The US dollar weakens.

This is because a vast sums of money is pumped into the main street and financial markets to prevent a financial calamity.

There are some possible repercussions. These are possibilities and not definite:

• There are evidence to suggest the weakness in the US dollar is gonna last longer
• Whether there is inflation or weakness in the currency would depend on each country’s central bank’s response
• Equity markets remains more attractive than bonds
• Ex US markets looked more attractive than US
• Cyclical stocks, value, and small caps look to do better in this climate based on past data.

Market Sentiments Remain Surprisingly Bearish

Even after the run-up in market indexes, according to the widely followed AAII survey, sentiments are pretty bearish still.

Market Value of US Stocks versus the World GDP Provides some Clues to Performance

With the stunning rise in big American tech stocks, the U.S. portion of this global equity market capitalization is nearing all-time highs.

The chart above shows that the market value of US stocks as a percentage of world GDP are at an all time high. In the 1960s, the US stocks have started to underperform stocks in other parts of the world by the time this index peaked.

CAPE Indicates the Valuation of US and Ex-US Markets

I was still wondering a few days ago how I could get my hands on the latest cyclical adjusted price earnings (CAPE) ratio of different countries. Lo and behold I found it in this BCA research.

The CAPE ratio provides a slow moving snapshot of the valuation of different countries. We can then compare to the CAPE for the countries/regions in it’s past history.

From the top chart, it seems US is more expensive then global valuation. The theme for the past 10 years is growth, what is more expensive will get more expensive.

While US, global and global ex US valuation have gone up, the valuation in the rest of the world is less excessive.

In fact based on the 32 year sample, the valution for rest of the world is rather cheap.

The bottom chart shows the cyclical-adjusted equity risk premium or the risk in the market over the risk-free rate. The equity risk premium tells a similar story in those countries other than the US, as a collective is still risky and therefore may command a higher return going forward compare to the US.

The Dance Between Fiscal Deficit, Inflation, Currency and Interest Rates

The charts above shows the interest rate differential and its affect on the value of the USD versus each country’s currency pair.

For example, the Euro area 2-year real rates were 2.21% below the comparable US real rates. Today, they are 0.19% higher than the US real rates. The relative higher EURO area interest rates have an effect on the demand for Euro vs dollars, in favor of selling dollars into Euro.

What we are seeing across various currency is that the real yield spread between US and other country rates is weakening in favor of the foreign currency. The effect might be a weakening of the USD.

One thing most facinating about this report was the education that I get on the dance between interest rate, inflation and the currency exchange rate.

This is probably something that I should revisit often.

Suppose the interest rate and inflation are initially the same in Country A and B but A suddenly and unexpectedly decides to run a larger budget deficit for the next 10 years.

What will happen to the value of A’s currency? It is not so straight forward. The result will depend on how A’s central bank reacts.

Scenario 1 shows that A’s central bank will not hike the interest rates at all in response to the larger budget deficit.

• Annual inflation will rise by 2% over the 10 years due to additional aggregate demand from easier fiscal policy.
• The price level in A will end up 20% higher than previously at the end of the 10 years
• The currency of A will fall immediately by 20%. The fall is immediate rather than 2% fall a year is that we are assuming A and B’s interest rate remains equal

Scenario 2 differs from scenario 1 in that a immediately move to neutralize the stimulative impact of a larger deficit by hiking interest rates by 2%.

• No net impact on aggregate demand, therefore inflation expecations in A do not change
• A’s currency immediately appreciate by 20%. Appreciation is necessary to create the expectation of a subsequent 2% a year depreciation in A’s exchange rate
• The slow currency depreciation in A offsets the 2% rise in interest that A’s bonds pay over B’s bonds

Scenario 3 shows what will happen if all else being equal we do it half way.

This is for one country with a lot of assumptions. If we have multiple countries, and a lot of assumptions, you wonder what is the net effect. This would explain why we need not always see high inflation.

Stocks over Bonds When Dollar is Weakening and Global Growth is Strong

Global equities have generally outperformed bonds when global growth is strengthening and the US dollar is weakening.

The Strong Correlation of Dollar and Certain Specific Factor Performance

For the long suffering non-US stocks, stocks that are more cyclical, value stocks and small caps, they tend to do better in a weaker US dollar environment.

While the sample is small, notice the tight correlation with the US dollar.

The interesting thing I did not realize that other than value and small factors, there is a disturbing trend between cyclical and defensives. Relatively speaking, the value of cyclical companies, value, smaller companies looks cheaper.

