Category: General Investing

“Fear incites human action far more urgently than does the impressive weight of historical evidence.”

Jeremy Siegel, Stocks for the Long Run

The COVID-19 pandemic has thrown markets into a frenzy. The month of March was likely the most volatile period in stock market history. Traders were zig-zagging in and out of the markets, causing daily swings of up to 10% in the S&P 500. 

COVID-19 is indeed a black swan event. No one really knows what will happen and how the market will pan out in the short-term. With so much uncertainty, what should long-term investors do now?

Focus on things that you can predict

There are many things we can’t predict in the stock market. But investing is not about accurately predicting everything that will affect stock prices. Instead, it’s about focusing on stuff that you can predict. It’s about investing in companies that are likely to succeed in the long-term.

Terry Smith is the founder of Fundsmith, the manager of the UK’s largest fund, Fundsmith Equity Fund. Here’s what Smith wrote in a recent letter to his investors:

“What will emerge from the current apocalyptic state? How many of us will become sick or worse? When will we be allowed out again? Will we travel as much as we have in the past? Will the extreme measures taken by governments to maintain the economy lead to inflation? I haven’t a clue. Rather like some of the companies we most admire, I try to spend very little time considering matters which I can neither predict nor control and focus instead on those which I can affect.”

Don’t forget that the stock market is the best place to invest for the long term

In times such as this, it is easy to forget that the stock market is actually the best place to invest your money for long-term returns.

According to data from NYU finance professor Aswath Damodaran, US stocks have outperformed bonds and cash by a wide margin over the long run. From 1928 to 2019, US stocks produced an annual return of 9.7%, while bonds (10-year treasuries) had a 4.9% return per year.

In a recent video, Motley Fool co-founder David Gardner shared:

“From day one, when we started the Motley Fool 27 years ago, we said three things. Number one, the stock market is the best place to be for your long-term money. Number two, the stock market tends to rise 9 to 10% a year. That includes every bad week, quarter, month, year, bear market… and number three, make sure that you are invested in a way that you can sleep well at night.”

Don’t try to time the bottom

One of the most-asked questions among investors today is “Have we reached the bottom?”

I think that nobody really knows the answer to that. But it should not stop us from investing.

If you insist on only buying at the trough, you might miss a few good opportunities. In fact, I’ve heard of stories of investors who planned to enter the market at the bottom but missed out when their preferred-bottom never came. As stocks rose and got more expensive, they couldn’t bring themselves to buy and missed out on years of gains.

Billionaire investor Howard Marks mentioned in his latest memo:

“The old saying goes, “The perfect is the enemy of the good.”  Likewise, waiting for the bottom can keep investors from making good purchases.  The investor’s goal should be to make a large number of good buys, not just a few perfect ones.”

But remember to pick the right stocks

If you intend to invest in individual companies rather than an index-tracking fund, then it is important to remember that not all companies are created equal.

The well-followed S&P 500 index in the US has risen steadily over the long-term but a lot of its return can be attributed to only a handful of outperforming companies.

In fact, my blogging partner Ser Jing reported an interesting statistic in an earlier article. He wrote:

“ A 2014 study by JP Morgan showed that 40% of all stocks that were part of the Russell 3000 index in the US since 1980 produced negative returns across their entire lifetime.”

That’s an astounding statistic and goes to show that simply investing in any random stock will not guarantee you positive returns, even if you hold for the long run.

Picking the right companies is as important as choosing the right asset class to invest in. It is perhaps even more important for times such as today, where poorly-managed companies with weak balance sheets are fighting for their survival. As Warren Buffett once said, “Only when the tide goes out do you discover who’s been swimming naked.”

Stay calm and keep investing…

It is an understatement that markets are volatile. We are also likely going to see sharp drops in earnings from many companies in the next few quarters. Already Starbucks has guided for a 46% fall in earnings for the first quarter of 2020 and I expect to see many more companies reporting similar if not worse figures than this.

However, over the long-term, I expect earnings for well-run companies to return and for life to eventually return to normal. 

Instead of focusing on the next few quarter results, I am keeping my eye on long-term results and which companies can survive the current economic standstill.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Some investors may be wondering why stocks have not fallen more. The S&P 500 in the US has rebounded sharply in recent days and is now down by just 15% year-to-date.

Yet US companies are expected to see their earnings decline much more than 15% in the next few quarters. This will make their price-to-earnings ratios seem disproportionately higher than they were last year.

So why is there this gap between stock prices and earnings?

Discounted cash flow

The answer is that stock prices are not a reflection of a single year of earnings. Instead, it is the accumulation of the future free cash flow or earnings that a company will produce over its entire lifetime discounted back to today.

This economic concept is known as the discounted cash flow model. Investor Ben Carlson wrote a brilliant article on this recently.

For example, let’s assume Company ABC is expected to earn $10 per share per year for the next 10 years. After discounting future cash flows back to the present day, at an 8% discount rate, the company’s shares are worth $67.10.

But let’s assume that because of the COVID-19 crisis, ABC’s earnings in the first year is wiped out. But it still can generate $10 a year in the remaining nine years after that. Using the discounted cash flow model, ABC’s shares are still worth $57.84

Despite a 100% decline in earnings in the coming year, ABC’s share price is worth just 14% less.

