Global Quantitative Easing - Hyperion and Tree Article Series

Recently no fewer than 17 central banks have started to implement monetary policy or exchange rate policy to ease according to Reuters here: http://in.reuters.com/article/2015/02/05...C120150205

In light of this, Hyperion and Tree likes to start a new thread to discuss what would likely be the effect of collective monetary easing on investing strategies to cure mainly Hyperion's bore dome because he can't find a job. The following is Hyperion and Tree's collective opinion and should not be view as advice to trade in any investments. If you like the article please upvote Hyperion and Tree's reputation. Hyperion: =] , Tree: -_-

So what happens if every central bank starts to implement monetary easing? Interestingly, it is likely that when everybody starts to ease, it would offset the monetary easing policy of every country and thus nullify the intended effects of monetary easy. To take an example, if one country starts to increase monetary supply or set lower nominal interest rates, ideally the effect is to weaken exchange rate and allow the exports of its country to be more attractive globally. If other countries around the globe also do the same thing, what happens is the exchange rate would strengthen again and thus the country that started to ease cannot benefit from exporting cheaply to other countries.

This means that countries whose economy is structurally in trouble with budget deficits, lack of tax revenue, lack of domestic demand, lack of competitive exports, and have high debt, could not recover from export driven growth. This leaves them with the painful option of restructuring their economy or defaulting on their debt. Hyperinflation would likely be a possibility if real interest rates in these countries are declining due to lack of economic activity. The key word is real interest rates.

For countries whose economy is doing well, however, the real interest rate should increase due to more economic activity. The effect will be although nominal interest rates are low, deflation will occur. This is because Nominal Interest Rates minus Inflation gives Real Interest Rates. If Real Interest Rates increase but Nominal Interest Rates stay low due to government intervention, Deflation has to occur. Under this situation, if you buy bonds, and bond yields keep decreasing, you can still buy more because effective real bond yields are actually increasing due to deflation.

Singapore
Recently in Singapore for the last 2 months the economy experience deflation of around 0.1%. This has some implications which are not immediately obvious. If you take the short term SGS bond yields in Singapore which is around 0.7% now and adjust for deflation of 0.1% to get the real bond yields, you get around positive 0.8% real bond yields. If now you assume that long term 10 year inflation is 3% as observe historically, and adjust the current 10 year SGS bond yields which is around 1.9%, you actually get negative 1.1%. In this case, short term real interest rates actually are higher than long term real interest rates. This is call an inverted yield curve which is a leading indicator of an economic crisis. It is likely that there are more sellers of short term SGS than buyers because more people need short term liquidity.

Although the above indicators suggests that Singapore might enter a recession this year, Hyperion and Tree likes to caution readers that the key assumption is that the average 10 year inflation stands at 3%. If this is not true, given that we now face global deflation for economies that are not in trouble, there is unlikely to be a crisis. This is because if say the next 10 years we experience a deflation of 3% a year. The actual adjustment to the current 1.9% 10 year SGS bond yield would be to add 3% and we have long term SGS real bond yields higher than short term real bond yields. Thus there is no inversion of yield curve.

Crucially, another indicator, the amount of loans in Singapore versus deposits was signally trouble few months ago. The amount of loans in Singapore was higher than deposits around July to September 2014. This suggests a general lack of liquity. For more info refer to:
https://www.dbs.com.sg/corporate/aics/Ge...posits.xml#


As observe from the link the other time this had occurred was during the Asian Financial Crisis in 1997.

In conclusion, the likelihood of a 1997 occurring again is indeed becoming real. Most interestingly, Singapore is an open economy, and thus Singapore is actually a great barometer for the South East Asian economies. Overall, this further suggests that in fact, South East Asian countries are heading for an economic crisis similar to 1997 based on the above 2 indicators.

We like to hear your views in the comments.

Thank You.

Regards,
Hyperion and Tree

Part 2:
Tree likes to add the following:
How does QE affect real interest rate?
Firstly, printing more money dilutes the value of money by current holders of money. The first person, which is usually the government, who spends the new money benefits and subsequently other people will experience a dilution in the form of inflation. This wealth transfer is likely to cause a reduction of real interest rates because other people have lose money.