Conclusion

In the years where US dollar is weak, foreign stocks have advanced 85% of the time, emerging market stocks have advanced 65% of the time.

Gold on the other hand is up only 42% of the time.

Can the cheap get cheaper? Possible.

It would be interesting to revisit this post 3 years from now to see whether this time is really different. Not just value vs growth, there is a narrative of small versus large and cyclical versus defensive which is lesser in the news.

Based on what we have discuss today, taking a concentrate bet in a narrow slice of the market is a form of speculation and I would hope that you are able to do deep research if you are thinking of computing large amount of your net wealth.

The alternate way to hedge against possible inflation is perhaps equities in emerging counties. They produce commodities and if there is a demand for the commodities, these countries are likely beneficiary as well.

The problem is…. they look poor for a good 10 years and it is hard to put money in something that looks ugly.

I think the investment crowd will turn when it is time to turn.

You cannot fight human nature. The retail investors, and the institution investors cannot afford to missed out on where the potential outperformance is.

Not investing in Ex-USA is a bet that things will continue like it is now. Investing exclusively in Ex-USA is to take a contrarian view.

The alternative is to have both to capture the returns of an expensive market and a cheap market.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

There was a time in my previous job that I had to take some system safety course.

A system safety course are courses where the participants learn how to design systems that are sound, putting safety as a priority.

System safety courses are dry shit. A lot of us don’t like it. Software safety are even worse. You learn ways to code software that puts safety as a priority.

I do not like to look at codes. As a support engineer, I was glad that most of what I had to do are look at codes and not code them.

Despite how much of a chore it was, deep down we know if we fxxk things up, its not just about losing our jobs.

In the system safety course, we were told of how an actual aircraft crashed.

The pilots observed that parts of the software system controlling the plans were abnormal.

Their training taught them that in the event of such issue, go through a list of steps to remedy the situation. If those remedy fails to fix the problem, reboot the system.

So one of the pilot rebooted the system.

The problem was… there was a glitch in the software pathway. When the system rebooted, the software checks a few conditions before they proceed to the next phase of the software.

If those system conditions are not met, the natural system result is to…. reboot the system.

When the system rebooted, the system conditions were in such a mode that it will not allow the system to proceed, so the flight system kept rebooting…. and rebooting… and rebooting…. until the whole plane crashed to the ground.

This case study seared into my brain that you can design very nice systems by following the best practices out there. But when it comes to systems that are safety-focused, those best practices could be rather dangerous.

How Safety Critical Should a Finance App Be?

I am sure you must have came across the story of Alexander Kearns.

Alexander Kearns threw himself in front of a train. Kearns left a note which indicates that he was distraught and confused over his Robinhood account.

Kearns, 20, was using the very popular app Robinhood to trade options.

When he saw that his balance was -$730,000, he lost it.

When I saw the headline, I thought it was one of those kids who punted on some of those near-bankrupt stocks like Hertz and go very wrong.

It was nothing like that.

Kearns’ cousin-in-law Bill Brewster originally thought that Robinhood had improperly granted Kearns vast amounts of leverage to trade with.

When Bill tweeted this out on Twitter, some twitter users alerted him that options traders on Robinhood sometimes see a negative cash balance until the other half of their trades are executed.

Now most believed Kearns died over nothing.

“My sense is that it was all over nothing. It was a user interface issue,” said Brewster.

Robinhood since then has acknowledged the problem and announced changes:

1. Roll out interface improvements on how the buying power is displayed
2. Make improvements to its in-app messages and emails that get sent to customers about options transactions
3. Changes to the in-app history page to help users “understand the mechanics” of options trades
4. “Considering” additional criteria and education for customers that seek authorization to trade sophisticated options to help them understand how they work

Bill Brewster Asks Some Hard Questions of Robinhood

Alexander Kearns story got so viral, in part because of his cousin-in-law.

When I came across the story, I did not pay attention to the cousin-in-law.

However, I had listened to a podcast his cousin-in-law was on.

The Acquirers Podcast is a podcast by Tobias Carlisle. On the show, he interviews many investors and if you subscribe to the podcast, you will be able to catch certain nuances of individual stock investing, particularly the traditional value investing approach or portfolio management from many of the episodes.

What I really dig about the podcast was a weekly segment called Value: After Hours. Tobias is usually joined by Jake Taylor, CEO at Farnam Street Investments, an independent firm managing $17 million in individual accounts as well as Bill Brewster, who runs family firm Sullimar Capital Group.

Through their interactions, listening to why they decide to purchase, discard certain holdings, and their opinions on various aspects of fundamental investing, you can grow overtime.