Other bad case scenarios

There are worse scenarios that can play out, but as long as a company’s long term future cash flow or earnings remains somewhat stable, its share price should not fall as much as its near-term earnings.

For instance, let’s assume that instead of earning $10 per share in the coming year, Company ABC now makes a loss of $10 per share. But in year 2 onwards, business returns to normal and it can generate its usual $10 per share for the next nine years. In this case, Company ABC’s shares are now worth $48.58, or 28% less than before.

Let’s make the situation worse. Let’s assume Company ABC has a $10 per share loss in year 1 and has zero cash flow in year 2. Let’s also assume that business only returns to normal in year 3. Its shares, in this case, are still worth $40.01, a 40% decline.

History shows that stocks fall less than earnings

This is the reason why stocks tend to fall far less than short-term earnings declines. We can look at the Great Financial Crisis as a reference. 

According to data from Nobel Prize-winning economist Robert Shiller, the S&P 500’s earnings per share fell 77.5% from $81.51 in 2007 to $18.31 in 2008.

But the price fell much less. The S&P 500 closed at 1520.71 in July 2007 and reached a low of 757.13 in March of 2009. That translated to a 50% decline in stock prices.

Simply put, a 77.5% decline in earnings translated to ‘only’ a 50% decline in stock price. 

Not only did the S&P 500’s price fall much less than earnings, but the subsequent years have also shown that stocks may have fallen too low. Investors who bought in at the troughs of 2009 enjoyed better-than-normal returns over the next 10-plus years.

Assuming stock prices fall in tandem with one-year forward earnings is short-sighted and does not take into account all the future cash flows of a company.

Last words on the price-to-earnings ratio

I guess the takeaway for this post is that you should not be scared off stocks by the high price-to-earnings ratio of companies that will likely appear in the coming months (a high price-to-earnings ratio because of a large decline in earnings but less drastic fall in share price).  

The fall in earnings, if only temporary, should logically only cause a small decline in the value of the company, especially if it can continue to make profits consistently over the extended future.

It is natural that the PE ratio will be high if a company’s earnings disappear in the coming year. But the disappearance of the earnings could be temporary. When COVID-19 blows over, some companies – not all – will see business resume.

For now, the PE ratio is a useless metric as earnings are battered down temporarily, making the figure appear disproportionately high. We should instead focus on normalised earnings and whether a company can continue to generate free cash flow in the future.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Financial markets all over the world have been in a state of turmoil in recent weeks because of the COVID-19 crisis. In uncertain times like these, you may look up to famous investors to emulate their actions. That’s understandable. After all, following authoritative figures can provide a sense of security.

But I’m here to tell you that following famous investors blindly is incredibly dangerous. 

Blind faith

A few weeks ago, I recorded a video chat with Reshveen Rajendran. During our conversation, Resh shared the story of his friend’s investment in Occidental Petroleum (NYSE: OXY), an oil & gas company. Resh’s friend had invested in Occidental’s shares at around US$40 each, only to see the share price fall sharply. At the time of recording, Occidental’s share price was around US$16 (it is around US$14 now). Resh’s friend did not know what to do with his/her Occidental investment.

After we finished recording, I had a further discussion with Resh. I thought there could be a really good educational element in the story of his friend’s investment in Occidental.

I found out that the friend’s investment thesis for Occidental was to simply follow Warren Buffett. But here’s the thing: Buffett’s investment in Occidental is radically different from what we as individual investors can participate in.

Buffett’s bet

In August 2019, Buffett invested in Occidental through his investment conglomerate, Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B). What Buffett bought was US$10 billion worth of preferred shares in Occidental. He wanted to provide Occidental with capital to finance its planned US$38 billion acquisition of Anadarko Petroleum Corporation, a peer in the oil & gas industry.

Occidental’s preferred shares that Buffett invested in are not publicly-traded. So individual investors like you and I can’t invest in them. The preferred shares come with an 8% annual dividend that Occidental is obliged to pay until they are redeemed; the dividend means that Occidental has to pay Berkshire US$800 million every year (8% of Berkshire’s US$10 billion investment) in perpetuity or until redemption of the preferred shares happen. Occidental has the option to redeem the preferred shares at US$10.5 billion any time after August 2029. In other words, Berkshire is guaranteed to make a return of at least 8% per year from its Occidental preferred shares as long as the oil & gas company does not go bust. 

Investing in Occidental’s preferred shares the way that Buffett did is very different from buying Occidental shares in the stock market. The normal Occidental shares we can purchase (technically known as common shares or ordinary shares) don’t come with any dividend-guarantees. Occidental is also not obliged to redeem our shares at a small premium to what we paid. If we buy Occidental shares, how well our investment will do over a multi-year period will depend solely on the business performance of the company. Buffett’s investment in the preferred shares comes with protection that we can’t get with the ordinary shares.

No cover

To the point about protection, consider the following. In March 2020, Occidental slashed the quarterly dividend on its ordinary shares by 86% – from US$0.79 per share to just US$0.11 per share – to save around US$2.2 billion in cash. That was the company’s first dividend reduction in 30 years. Occidental needed to take extreme measures to protect its financial health in the face of a sharp decline in oil prices. Meanwhile, there’s nothing Occidental can do about the 8% dividend on Buffett’s US$10 billion preferred shares investment – Occidental has to continue paying the preferred dividends. To add salt to the wound, Occidental’s US$0.11 per share in quarterly dividend works out to just US$392 million per year, which is less than half of the US$800 million that Buffett’s preferred shares are getting in dividends annually. 