However if the printed money is spend wisely on projects that have high return on investment, it would be able to offset the effects of wealth transfer and increase real interest rates. So depending on how QE is spend, real interest rates will go up or down.

If a country is experiencing structural problems, but the printed money is not spend to solve those problems, and instead used to buy bonds, more likely than not real interest rates would drop because of the wealth transfer effect. More people have less money to engage in economic activity as their money has been diluted. Depending on level of nominal interest rates, there may be inflation or deflation.

Since what really matters is real interest rates, holders of currencies of countries with high real interest rates would likely do well in the next decade.

Hyperion:
How to look for countries that will have high real interest rates?
Assuming that most countries will have to print money to counter effects of global QE, the country that can invest the printed money well would likely generate high real interest rates. Thus, one way is to look for countries that 1) have a capable government and 2) have a plenty of projects that can be invested to give high returns. Most likely such a country would have a recent change of government that intends to exploit inefficiencies in the economy left by the previous government.

Thank you.
Regards,
Hyperion and Tree

Hi Hyperion and Tree. Given the current economic situation where a combination of QE causing inflation and low interest rates, and oil prices fluctuating due to rising alternative technology, and political unrest like changing leaders every few years. How do you see the fundamental of companies changing. Even someone as strong as WB has been caught off guard in the supermarket case. Can traditional FA still works in today investing world? With all the volatility in the market due to uncertainties, what is your approach in investing? would greatly appreciate your sharing. Tks.

(07-02-2015, 03:47 PM)HyperionTree Wrote: Hyperion:
How to look for countries that will have high real interest rates?
Assuming that most countries will have to print money to counter effects of global QE, the country that can invest the printed money well would likely generate high real interest rates. Thus, one way is to look for countries that 1) have a capable government and 2) have a plenty of projects that can be invested to give high returns. Most likely such a country would have a recent change of government that intends to exploit inefficiencies in the economy left by the previous government.

This is a very good post. Thank you hyperion and tree. I'm lazy to do my research and calculations... but Indonesia comes to mind. Jokowi seems to me to have capable leadership. What are your thoughts on Indonesia if you have any, despite the ID rupiah decline?

(08-02-2015, 06:34 AM)Life is a game Wrote: Hi Hyperion and Tree. Given the current economic situation where a combination of QE causing inflation and low interest rates, and oil prices fluctuating due to rising alternative technology, and political unrest like changing leaders every few years. How do you see the fundamental of companies changing. Even someone as strong as wb has been caught off guard in the supermarket case. Can traditional FA still works in today investing world? With all the volatility in the market due to uncertainties, what is your approach in investing? would greatly appreciate your sharing. Tks.

Most folks here dont realize that WB only gets ~60% of his decisions right, but on a money-weighted basis, it is about 80% because he gets the majority of this big ticket items either right or really right...Read through his ARs over the years and you will lose count of how many mistakes he admitted to make.

No one will get things right all the time, in fact, no 1 will get things right MOST of the time. But the the good thing is, we can negate some of our company selection deficiencies with asset allocation.

(08-02-2015, 07:55 AM)weijian Wrote:

(08-02-2015, 06:34 AM)Life is a game Wrote: Hi Hyperion and Tree. Given the current economic situation where a combination of QE causing inflation and low interest rates, and oil prices fluctuating due to rising alternative technology, and political unrest like changing leaders every few years. How do you see the fundamental of companies changing. Even someone as strong as wb has been caught off guard in the supermarket case. Can traditional FA still works in today investing world? With all the volatility in the market due to uncertainties, what is your approach in investing? would greatly appreciate your sharing. Tks.

Most folks here dont realize that WB only gets ~60% of his decisions right, but on a money-weighted basis, it is about 80% because he gets the majority of this big ticket items either right or really right...Read through his ARs over the years and you will lose count of how many mistakes he admitted to make.

No one will get things right all the time, in fact, no 1 will get things right MOST of the time. But the the good thing is, we can negate some of our company selection deficiencies with asset allocation.

