Global stocks are on track to register the fourth straight month of gains, extending the remarkable sharp and quick recovery from the Covid-19 pandemic-driven lows in March.
This is a market rally that is clearly at odds with underlying economic fundamentals and corporate earnings. We can all agree on the confluence of factors behind the steep gains — unprecedented liquidity from government stimulus efforts, a surge in retail day traders and a lack of viable investment alternatives in a near-zero or negative interest rate world.
While most stocks have rebounded from their earlier lows, there is no doubt that the biggest of gains are focused on select sectors, notably technology and healthcare. Excessive speculation in some of these high-flying stocks is worrying.
The current frenzied retail trading was initially triggered by the lack of alternatives during the lockdown with the closure of gaming outlets and live sporting events. The subsequent market rally then created the perception that “stocks only go up”, as many millennial Robinhood investors are fond of saying.
True, the odds of winning in an up-market is certainly better than placing a gaming bet, where the odds are at best, fair. Everyone is a winner when share prices go up. Of course, when the up-market turns into a down-market, everybody becomes a loser.
It is worrying when new investors are shifting their savings from low-yielding fixed deposits to higher-return stocks without fully comprehending the risks. And even more worrying when the speculation is enabled by share margin financing.
It is not surprising that investment banks and brokers are facilitating the surge in retail trading. The cost of funds has been falling — money is cheap — and loan demand from businesses is weak. Few businesses are planning major expansions amid the highly uncertain global economic outlook and operating environment.
The trouble is, while share margin financing can fuel a market rally, it can also cause it to crash — because as it is, these funds can be arbitrarily withdrawn, no justification required.
This could happen if banks-brokers get jittery over the rally — for instance, when richly valued stocks start showing signs of weakness in momentum. We see this as a more-than-probable event. In fact, all it takes is for one bank to trigger a domino-effect selloff.
Recall the sudden price drop for glove-maker stocks in early June, when several banks moved to tighten their share margin valuations. For sure, the share prices of these glove makers have moved smartly higher since then. But the fact remains that they will be vulnerable to similar “arbitrary” decisions in the future.
It also raises an interesting question. If the banks were to consider a similar move today, would any of their related trading from now till the actual announcement be deemed insider dealing?
The average daily traded value by retail investors on Bursa Malaysia is at an all-time high. Should the Securities Commission and exchange operator introduce rules to protect these small retail investors from the losses that will surely materialise when financing is suddenly cut off? Clearly, here, the banks-brokers hold the balance of power that can unduly influence share prices.
A possible solution is for share margin financing criteria to be made more transparent, thus giving more certainty to investors. For instance, the amount of margin financing, up to a certain maximum percentage, can be capped at two times pre-set share prices. Prices can be reset at fixed intervals, say, every six months or a year. Different sectors can even be given different weightages.
The point is to make the process of fixing the margin amount transparent, not arbitrary as it is now.
There is a certain urgency to this, given the massive rally we have had and excessive valuations for some stocks. Prices that are being driven by storylines can change very quickly.
Indeed, stock prices have been looking a bit wobbly in recent days, as optimism on economies reopening is, increasingly, being met with the reality of economics and resurgence in virus infection cases.
In almost every continent, in the US, South Africa, Israel, Spain, Hong Kong and Australia, restrictions are being reinstated to varying degrees as the number of new cases surges. Even in Malaysia, the threat of a second wave is present, as complacency sets in.
Against this backdrop, we are inclined to shift our portfolio out of growth into more value-oriented stocks, and assume a slightly more defensive stance. Looking ahead, we suspect markets could see more volatility — and perhaps less irrational exuberance — as economic data is likely to paint an uneven recovery.
Case in point: US initial unemployment claims rose to 1.42 million for the week ended July 18, higher than market expectations and reversing the steady decline trend since hitting the peak in late March. This could suggest that worker recalls for economic reopening is slowing, especially in view of the renewed surge in new Covid-19 cases. The unemployment rate remains high at 11.1%.
Tensions between the US and China too appear to be flaring up again and could remain in the headlines running up to the US presidential election in November. It could be a useful distraction strategy for President Donald Trump, following his perceived mishandling of recent domestic hot issues pertaining to the virus outbreak and police violence.
We disposed of our entire holdings in Starbucks Corp and Apple in the Global Portfolio. Starbucks reported a loss for its latest quarter, owing to the pandemic, but expects a gradual recovery over the coming months. We are cautious, however, that the pace of earnings recovery could now be delayed with the resurgence of the virus.
We decided to lock in gains on Apple, which has enjoyed a massive rally in the past few months. We recycled part of the proceeds into Taiwan Semiconductor Manufacturing Co (TSMC) and raised cash holdings to US$43,317 ($59,684).
Sentiment for US homebuilder and building materials-related stocks has been upbeat amid bullish housing data. Builders are reporting rising demand, especially for single-family homes in the suburbs and lower-density neighbourhoods, owing partly to behavioural changes (work from home) resulting from the pandemic.
There could also be some element of pent-up demand, on the heels of movement control measures in earlier months. Homebuyer demand is further driven by the precipitous drop in mortgage rates, which are now hovering around 3% (for a 30-year fixed rate loan), the lowest in 50 years.
Shares in Builders FirstSource, BMC Stock and Home Depot have done quite well of late. We will hold on to these stocks for now.
The Global Portfolio ended broadly lower for the week ended July 29, losing 2.7% and paring portfolio returns to 23.4% since inception. Nevertheless, this portfolio is outperforming the benchmark MSCI World Net Return index, which is up 14.8% over the same period.
All but one stock in our portfolio ended in the red for the week. The big losers include Microsoft Corp (-4.6%), Alphabet (-3.9%), TSMC (-5.5%) and Vertex Pharmaceuticals (4.4%). Only Home Depot finished the week marginally higher.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