Yes, Buffett did buy some ordinary Occidental shares after his August 2019 investment in the oil & gas company’s preferred shares. But the total invested sum in the ordinary shares is tiny (around US$780 million at the end of 2019, or an average share price of US$41.21) compared to his investment in the preferred shares. 

We can end up in disaster if we follow Buffett blindly into an investment without understanding his idea’s key traits. Buffett’s reputation and Berkshire’s actual financial clout gives him access to deals that we will never have. 

Following authority into disaster

Resh’s story about his friend’s investment in Occidental shares reminded me of something that Morgan Housel once shared. Housel is currently a partner with the venture capital firm Collaborative Fund. Prior to this, he was a writer for The Motley Fool for many years. Here’s what Housel wrote in a 2014 article for the Fool:

“I made my worst investment seven years ago.

The housing market was crumbling, and a smart value investor I idolized began purchasing shares in a small, battered specialty lender. I didn’t know anything about the company, but I followed him anyway, buying shares myself. It became my largest holding — which was unfortunate when the company went bankrupt less than a year later.

Only later did I learn the full story. As part of his investment, the guru I followed also controlled a large portion of the company’s debt and and preferred stock, purchased at special terms that effectively gave him control over its assets when it went out of business. The company’s stock also made up one-fifth the weighting in his portfolio as it did in mine. I lost everything. He made a decent investment.”

Housel also committed the mistake of blindly following a famous investor without fully understanding the real rationale behind the investor’s investments.

In conclusion

It’s understandable if you want to follow the ideas of famous investors. That’s especially so during uncertain times, like the situation we’re in today. But before you do, please note that a blind adherence can be dangerous. Famous investors can invest in financial instruments in the same company that we can’t get access to. Or, their investment motives may be completely different to ours even for the same shares.

It’s always important to know why we’re investing in something. “I’m buying because Buffett or [insert name of famous investor] is buying” is not a valid investment thesis. 

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

This is a short article about important data you have to note if you’re reading broad economic conditions as a gauge for when to buy stocks. It was inspired by a recent question from a friend:

“While I understand that it’s impossible to time the market precisely, doesn’t it make sense to sell stocks and keep cash when you are fairly certain of a sustained economic decline (e.g. Covid)?”

During the 08/09 Great Financial Crisis, the S&P 500 in the US bottomed in early-March 2009. But interestingly, many stocks actually bottomed months before that, in November 2008. In The Good Investors, I have shared my investment theses for a number of US-listed companies in my family’s investment portfolio. Some of these companies were listed back in November 2008, and they include Netflix, Berkshire Hathaway, Amazon, Intuitive Surgical, MercadoLibre, Booking Holdings, and Mastercard.

The chart immediately below shows the share price changes from January 2008 to December 2009 for the individual stocks mentioned and the S&P 500. Notice the two red bubbles showing the time when most of the individual stocks bottomed (the one on the left) versus when the S&P 500 bottomed (the one on the right).

The individual stocks I talked about – Netflix, Berkshire, Amazon, Intuitive Surgical, MercadoLibre, Booking, and Mastercard – are companies that I think have really strong business fundamentals. They wouldn’t be in my family’s portfolio, otherwise! 

Now, let’s look at another chart, this time showing the US’s economic numbers from 1 January 2008 to 31 December 2010. The economic numbers are the country’s unemployment rate and GDP (gross domestic product). Notice the red bubble: It corresponds to November 2008, the time when most of the aforementioned stocks with strong business fundamentals bottomed. Turns out, the US’s GDP and unemployment rate continued to deteriorate for months after the individual stocks bottomed.

The observations I just shared have never been widely discussed, based on my anecdotal experience. But they highlight something crucial: It turns out that individual stocks – especially the companies with strong fundamentals (this is subjective, I know!) – can find a bottom significantly faster than economic conditions and the broader market do. 

The highlighted thing is crucial for all of us to note, in today’s investing environment. Over the next few months – and maybe even over the next year – It’s very, very likely that the economic data that are going to be released by countries around the world will look horrendous. But individual stocks could potentially reach a bottom way before the deterioration of economic conditions stops. If you miss that, it could hurt your portfolio’s long run return since you would miss a significant chunk of the rebound if you came in late.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

It’s great to learn from our own mistakes. But it’s even better to learn from those of others. COVID-19 has brought extreme market volatility and economic distress to the world. In a time like this, it’s easier for us to make investment mistakes.

I’m here to share the eggs I’ve had on my face in the stock market and what I’ve learnt from them, so that you can benefit from my errors. 

The backdrop

I started investing for my immediate family on 26 October 2010. The portfolio I help manage consists of stocks listed in the US market. There are currently over 50 stocks in it.

Some of the biggest losers in the portfolio include Atwood Oceanics, Ford (NYSE: F), Gilead Sciences (NASDAQ: GILD), GoPro (NASDAQ: GPRO), National Oilwell Varco (NYSE: NOV), Tapestry (NYSE: TPR), Under Armour (NYSE: UAA), and Zoe’s Kitchen.

Atwood Oceanics and Zoe’s Kitchen were privatised in October 2017 and November 2018, respectively, and I sold their shares on September 2016 and November 2018. I sold National Oilwell Varco in June 2017. I still own the other stocks mentioned.

