sounds awfully familiar? This delusion stems from the widespread belief that the FED controls interest rates. In reality, the FED does not dictate interest rates as they are merely one of the factors that influence interest rates.

Looking at the divergence between inflation and interest rates today, it is only a matter of time before both converge.

However, the million dollar question isn’t “when will interest rates rise?” or “is hyperinflation coming?” No one has the answers to these questions. Instead, investors should all ask this question: “what type of businesses do well regardless of inflation?”

Traditional wisdom says that businesses with the greatest tangible assets will do well during times of inflation. This sounds intuitive but there is actually one type of business that does even better during periods of high inflation.

During periods of high inflation, the capital light business will do much better. The winning formula is intangibles of lasting value with relatively minor requirements for tangible assets. All things equal, the less capital intensive business will do better than asset-heavy businesses in the face of inflation.

By intangible assets, I am not referring the intangible assets and goodwill stated on their balance sheets that are likely not worth anything close to their stated value. When I refer to intangible assets, I mean economic goodwill in the form of competitive advantages that are difficult to quantify. This exists in various forms such as pervasive reputation with consumers based on past experiences with products and personnel (Amazon), brand name (Apple, Coke), being the low cost provider (Costco), network effect (Facebook) and many more.

Why do these companies do better than others during inflationary periods?

It goes without saying that when we invest, we want our investments to grow in real terms (ie be able to purchase more goods and services). This is done by achieving a rate of return in excess of inflation. And the best way to do so is to invest in businesses that are able to raise prices easily without investments in a lot of assets. Companies with these two qualities are able to earn returns far in excess of inflation (think about the companies mentioned above).

Note that throughout the entire article I give no thought to what the FED is going to do, whether inflation is here to stay or what interest rates will be tomorrow. It’s not that these are unimportant. They do influence the markets but they are simply unpredictable. Investors will do much better if they focus their efforts on things that they can control, such as picking excellent companies.

Posted on by CTKS · 2 Comments

4 Reasons Why You Should Invest

Still on the fence about whether to invest? In this article, I will make the case of why investing is essential, and perhaps even necessary for most of us.

The first reason why you should invest is because earning and saving is only half of the equation to building wealth over the long term. When we work, we are “exchanging” our time for money. As we only have 24 hours a day, there is a limit to how much we can work and how much money we can earn using our time. If we want to maximise our earned income by working more hours, we will eventually have to work at the expense of having less time to rest or to do things that brings us joy. Worst still, our mental health will deteriorate and we may become at risk of burning out. Personally, I view investing as making your money work for you, even when you are asleep. As your income from investing increases, it can supplement your main income stream and this means it will free up more time for you to do the things you love such as pursuing your hobbies or spending time with family and friends.

This brings me to my next point, which is that investing can help diversify your sources of income. Diversification one’s sources of income is a topic that is not talked about enough. One only needs to look back at the past year and a half to see why diversifying our income streams is necessary. As Covid-19 ravaged the world and forced many economies into lockdown, many people lost their jobs. If our day job is our only source of income, losing it means having to survive on stimulus checks an watching our savings whittle down. During the same period, the stock market has continued to chug along, rewarding those who remain invested. Thus, a second source of income via investing could potentially help tide us over in a time of crisis. Furthermore, research has shown that generally, the more sources of income you have, the more income you tend to make. With dividends and capital gains being the most common income streams after earned income, investing in equities is a good place to begin.

Next, I view investing as a way to protect your savings against inflation, the silent killer. Today, cash sitting in the bank earns an interest of 0.05%, essentially nothing. Imagine that you saved up a respectable sum of $50,000 by the time you are 30 years old. If you were to leave this sum in the bank, it will be worth less than $33,400 in real terms by the time you reach 50 years old (assuming an average inflation of 2%). Essentially, you would have lost over $16,600 by simply doing nothing. Investing, on the other hand, allows us to earn a return greater than the inflation rate. This grows our savings in real terms, protecting them from being eroded by inflation. Inflation is so deadly because it lurks in the shadows and goes largely unnoticed. By the time people feel its effects, it is often too late. Thus, the sense of assurance we feel when we have loads of cash in our bank account is a false one. If you are not convinced about the threat of inflation, just ask your parents how much a cup of coffee or a bowl of noodles cost when they were a student! Thus, while returns on investing in stocks are not guaranteed, leaving your retirement savings in the bank is a sure way to have your savings eroded.

Lastly, being able to retire on savings alone is a luxury. For someone who earns the median wage of $4,500 in Singapore from 25 years old to 60 years old, being able to save $1 million dollars for retirement seems like an impossible uphill task. They would need to save $2,380 a month, more than 50% of their income, in order to hit this goal. If the same person were to dollar cost average into an ETF that has an 8% annual return on average, he will only need to contribute $465 each month to achieve the goal within the same time period of 35 years. Now that is a much more achievable goal! While I admit that this is a theoretical example, the 8% return is a rather conservative one given that the S&P500 has a historical average return of 10% annually. Furthermore, by saving and investing more than the $465 there will be more leeway for any potential setbacks.

I hope that this post has convinced you about the importance of investing in order to achieve achieve our financial goals more easily. While there are indeed risks involved, as with most things, avoidance is not the solution. Instead, we should recognise the risks involved and understand that successful investing can be achieved with the right strategy and mindset. Thankfully, these are well within our control. If you would like to learn more about investing, check out my other posts on how to invest here. Additionally, I will be sharing which ETFs I personally DCA into monthly so click here to join The Dollar Sapling telegram channel and stay tuned!