The latest episode of Value: After Hours was very weird for me because I was enjoying the light-hearted interactions between Tobias, Jake, and Bill.

Suddenly (you can listen to the episode here), Bill decided to warn us that if we do not want to be bothered by some “personal family drama”, we should tune out that at that point (start at 42 min of the podcast).

I did not get the relation until the point when you hear a grown man starts weeping while reading through the letter.

It was such a hard part to listen to.

This is especially so when for the first 42 mins of the show, you did not detect any sadness coming from him!

That was when I realize HE was the cousin-in-law.

Through his half weeping commentary, Bill raised some notable comments:

1. “I see an ad saying how Robinhood’s app has gamify investing. How the founders are proud of their design features.”
2. “How about you design an internal settlement figure into the background function rather than the home screen. Even an experienced trader referred to that as an alarming sight.”
3. “In what world is it OK to show your users a negative balance of -$730,000 when you know a lot of your money is retail money?”
4. “Why is it that kids are able to get that notional exposure at all?”
5. “What is it about your product that made my (Bill) story go so viral?

“You name your company Robinhood obviously to draw some images of wanting to help the less fortunate. You allegedly gamify investing and democratize trading. That is not good for society and it is toxic. You claim to enable people by granting access but you really make money incentivizing orders so hedge funds can front-run clients. That attitude gives finance a black eye and it is the type of stuff that gives Elizabeth Warren a leg to stand on.

Some Finance Stuff Stayed Complex No Matter How You Dumb it Down

I think that whether you have a new age platform like Robinhood or a traditional account with Fidelity, Charles Schwab, or Interactive brokers, you cannot stop human’s animal instinct to gamble.

During this period, if you give people support checks in their mailbox, a lot of time, and a volatile stock market, you can expect the animal instinct to come out.

But there is something very unassuring about these new peer-to-peer lending, roboadvisers platform that the old birds might find it hard to get used to.

They abstract many of the complexities and make things so much streamlined, so much easier.

In a lot of aspects, it is good. Youngsters and old birds alike have an aversion to complexities. Finance has a lot of complexities (sometimes the industry deliberately made it that way to enable them to charge more) and this turns off people of all age groups from investing.

Simplifying things gets more people that wish to invest but find it hard to start investing.

But fxxk. For some things, it make sense to be hard.

Can you imagine a 20 year old university student trading futures and upon expiry, they didn’t know they need to take delivery of a few barrel of oil?

Going back to my flight system example, while the systems can fly a plane on their own, the pilots are trained to understand the system as well as fly the plane if the system breaks down.

There is a barrier to becoming a pilot for good reasons because the plane cost a lot of money, there are a lot of lives at stake. There are risks involved.

Options is a form of derivative and margin is borrowing money.

If you do not know them well enough, they can blow up in your face. Even if you are an experienced trader, they will still blow up in your face because they interact with markets.

While most of the time markets can be very predictable… we know very well this year that markets can switch rapidly. You may have a great trading algorithm that you have extensively backtested. Yet, the unpredictable nature of the markets may create a situation your algorithm is not build to handle.

There should be enough oversight in certain areas of finance that is complex enough that people who do not wish to get educated or lack the necessary competency.

Products Evolve for the Better Over Time But We Should Prioritize Certain Aspects of Products Above All Deliverables.

The decision on systems and product design lead to this unfortunate incident.

These decisions sometimes is not a simple thing.

At my work in Providend, my first draft of the tool to the advisers or the clients (some of you might have seen my handy work) always looked overloaded with stuff.

It took many iteration of internal deliberations on whether

1. We want to show this to the clients
2. Can we show more of this to the clients
3. I think it is better to present this data in this kind of chart
4. Will they get the wrong impression about things if we show them this

Going back to the drawing board is damn frustrating. Sometimes you get hot inside because you put in enough thinking and its back to the drawing board. Maturity is when you realize that if you put out something slip shot, the whole firm gets more problems because you create more misunderstanding with the clients or the adviser.

Given all this, all the materials in the financial planning process often are an iterative process. There will always be things you missed out and bugs here and there. We get a version that is deliverable and keep iterating.

It is just the way it is. We are not perfect.

As a company, you can put priority to certain aspects of the business. If I remember correctly, in the book Good to Great, a CEO turned around his company by elevating the emphasis of safety in his company.

Why that worked out is because to be a very safe company, it requires everyone to be conscientious, accountable, and communicate well.

I do not think a trading app is classified as safety critical. However, I think poor design, leads to poor communication, leads to misunderstanding, and a whole lot of other problems.