Lesson 1: It’s okay to fail if you have the right investment framework 

My family’s investment portfolio has clearly had many epic losers. But from 26 October 2010 (the inception of the portfolio) to 29 March 2020, the portfolio has still grown in value by 16.0% annually, without including dividends. This is significantly higher than the S&P 500’s return of 10.7% per year over the same period, with dividends.

It’s okay to have multiple failures in your portfolio. There’s an investment framework that I’ve been using for my family’s portfolio for years. It has guided me towards massive winners, such as Netflix (NASDAQ: NFLX), Amazon (NASDAQ: AMZN), and MercadoLibre (NASDAQ: MELI). The winners in the portfolio have more than made up for the losers.

If you’re investing with a sound investment framework, then don’t beat yourself up too hard if some of your stocks are down big. Look at your performance from a portfolio-perspective, and not harp on how each position is doing.

Lesson 2: Diversify smartly, and stay away from commodity-related companies

Atwood Oceanics and National Oilwell Varco are companies in the oil & gas industry. When I invested in them, Atwood was an owner of oil rigs while National Oilwell Varco was supplying the parts and equipment that kept oil rigs running.

They were among my first-ever investments, back when I was a greenhorn in the stock market. I invested in them because I wanted to be diversified according to sectors. I also thought that oil & gas was a sector that is worth investing in since demand for the commodities would likely remain strong for a long time. My views were right, but only to a small extent. I was wrong on two important areas.

First, it is important to be diversified according to sectors (and geography too!). But there are some sectors that are just not worth investing in for the long run because their economic characteristics are poor. For instance, the energy, materials, and transport sectors have historically produced poor returns on invested capital. This is illustrated in the chart below from a 2006 McKinsey report which mapped out the average return on invested capital for various sectors from 1963 to 2004. Charlie Munger, Warren Buffett’s long-time lieutenant, once said:

“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount.”

Second, demand for oil did indeed grow from 2010 to 2016. But oil prices fell significantly over the same period. The trends in oil consumption and oil prices for that period are depicted in the chart below.

The sharp fall in oil prices despite the rising demand illustrates the difficulty in predicting oil prices. In fact, it’s practically impossible. I recently learnt about a presentation that Peter Davies gave in 2007 titled What’s the Value of an Energy Economist? In it, he said that “we cannot forecast oil prices with any degree of accuracy over any period whether short or long.” Back then, Davies was the chief economist of British Petroleum, one of the largest oil & gas companies in the world.

With lower oil prices, the business results and share prices of Atwood Oceanics and National Oilwell Varco plummeted. The chart below shows National Oilwell Varco’s share price and earnings per share from 2010 to 2016 (data for Atwood Oceanics is not available since it’s now a private company). I think the predicament of Atwood Oceanics and National Oilwell Varco can be extrapolated to other commodity-related companies. It’s tough to predict the price movements of commodities; this in turn makes it difficult to have a good grasp on the business results of a commodity-related company over a multi-year period.

Lesson 3: Not selling the losers is as important as not selling the winners

You’ll notice that my family’s portfolio is still holding onto many of the big losers. The sales of Atwood Oceanics and National Oilwell Varco happened because of something that Motley Fool co-founder David Gardner shared a few years ago:

“Make your portfolio reflect your best vision for our future.”

Part of the vision I have for the world is that our energy-needs are entirely provided by renewable sources that do not harm the precious environment we live in. For this reason, I made the rare decision to voluntarily part ways with stocks in my family’s portfolio (referring to Atwood Oceanics and National Oilwell Varco).

I sell stocks very rarely and very slowly. This aversion to selling is by design – because it strengthens my discipline in holding onto the winners in my family’s portfolio. Many investors tend to cut their winners and hold onto their losers. Even in my earliest days as an investor, I recognised the importance of holding onto the winners in driving my family portfolio’s return. Being very slow to sell stocks – even the big losers – has helped me hone the discipline of holding onto the winners. And this discipline has been a very important contributor to the long run performance of my family’s portfolio.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

US airlines finally got something to cheer about.

Earlier this week, US senate leaders came to an agreement on a US$2 trillion stimulus bill. A whopping US$60 billion of that will be used to bail out struggling US airlines.

Airlines, in return, must forgo layoffs until the fall (sometime in the fourth quarter of 2020), accept limits on executive compensation and dividends, and maintain certain routes. Despite the limitations, I think this is a deal the airlines will happily take to save themselves from bankruptcy.

Bailouts are nothing new though. The US has a long history of bailing out companies that were deemed too important to fail. These companies either provided essential services, accounted for a decent chunk of the economy, or employed a large number of people.

But bailouts take different shapes and forms. The ways that the government injects cash into companies (or individuals), the kind of industries the government tries to save, and the impact on shareholders differ every time.

In light of the latest bailout, I decided to take a short trip down memory lane to see the different kinds of bailouts that have occurred.

The Great Depression

One of the greatest economic catastrophes of modern history occurred from 1929 to the early 1940s. It was the longest, deepest, and most widespread depression of the 20th century.

In 1933 US President, Franklin D. Roosevelt took the oath of office and started implementing solutions to bring the economy out of the recession. 

One of the things he did was to bail out struggling homeowners. At that time, the national unemployment rate was around 25%, so many Americans who lost their jobs were unable to pay off their home mortgages and were left homeless. 