If things are so simple looking then everyone can succeed in investing. Scratching the surface and looking at events unfolding and solving them one at a time is not going to work. WB has his own ways to succeed at his time but today is not yesterday. reading history and predicting future is what alot of investment gurus are doing. Contrary thinking is what WB is advocating not his style of investment or his past glorious. If anyone think they can understand who who more and by reading some AR or FS he/she can fully understand this or that then it is in itself this thinking that is dangerous and leading to self review risk.

Part 3:

Thanks for all your comments. Initially, Hyperion and Tree thought that nobody was interested given the muted responses. We will answer any comments at the bottom of this post.

Historical Real Interest Rates in Singapore
Hyperion did some calculations to produce the graph below:
[Image: 14jqpa9.jpg]
The orange line is the Real 1 Year SGS Interest Rates. It is calculated as follows, Monthly Real 1 Year SGS Interest Rates = Monthly 1 Year SGS Yield minus Department of Statistics Monthly YOY Inflation Rate.

The blue line is the difference between the Monthly Real 1 Year SGS Interest Rates and the Monthly Real 10 Year SGS Interest Rates. The calculations for the Real 10 Year SGS Interest Rates are rather tricky. First, Hyperion took the annual inflation rate from 1990 to 2014. For year 2014, Hyperion calculated the 10 year geometric average of the CPI from year 2004 to 2013, and calculated the 10 year geometric average of the CPI from year 2005 to 2014. Then, Hyperion divides the GeoAvg 10 year CPI(2005-2014) by GeoAvg 10 year CPI(2004-2013) to get the 10 year average annual inflation for the past 10 years since 2014. Finally, Hyperion use the formula Monthly Real 10 year SGS Interest Rates = Monthly 10 Year SGS Yield minus past 10 years GeoAvg annual inflation. In short, for each year, the previous historical 10 year annual inflation is calculated and used to adjust the Monthly 10 year SGS Yield. Do note that this method will calculate different historical 10 year annual inflation for each year. For example, the historical 10 year annual inflation in 2000 is 1.7% while 2014 is 2.7%.

Unfortunately, data back to 1997 cannot be found yet.

Tree:
How to read the chart
To read the chart, note that when the blue line goes negative, it suggests that the real yield curve is inverting because the blue line is the long term real interest rate minus short term real interest rates. An inverted curve means that the short term 1 year real interest rates are higher than long term 10 year real interest rates, and suggests that in the short term there are more people selling SGS bonds. More sellers suggests that there is lack of liquidity in the system and thus an impending crisis. There are two ways the yield curve can invert:1) Short term rates increase and 2) long term rates decrease. Crucially, if short term 1 year real rates increased significantly, it is a stronger signal because it implies a very sudden change of circumstances such that there is shortage of money in the short term.

In September 2006 to March 2007, October 2009 to November 2009, and October 2014 to December 2014, the blue line when below zero for a consecutive few months.

September 2006 to March 2007
It is hard to conclude that the inverted yield curve in September 2006 to March 2007 is an indicator for the subsequent Great Financial Crisis worldwide because after that the blue line when above zero. During this period, the blue line recovered due to a very significant drop in real short term 1 year interest rates as observed the orange line when down significantly. It remains unclear how to interpret this section of the data.

Further the problems of the Great Financial Crisis did not originate from South East Asia and thus, one should not expect the indicator to predict a crisis in this part of the world. However, despite the indicator predicting a crisis in Asia, nothing of significance happened.

October 2009 to November 2009
This period coincides with the Eurozone crisis when people were afraid that Greece might the European Union. The cause of the inverted yield curve was sudden strong increase in short term real interest rates. Again, the problems did not originate from South East Asia. However, despite the indicator predicting a crisis in Asia, nothing of significance happened.

October 2014 to December 2014
Yet to be seen whether this indicator will work this time round.

Conclusion
Hyperion notes that historical performance of the indicator is not very good in predicting economic crisis in the region. Tree argues that the indicator is working, but due to steps taken by the government crisis has been averted or the crisis was resolved due to external factors or the broader economy is not very linked to the bond market in Singapore. Of course, the inherent assumption is if the economy is doing badly, there are no good investments. This is a bad assumption and is likely the major reason why macro economic, top down research is hard to work out well. In short, nobody really knows which shows how difficult is it to time the stock market.