But sometimes you got to wonder the motivations of these startups.

They got this grow at all costs, hacking mindset that they would just close an eye to some stuff.

And it might lead to incidents more incidents like this.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

DBS has a pretty good report out which shows some of the “stress-test” they put the REITs listed in Singapore through.

For those serious in investing in REITs, this is a good blueprint how you can assess the defensiveness of REITs in times of stress.

This kind of assessment is very quantitative and should not be the only way you assess the REIT’s defensiveness. You have to layer the qualitative aspect as well.

Let me share some of the main takeaways.

The Metrics that DBS uses to Measure Whether Each Singapore REITs Will Survive Better

Firstly, we have to be clear what they mean when they measure the survivability of the REITs.

I do not get a clear statement from the report but after reviewing the report, a REIT survives better by coming through this testy period in a much better condition than before they enter it.

1. They have enough cash flows after paying all the necessary expenses so that they do not need an additional external capital injection
2. When their assets are re-valued downwards, their overall debt to the asset is still within the MAS gearing limit (now it is at 50%)
3. The lower amount of debt that needs refinancing in the short term
4. Able to sustain the dividends better
5. Most importantly, investors have less risk that they will need to inject equity capital by way of rights issue into the REIT, to shore up capital when no one wants to loan them money they really need

These are more fundamental measures and less about the stock price. However, stock price tends to reflect over time the health of the REIT.

Key Metrics Show the Singapore REIT Sector is in a Better Shape Than the Previous Downturn

DBS compares current REIT sector industry metrics against the 4 years before and after the Great Financial Crisis (GFC) from 2007 to 2010.

DBS noticed that during the GFC:

1. Interest coverage ratio remain stable at greater than 4.0 times
2. There are more stress on the balance sheet
3. Asset valuation decline by 2% to 15%
4. Office sector was the most hard hit

Currently, the overall sector is in a much better position:

1. The gearing level was similar to 2007
2. Interest rate today is much lower
3. REIT sector enter this challenging period with a lower portfolio encumbrance (this means that the amount of debt secured against their properties is lesser. That means they have more properties unsecured to collatorised during refinancing shoudl they need it. Financing companies find you less risky if the debt is secured with properties. In the event the REIT defaults, they can possess the property)
4. With the recent changes to the MAS leverage limits from 45% to 50%, this provides greater flexibility for the REIT to manage their capital structure in times of financial stress

Personally, when I reviewed DBS’s data, it does not give me the idea that current situation is much different from the previous years they compared against.

If we are in a bad shape back then, the data does show that we are in a bad shape now. Vice-versa.

The only takeaway is that this may be reflective of the overall health of the larger REITs. These larger REITs will shape the table above. It seems to tell me things are not so different for the larger REITs compared to back then.

DBS’s Framework for Stress Testing the REITs

DBS decided to put our REITs through some stress tests.

These are their parameters:

DBS look at

1. potential asset devaluations on gearing level
2. lower cash flow on interest coverage ratios (ICR)
3. whether a REIT will breach DBS’s more conservative leverage threshold of 40% after their property devalues 15%
4. trading below revised NAV (assuming that the REIT needs to be re-capitalized with a rights issue)

And the results is below:

So the more green ticks each REIT have, the better they will emerge oiut of this.

We can see some with 4 to 6 ticks:

1. SPH REIT (6)
2. Capitaland Mall Trust (5)
3. Lendlease Global (4)
4. Mapletree Commercial Trust (4)
5. Ascott REIT (5)
6. Ascendas India Trust (5)
7. Mapletree Industrial (5)
8. Keppel DC (5)
9. Prime REIT (6)

Then there are some REITs that have 1 tick or less:

1. Suntec REIT (1)
2. ARA LOGOS (1)
3. ESR REIT (1)
4. EC World (1)
5. Manulife US REIT (1)

1. Which Singapore REIT have a More Conservative Capital Structure?

A lower gearing limit:

1. Gives financial flexibility to tap debt capital markets if needed
2. Cost of funds is cheaper
3. Ability to leverage up to acquire distressed assets

2. The Interest Coverage Ratio Test

The interest coverage ratio test is one that I appreciate less because…. I omit a situation where a REIT, with a diversified tenant base… can suddenly have no income…

DBS stress test the REITs by cutting the REIT’s EBIT by 50% and 75%. What DBS got is a “cash-backed ICR”

They assume that every quarter of delay in collections will lower the EBIT by 25% . In the even of a 6-month and 9-month delay, this will reduce the EBIT by 50% (unlikely) and 75% (highly unlikely).