The Home Owners’ Loan Corporation was set up to solve the problem. The newly formed government agency purchased defaulted mortgages from banks and refinanced them at lower rates, allowing about a million homeowners to benefit from lower mortgage rates.

This bailout was targetted at individuals at that time and kept people off the street. However, it was not until World War II ended that the depression was officially over and the post-war boom began.

The Great Financial Crisis

The next most important economic crisis occurred much more recently in 2007-2008. Known as the Great Financial Crisis, the collapse of Lehman Brothers amid the bursting of the housing bubble culminated in a global financial crisis.

However, this time, the US government’s response was swifter and the bailouts introduced saved banks, restored confidence, allowed banks to lend again, and eventually led to the 12-year bull market that ended this year.

So what did the US government do in 2008? The Emergency Economic Stabilisation Act of 2008, often called the “bank bailout,” was signed into law by then-President George W. Bush. The new law led to the creation of the US$700 billion Troubled Asset Relief Program (TARP) to inject capital into banks. But these funds were not given as grants, rather they were used to purchase toxic assets from the banks.

A key part of the US federal government’s plan was to buy up to US$700 billion of illiquid mortgage-backed securities. These were essentially a bundle of home loans packed into one.

On top of that, the US government injected cash into banks through the purchase of preferred stock. Citibank needed a particularly big injection of capital, with the government purchasing US$45 billion in preferred and common Citigroup stock. Selling stock when your share price is down 80% is never going to be pretty and Citigroup shareholders learnt that the hard way as they were diluted almost six-fold. Till today, Citigroup’s share price is still more than 80% off the high it reached in 2007. However, what the bailout achieved was to save Citigroup from insolvency and shareholders could at least survive to fight another day.

Overall, TARP improved the balance sheet and reduced the potential losses of banks and financial institutions.

The net effect for the government was also positive as it was reported that TARP recovered US$441.7 billion of US$426.4 billion invested, earning a US$15.3 billion profit when everything was done and dusted.

COVID-19 Crisis

Fast forward to today and we are once again seeing a massive bailout, this time with the aviation industry.

As mentioned earlier, struggling US airlines are getting an early Christmas present this year, to the tune of US$60 billion.

According to a draft of the legislation, airlines will receive up to US$25 billion in direct grants. That’s practically free money for the airlines as long as they promise not to layoff workers till the fourth quarter of 2020, accept limits on executive compensation and shareholder dividends.

Additionally, the bill also grants US$25 billion in loans and loan guarantees for passenger airlines and US$4 billion for cargo air carriers. The promise of loans will help struggling airlines raise much needed new capital even if the banks won’t lend to them.

The news is, of course, great for shareholders and employees. Employees get to keep their jobs while shareholders don’t have to worry about potential bankruptcies. The injection of cash will tide airlines through this challenging period. Airline shares have been creeping up since rumours of a bailout began.

The Good Investors’ conclusion

Bailouts may seem like a bad word but they are great for shareholders. The injection of cash into a company can tide them through when all hope seemed to be lost.

However, bailouts also bring to light that the company was not managing its finances well enough. Overleverage, bad investments, and in the case of Airlines, overspending on share buybacks destroyed their balance sheets to the brink of collapse.

Although bailouts can eventually save the day, they are one-off special situations and investors should never rely on them to get them out of trouble.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Freediving is the sport of diving underwater that relies on holding our breath without any breathing apparatus. Professional freedivers have been known to descend to depths of 100 metres or more on one single breath. It’s truly a sight to behold on what the human body can achieve.

I went to a freediving trial a few years ago in a deep swimming pool in Singapore. During the session, I was taught that when we hold our breath, a long gap actually exists between the time when our urge to breathe kicks in and the time when we actually do need to breathe. The information was interesting to me, so I’ve remembered it till now.

A few days ago, I went for a swim in the morning. While swimming, I tried extending the number of breast-stroke repetitions I could do while underwater. But try as I might, I couldn’t. I knew, logically, that my body would not be physically harmed even if I continued holding my breath for an extended period of time after the urge to breathe kicks in. But the urge was too strong. Each time it appeared, I gave in to it after a few short seconds. I couldn’t fight the visceral urge. After I stopped my swim, a light bulb went on in my head. I saw a link between investing and freediving.

Freediving requires us to fight the visceral urge to breathe when holding our breath. But it is difficult to do so, even if we have all the right analysis and understand the logic. I knew I would be fine and that my body did not have to breathe at that instant. But my body was screaming at me to surface from the water and take in some air.

Investing requires us to fight the visceral urge to capitulate when bear markets inevitably occur. But it is difficult to do so even if we have all the right analysis and understand the logic. Our brains will be screaming at us to sell when stocks are falling, even if we understand that we are going to be fine over the long run just leaving our portfolios as they are (assuming they were well-constructed from the start).

So what can we do?

We can train our bodies to hold our breath for long periods of time – there are well-documented methods.

I don’t know what the solution is for investing. But I’m hopeful that those of us who are susceptible to panic during bear markets can find some relief if someone can provide an empathetic listening ear and useful context when they occur. The current volatility in stocks – because of fears over the coronavirus, COVID-19 – means that many of us are likely enduring our brains screaming at us to sell. I want to help.