Comments
Izam on Indonesia
No thoughts as this is beyond expertise of Hyperion and Tree. Nonetheless, it would be an interesting study if we have time.

Life is a game: Can traditional FA still works in today investing world?
Hyperion and Tree both believe FA still works because of the following reasons:
1) The growth of people investing without considering FA is increasing faster than the growth of people investing with FA. Just do a pole among your friends and you'll realise how many people are not doing FA. This is likely to persist because not everybody has the right patience as discussed by Warren Buffet, to do FA. The alpha generated by FA is unlikely to disappear in the long run after the FED normalise interest rates.
2) While FA sounds easy, few truely understand the essence of FA because of the amount of study required in accounting standards, newspapers, trade magazine, and micro economics.
3) FA methods have actually improve overtime especially due to more disclosure in financial reports and advances in micro economics. If you study micro economics, you'll be surprise to find how much the theory has improved and how realistics the models have become to describe business behavior. To start, you may look at last year's nobel prize winner, Jean Tirole, a truely undervalue economist of our time.

If you check out famous value investors in the region like Malaysia, Thailand, Indonesia, and Singapore, you will realise that they have done pretty well. In particular, Hyperion like to study the case of Mr Tan Teng Boo because his track record is public and audited. Best of all, his reasons for buying the stocks are available as long as you subscribe to his newsletter. The amount of research he puts in is a benchmark of how much hard work you need if you intend to hold 10 stocks in your portfolio.

For an alternative, Tree suggests you may read Teh Hooi Ling's new book "Show Me the Money" to study the diversified approach of holding 100 stocks diversified over different regions like Hong Kong, Malaysia, Indonesia and Singapore. This approach has its advantage of buying low PE and PB stocks with minimal research. Risks is reduce by diversification and the returns are in the high 10% for past 10 years which is quite respectable.

If you carefully study Warren Buffet's methods, you'll realise he started with diversified approach and gradually concentrated his portfolio. This is likely because it takes time to gain expertise to be able to bet in a concentrated approach.

Life is a game: With all the volatility in the market due to uncertainties, what is your approach in investing?

Tree says volatility is the friend of value investors as Mr Market will quote you more varied prices for you to invest. If the market is not volatile, there is no room for a stock picker to outperform because the better strategy is to buy the index. Hyperion suggests you consider the amount of information that is publicly available about the company before deciding to concentrate or diversify. For example, in South East Asia, the markets are sometimes smaller than USA or China, and thus there is lack of market research that is necessary for investing. This suggests you may want to use a diversified approach unless you have expertise in that country to concentrate.

Thank You.

Regards,
Hyperion and Tree

Hi Hyperion and Tree. Many thanks for the valuable insight and recommendations. I will go read up on the book you introduce. Personally I like the book Valu Able by Mr. Roger Montgomery and economist wise I am following Mr. Richard Duncan.

(08-02-2015, 06:34 AM)Life is a game Wrote: Hi Hyperion and Tree. Given the current economic situation where a combination of QE causing inflation and low interest rates, and oil prices fluctuating due to rising alternative technology, and political unrest like changing leaders every few years. How do you see the fundamental of companies changing. Even someone as strong as WB has been caught off guard in the supermarket case. Can traditional FA still works in today investing world? With all the volatility in the market due to uncertainties, what is your approach in investing? would greatly appreciate your sharing. Tks.

"Even someone as strong as WB has been caught off guard in the supermarket case. Can traditional FA still works in today investing world?"

The last time I saw similar doubt, was before the burst of dot-com bubble in year 2000. IIRC, value investing was quoted as "out-dated, and not moving with the advances in technology etc etc".

As the past success will never guarantee the future, will this time be difference? I bet on FA still work today, or in foreseeable future. How about your?

Peter lynch said, "six out of ten is all it takes to produce an enviable record on Wall Street". So we will be caught off-guide, but just need to minimize the odd.

(Sharing a view, and have no issue to co-exist with yours)

FA definitely works. Nvm I am just expressing a concern that no one really is concern about.