In this higher stressed scenario, the ICR range is reduced to 1.1 times to 7.9 times. With a 9-month delay, some ICR can go below 1 times.

This stress test is good, but in reality it is very broad stroke. Some type of REITs such as office should be less affected such that their EBIT broadly falls by 50% and 75%.

So you do have to be a bit qualitiative about it.

Out of the troubled hospitality and retail REITs, SPH REIT and Lendlease looked particular strong despite this very stressful test.

3. Which Singapore REIT is More Sensitivity to Decline in Valuations

While the REIT managers did not give clear indications, history tells us that it is likely the REITs will face a decline in valuations.

DBS tested the REITs gearing levels to a 5%, 10% and 15% drop in valuations.

All S-REITs did not breach the 50% gearing limit set by MAS. However, if we use DBS’s more conservative 45% threshold the following REIT would touch the limit first:

1. OUE Commercial
2. Suntec
3. Far East Hospitality REIT
4. ARA LOGOS
5. ESR REIT
6. Mapletree Logistic Trust
7. Soilbuild Business
8. EC World

4. Which Singapore REIT can Sustain the Dividends with the Help of Short-Term Debt?

DBS stress test the REITs ability to sustain the dividends by temporary take on debt. This would corelate to the REIT’s individual debt levels and gearing limits:

The Singapore REITs could maintain the dividends, but some of the REITs will break a 40% gearing level.

5. Which Singapore REIT Trades Below NAV Even After Potential Decline in Value?

Since DBS stress-tested the Singapore REITs with lower valuation, they also presented the data in terms of attractiveness in terms of valuations.

One of the risk in investing is to use historical data and come to a conclusion that this stock is cheap. The right way to do is to do what DBS did, which is assume a discount in value that may happen and see which one still look attractive:

Those that are highlighted in green are the REITs that, after a decline in portfolio value, still has a net asset value (NAV) per unit higher than current REIT unit price. This indicates even after both price decline and NAV decline, the REIT looks attractive.

On a NAV basis, DBS believes that many REITs are trading at an implied 15% decline in portfolio valuation.

Capitaland Mall, Starhill, and Lendlease are trading at a greater than implied 15% decline in portfolio valuation.

6. Singapore REIT Re-capitalization Risks When Property Value Declines

When the REIT portfolio decline in value, the gearing level increases.

Some REIT might potentially need to raise capital via rights issues, placements.

This will dilute and reduce your dividends because you are not buying properties with this capital but the number of shareholders increases to share the same pot of rental earnings.

DBS stress test this by simulating:

1. the REIT does an equity fund raising if gearing goes above 40%
2. the rights issue is priced at a 25% discount to current trading price

The REIT highlighted in green are the REITs that after a 15% decline in portfolio value, they did a necessary rights issue, and their NAV per unit is still higher than current share price.

Based on DBS’s assumptions, 50% of Singapore REITs in their coverage will not require any equity fund raising even if property valuations fall by 10%.

If property valuations drop by 15%, those that need to recapitalize will see their NAV per unit drop by 23% to 34%.

10 of them are trading at prices that are even below the revised NAV. They are mainly in the retail and hospitality sector.

The table above shows the potential effects of the equity raising dilution on dividend yield. With the rights issue, the DPU should be diluted.

However, even after that decline scenario, some REITs are still trading with a dividend yield that is higher than their 10-year historial average yield.

Those are highlighted in green.

On average, the dilution on DPU Yield is about 1% – 2%.

The Singapore REITs that potentially will experience the largest declines in DPU Yields are:

1. ARA LOGOS (1.3% decline)
2. ESR REIT (1.3% decline)
3. Soilbuild Business (1.1% decline)

For some, even after this decline, the REIT is still traded at attractive yield.

Last Word

I feel that DBS tried its best to provide some rational negative operation assumptions.

They did a lot of hard work there and we got to thank them for that.

In this whole exercise DBS is trying to help us assess, based on current price, what are some of the scary stuff that may have been priced in.

It is to help us see in the spectrum of very undervalued to very overvalued, where each REIT is right now.

However, I believe the markets and fundamentals are rather fluid here as well. When the property value actually goes down, the share price might react very negatively, forward pricing in a potential rights issue.

If it looks attractive today, when the event happens, it might look even more attractive.

Of course, if these valuation declines do not happen, then you missed the boat.

Some investors will look towards this for attractive mis-pricing. Others will use this as a way to assess their Singapore REIT on the risk spectrum better.

Let me know which REIT caught your eye or some realization you have after this review.

I have a FREE REIT Training Center. The link is below.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works