I have a long article sharing the useful context. The Singapore-based roboadvisor Endowus also put out a wonderful video recently sharing even more context. You can contact me at thegoodinvestors@gmail.com too. I cannot give financial advice, but I can perhaps help you deal with your investing-related emotions in a more constructive manner. You’re not in this alone.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

We are currently in the midst of the fastest ever bear market in history. We live in uncertain times. No one knows how long the COVID-19 outbreak will last and what is the depth of its near-term economic implications. 

Across the globe, sporting events have been postponed, numerous gyms and schools are closed, and travel restrictions have been imposed. All of which will reduce expenditure and have a very real impact on corporate earnings and the economy.

Our foreign minister, Dr Vivian Balakrishnan, recently reminded everyone to be vigilant and that the economic implications would last at least a year. 

Even the emergency rate cut by the Fed on Sunday to bring interest rates to 0%, and the announcement of US$700 billion in quantitative easing, failed to spark any enthusiasm in the stock market. The S&P 500 in the US closed with a 12% fall in the wee hours this morning. At home, the Straits Times Index was down 5.25% on 15 March 2020.

In these dark times, I thought it would be a good idea to outline my gameplan to survive this and future market downturns.

Only invest the money I don’t need for the next five years

Stocks are volatile. That’s a fact we can’t escape. This is not the first bear market and certainly not the last.

My blogging partner, Ser Jing, shared some interesting stock market facts in an earlier article. He wrote:

“Between 1928 and 2013, the S&P 500 had, on average, fallen by 10% once every 11 months; 20% every two years; 30% every decade; and 50% two to three times per century. So stocks have declined regularly. But over the same period, the S&P 500 also climbed by 283,282% in all (including dividends), or 9.8% per year. Volatility in stocks is a feature, not a bug.”

Steep drawdowns are bound to happen and investors need to be able to ride out the paper losses and not be forced to sell.

Stocks can take months, if not years, to recover from a bear market. There have been 12 bear markets since World War II. These bear markets have taken two years to recover on average. The longest bear market occurred in the aftermath of World War II and took 61 months to recover.

Given the frequency of bear markets and the time taken for stocks to recover, I only invest money that I do not need for at least five years. Being forced to sell in a bear market could be detrimental to my returns and net worth over the long term.

Don’t leverage

Leverage can kill your portfolio in a bear market.

Leveraging essentially means borrowing to invest – or investing more than you can afford. The case for leveraging is that if you can borrow at let’s say 5% but have a return of 10%, then you can earn the difference.

However, there is one major pitfall to leveraging to invest in stocks- margin calls. If the value of your stocks falls below a certain threshold, brokerages who lend the money will force you to sell your stocks to ensure that you can pay them back.

During the Great Depression, the US stock market fell by 89.2% from top to bottom. If you had invested on margin, you would have likely been forced to liquidate your investments to pay back your lender.

Your entire portfolio would have gone to zero. That’s the danger of margin calls. Even though stocks eventually recovered, stock market participants who leveraged could not participate in the rebound and subsequent bull market.

The Great Depression was the steepest decline we’ve seen. But there have been other notable bear markets that would have likely caused margin investors to be completely wiped out. The Great Financial Crisis of 2008 saw a 53.8% peak-to-trough decline in US stocks, while the 1973-74 crash had a peak-to-trough decline of 44.9%.

Investors who invest with margin can gain some extra returns on good years but can easily be wiped out on the next downturn.

Invest in companies that can survive a downturn

I also invest only in stocks that can survive an economic downturn. Companies that have strong balance sheets with more cash and debt are likely to be able to weather the storm. 

Most companies, no matter how strong their moat is, will likely see a fall in sales over the next few months. Even companies like Netflix, which on the surface seem unaffected by the COVID-19 outbreak, might see revenue fall as consumers are more conscious about their spending habits.

In a time like this, when companies are facing disruption to sales, it is important that we only invest in those that are able to service their debt, continue paying their fixed costs ,and still come out at the end of the tunnel.

Warren Buffett described it best when he said,

“Only when the tide goes out do you discover who’s been swimming naked.”

It is in times like these when companies that are over-leveraged and have high-interest cost may end up going underwater. Shareholders of these companies will be left grasping at straws.

The Good Investors’ conclusion

The stock market is a great place to build wealth over the long run. However, it is important that we abide by certain investing principles that help us survive a market meltdown, as we are seeing unfold in front of us.

These three simple rules help me keep calm during these dark times, knowing that this too shall pass.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Stocks around the world have been incredibly volatile in recent weeks because of the new coronavirus, COVID-19. All over the world, business activity has slowed, large-scale gatherings of people have been cancelled, planes are grounded, hotels are empty, people are quarantined, and healthcare systems are pushed to their limits. Recessionary fears are also rampant.

Amidst the market and societal turmoil, I want to share some important investing-related reminders for all of us to provide context, soothe fraying nerves, and be a voice of calm, reason, and peace.

But before I get there, I want to stress this: COVID-19 or no COVID-19, recession or no recession, I am not changing the way I am investing. Regardless of how COVID-19 or the global economy develops, the stock market is still a place to buy and sell pieces of a business. This also means that a stock will do well eventually if its business does well. So I will continue looking for companies that excel according to my investing framework, and investing in their shares for the long run.

On to the update…!

1. Recessions are normal

The chart below shows all the recessions (the dark grey bars) in the US since 1871. You can see that recessions in the country – from whatever causes – have been regular occurrences even in relatively modern times. They are par for the course, even for a mighty economy like the US.

The following logarithmic chart shows the performance of the S&P 500 (including dividends) from January 1871 to February 2020. It turns out that US stocks have done exceedingly well over the past 149 years (up 46,459,412% in total including dividends, or 9.2% per year) despite the US economy encountering numerous recessions. If you’re investing for the long run, recessions can hurt over the short-term, but they’re nothing to fear.

2. The stock market has regularly seen serious short-term losses while on its way to earning great long-term returns

Between 1928 and 2013, the S&P 500 had, on average, fallen by 10% once every 11 months; 20% every two years; 30% every decade; and 50% two to three times per century. So stocks have declined regularly. But over the same period, the S&P 500 also climbed by 283,282% in all (including dividends), or 9.8% per year. Volatility in stocks is a feature, not a bug.

In fact, stocks have also experienced brutal one-day drops that – with the proper perspective – turn out to be blips.

Some market commentators have labelled 9 March 2020 as Black Monday because the S&P 500 fell by 7.6% that day. But that is nothing compared to the historical Black Monday – on 19 October 1987, the S&P 500 plunged by 20.5%. To make matters worse, the index was already down by 10.1% in the three days preceding 19 October 1987. So in four trading days – from the close on 13 October 1987 to 19 October 1987 – US stocks were down by 28.5% in all.

Black Monday (the historical one) was a harrowing experience for those who lived through it. But here’s the thing: From 13 October 1987 (before Black Monday happened) to 9 March 2020, the S&P 500 was up by 773% in total, or 6.9% per year. With dividends, the S&P 500 was up by around 2,100%, or 10.0% annually.

From an individual stock perspective, we can also look at the US e-commerce giant Amazon (NASDAQ: AMZN). The company (which is in my family’s investment portfolio) was a massive long-term winner from 1997 to 2018, with its share price rising by more than 76,000% from US$1.96 to US$1,501.97. But in the same timeframe, Amazon’s share price also experienced a double-digit top-to-bottom fall in every single year (the declines ranged from 13% to 83%).

One of my favourite finance writers is Morgan Housel. In an April 2019 blog post, he brilliantly articulated a concept that I’ve held in my mind for a long time: Instead of seeing short-term volatility in the stock market as a fine, think of it as a fee for something worthwhile. The stock market has produced good to great returns over the long-term. But it demands an admission fee. And the admission fee is what we’re currently experiencing.

3. Recessions and market crashes are inevitable

The late Hyman Minsky was an obscure economist when he was alive. But his ideas flourished after the Great Financial Crisis of 2007-09.

That’s because he had a framework for understanding why markets and economies go through inevitable boom-bust cycles. According to Minsky’s then radical view, stability itself is destabilising. When an economy is stable and growing, people feel safe. And when people feel safe, they take on more risk, such as borrowing more. This leads to the system becoming fragile.

The same goes for stocks. Let’s assume that stocks are guaranteed to grow by 9% per year. The only logical result would be that people would keep paying up for stocks, till the point that stocks become way too expensive to return 9% a year. Or people will take on too much risk, such as taking on debt to buy stocks.

But bad things happen in the real world and they happen often. And when stocks are priced for perfection, bad news will lead to lower stock prices.

4. There is always something to worry about

Peter Lynch, the legendary manager of the Fidelity Magellan Fund from 1977 to 1990, once said that “there is always something to worry about.” How true. The table below, constructed partially from Morgan Housel’s data, shows that the world had experienced multiple crises in every single year from 1990 to 2019.

But over the same period, US stocks were still up by nearly 800% after factoring in dividends and inflation.

COVID-19 is not the first deadly disease outbreak the world has faced. But global stocks have registered solid long-term gains despite multiple occurrences of epidemics/pandemics in the past. The chart below shows the performance of the MSCI World Index (a benchmark for global stocks) from 1970 to January 2020 against the backdrop of the various epidemics/pandemics we’ve experienced in the past 50 years.

5. Don’t invest in stocks with money that you will need within five years, at least; also, don’t use leverage

When I was helping to run the Motley Fool Singapore’s investment newsletters, my ex-colleagues and I repeated the same message over and over again: You should not invest with money that you need within the next five years.

The message is meant to prepare for days like we’ve seen over the past few weeks. The worst thing that can happen to us as investors is to be placed in a position where we’re forced to sell stocks. It doesn’t matter if we’re forced to sell when stock prices are high. But it can be disastrous to be forced to sell when stock prices are low.

To reap the rewards of long-term investing, we need to give ourselves holding power. And a very simple but effective thing we can do to gain holding power is to invest with money that we would very likely not need to touch for a good number of years.

Another simple but effective way we can have holding power in the financial markets is to not use leverage. Investing with leverage is to invest with borrowed capital. If we invest with leverage, we could very easily become forced-sellers when stocks fall. This becomes a severe headache during occasions when stocks fall sharply, such as over the past few weeks. 

6. Volatility clusters

As mentioned earlier, the S&P 500 fell by 7.6% on 9 March 2020. The decline was so severe it triggered a circuit breaker in the process. On 10 March 2020, the prominent US market benchmark jumped 4.9%. A great day in the market followed a bad day.

This clustering of volatility is actually common. Investor Ben Carlson produced the table below recently (before March 2020) which illustrates the phenomenon.

The clustering means that it’s practically impossible to side-step the bad days in stocks and capture only the good days. This is important information for us, because missing just a handful of the market’s best days will destroy our returns.

Dimensional Fund Advisors, which manages more than US$600 billion, shared the following stats in a recent article:

• $1,000 invested in US stocks in 1970 would become $138,908 by August 2019
• Miss just the 25 best days in the market, and the $1,000 would grow to just $32,763

So it is important that we stay invested. But this does not mean we should stay invested blindly. Companies that currently are heavily in debt, and/or have shaky cash flows and weak revenue streams are likely to run into severe problems if there’s an economic downturn. If a global recession really happens this time (it looks increasingly likely that it will) and our portfolios are full of such companies, we may never recover. It’s good practice to constantly evaluate the companies in our portfolios, but I think there’s even more urgency to do so now.

7. Stick with high-quality businesses – don’t be attracted to a stock just because it has a low valuation

It’s easy for us to be lured by stocks that have low valuations after sharp declines in their prices. But it’s crucial that we also pay attention to the quality of the underlying businesses of the stocks we’re looking at. Low-quality businesses can’t compound in value. If we invest in them, our investments can’t grow over time. We may even lose money.

My friend Chin Hui Leong is a whip-smart investor and the co-founder of The Smart Investor, an investment education website. On 5 May 2009, he invested in American Oriental Bioengineering (AOB), a China-based pharmaceuticals company that was listed in the US. Chin was attracted to its low valuation – back then, AOB’s price-to-earnings ratio was only 7.

The S&P 500 reached a bottom during the Great Financial Crisis in March 2009 (it hit 677 points) and has nearly quadrupled since. So the timing of Chin’s investment in AOB was great. But he went on to effectively lose his entire investment in the company over a few short years because of its poor business performance subsequently. From 2009 to 2013, AOB’s revenue shrank from US$296 million to US$122 million while its US$41 million in profit became a loss of US$91 million. A cheap stock can easily become a big loser if its business does poorly.

Chin also has a fantastic and inspiring example of what can happen if we stick with high-quality businesses. He invested in Netflix (NASDAQ: NFLX) (my family also owns shares of Netflix) on 12 January 2007 at a share price of around US$3.20. On this occasion, his timing was poor. The S&P 500 closed at 1,431 on the day of his Netflix investment and reached a peak of 1,565 on 9 October 2007 before the Great Financial Crisis hit. But today, Netflix’s share price is around US$330, about 100 times higher than when he first invested. 

8. Oil prices are low now, but we still shouldn’t buy oil & gas stocks indiscriminately

There are two widely-tracked prices for oil: West Texas Intermediate (WTI) crude and the international benchmark. Brent crude. Both shockingly fell by more than 30% each on 9 March 2020 at their respective low points.

WTI eventually closed the day with a 24.6% decline to US$31.13 per barrel while Brent crude settled with a 24.1% slide to US$34.36 per barrel. These prices were the lowest seen since February 2016. Some market observers have linked this sharp fall in oil prices to the recent turmoil in financial markets that we are seeing.

The lower oil prices have also caused the share prices of oil & gas stocks around the world to plummet. In the US market, Exxon Mobil (NYSE: XOM) plunged by 12.2% on 9 March 2020. Meanwhile, at our home in Singapore, Keppel Corporation (SGX: BN4) fell by 9.6% while Sembcorp Marine (SGX: S51) was down by 11.4%.

Oil prices are near multi-year lows now – they were around US$100 in 2014 and around US$32 at the moment. It could thus be tempting to pick up oil & gas stocks with the view that their share prices will tag along when oil prices rise. There are two problems here.

First, it’s practically impossible to forecast future oil prices. In 2007, Peter Davies gave a presentation titled What’s the Value of an Energy Economist? In it, he said that “we cannot forecast oil prices with any degree of accuracy over any period whether short or long.” Back then, Davies was the chief economist of British Petroleum, one of the largest oil & gas companies in the world.

Second, oil prices and oil & gas stocks can move in opposite directions. In mid-2014, oil prices started their rapid descent from around US$100. WTI reached a low of US$26.61 in February 2016. 10 months later (on 21 December 2016), WTI had doubled to US$53.53. But over the same period, 34 out of a group of 50 Singapore-listed oil & gas stocks saw their share prices fall. The average decline for the 50 companies was 11.9%.

There can be many obstacles that stand between a positive macrotrend and higher stock prices. In the case of oil & gas stocks, these include a weak balance sheet and deteriorating business fundamentals as a result of poor operational capabilities.

9. We will get through this 

There are 7.8 billion individuals in our globe today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life – COVID-19 or no COVID-19. This motivation is ultimately what fuels the global economy and financial markets.

Miscreants and Mother Nature will occasionally wreak havoc. But we should have faith in the collective positivity of humankind. We should have faith in us. We can clean up the mess. To me, investing in stocks is the same as having faith in the long-term positivity of mankind. I continue and will continue to have this faith, so I continue and will continue to invest in stocks.

I want to leave the last words in this article to Morgan Housel. A few days ago he published a blog post with the most apt of titles: We’ll Get Through This. In it, he wrote:

“Remember that when progress is measured generationally, results and performance should not be measured quarterly.

It looks bad today.

It might look bad tomorrow.

But hang in there.

We’ll get through this.” 

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.