Market update - Substantial rise in treasury yields

Update of Treasury yields in the US

2yr Treasury Yields - 0.51%
10yr Treasury Yields - 2.98%
30yr Treasury Yields - 3.88%

What do these numbers means? A rise in yields implies a fall in bond prices. If you have investment in bonds,  most likely you'll see a drop in your portfolio value. Short term yields have already more than doubled from 0.24 to. 0.51.

This also means that interest rates are rising. Those with floating rate loan packages will feel the effect of higher interest rates. If you have substantial loans like housing and car loans, do take note of the impact.

The good news is a rise in interest rates usually signify a economic recovery. Money is flowing out of bonds(which is considered a safer asset) into equities and other more risky assets.

Dry bulk shippers have bottomed out from its low and have risen substantially the past one month. Baltic dry index (BDI) is also rising indicating an increase in shipping freight rates. Will Singapore shipping stocks start to recover as well? This will need to be monitored further.

Reits and property stocks will be negatively impacted by the rise in interest rates. Reits generally have high debt to service ratios which means they borrow a substantial amount of money.  Higher interest rates will impact a reit's profit.

There may be an adverse effect as some Singaporeans are overleveraged on debt. Some with debts of more than 60% of their income. Will there be more loan defaulters and bankruptcy? That we'll not be sure and need to see how the situation develops.

Like my Facebook page to receive instant market updates and notifications of new articles. SG Young Investment is dedicated in helping you to achieve financial freedom.

You can also Subscribe to SG Young Investment by Email

How to pick stocks (Part 1) - Economic Moats

Finally, i'm more free to continue blogging and write up good articles for readers of my blog. Just finished my exams yesterday and looking forward to my Taiwan holiday trip in one weeks time. In the meantime, i'll be starting a series of posts on how to pick stocks. As an economics student, i'll start of with what is familiar to me which is how to analyse a company's economic moat. Many of you may have already heard this term. Read on to find out more.

Introduction
How to know what companies to invest in? This is a question many people will ask. When choosing which companies to buy, we need to know its competitive advantage against other companies. Investopedia defines economic moats as: "The competitive advantage that one company has over other companies in the same industry. This term was coined by renowned investor Warren Buffett."

An economic moat is like a company building a fortress. By having a competitive advantage, firms can continue to have profits in the long run. As a shareholder of a company, you'll also want the company to continue generating profits and cash flow. In this way, the share price can continue rising and dividends will also increase with it.

Category of Industry Competition
In economics class, we learn that there are basically 4 different industry competition:

1) Monopoly Competition
2) Oligopoly Competition
3) Monopolistic Competition
4) Perfect Competition

Monopoly
From the name, you can roughly know what sort of industry it is. In a monopoly, there is only one firm in that industry and this firm has complete control of the market. It is similar to a familiar board game that we play called monopoly. The objective of the game is to buy up all the properties and gain control of the market. This industry has high barriers to entry through legal restrictions, economies of scale and control of essential resources. In simple terms, it means that if other firms or competitors want to enter this industry, it is almost impossible. Examples of firms in this industries are utilities companies which provides water and electricity. Very seldom do we see listed companies which belongs in a Monopoly.

Oligopoly
An oligopoly consists of around 3-7 firms that dominate the market. Each firm has a big market share with few competitors. However, the competition among these few firms are intensive and firms need to constantly have a strategy to stay ahead of competition. There is often a leader in the market among the few firms and others act as followers. Examples of firms in this industries are Telcos. In Singapore context, they are namely Singtel, Starhub and M1. From these 3 names, we can roughly guess who is the leader in the market with the biggest market share.

Monopolistic Competition
There are large number of firms in this industry (30 or more). They offer similar but slightly different products. With so many firms in the market, each firm only has a small market share. Firms differentiate their products through product differentiation by advertising and building their brand name. Examples of firms in this industry are food and beverage companies. In Singapore, we see many different F&B companies. Most of them own several restaurants and fast food chains. An example is Breadtalk which owns a bakery, food court, restaurants etc. It has established its brand over the years and this is a form of economic moat.

Perfect Competition
In a perfect competition, there are large number of buyers and sellers. There is a standardised product. In simple terms, these are markets like foreign exchange market, commodity market etc.

Understanding which category the firm belongs to is important in determining the firms future profitability and how long it can hold off competition.

Building an Economic Moat
We always need to ask ourselves why is the firm suitable for investing? Are profits still coming in and if so is there a threat that competitors can steal away its customers?

There are ways that firms can build sustainable competitive advantage.

1) Differentiate their products from competitors 
For firms in the monopolistic competition, this is especially important.

2) Building a brand
A brand is a form of product differentiation. People tend to look for brands that they trust to determine the quality of their products. A strong brand attracts customers and prevents competitors from taking aways their customer.

3) Offering similar products or services at a lower cost  
If a firm is able to offer similar products at a lower costs, this creates a competitive advantage for it. Firms that are able to do that creates high barriers of entry and makes it difficult for new firms to enter. Airline companies have been driving down costs by offering budget services. Singapore airlines for example, has a fairly new budget airline Scoot. Their planes are old SQ air buses which are much bigger than other budget airlines. In this way, they can have more passengers on board at a time and the price each passenger pays can be cheaper.

4) Creating high switching costs
Firms which provide services and products such as IT systems can create high switching costs. Especially for banking systems, they are so complicated that banks will not want to risk in changing to other systems. In this case, most likely the firm that provides the service will continue providing it for a long time. An example of a listed company in Singapore is Silverlake Axis. They provided integrated banking solutions to various banks around the world.

5) Locking out competitors
Firms can lock out competitors by having regulatory exclusivity and patents for their products. Casinos require licenses and in a country, very few licenses are given out. A firm that has this license gain a competitive advantage. Las Vagas Sands, a well known casino brand has been having this competitive advantage for a long time and are still doing well until now.

Patents can lead to years of extremely high profits for a firm. Breakthrough medical products have patents to protect them. Pharmaceutical companies with patented products will have almost guaranteed profits for many years.

Conclusion
Firms in certain industry will find it easier to make money compared to other industries. In industries where there are many firms, competition will lower market share and in turn lower profits for that firm. This is not good news for shareholders. We need to identify which industry the firm belongs to in order to critically access the firm's profits in the long run.

In the next series, i'll discuss on how to evaluate the profitability of a company using various financial ratios.

Part 2 is now available. Click here to read: How to pick stocks (Part 2) - The profitability of a business

Like my blog? Subscribe to receive updates of new posts by email.
Subscribe to SG Young Investment by Email

Related Posts:
1. Company in focus - Breadtalk
2. Analysing a company - The importance of R&D
3. Quantitative Easing - how it affects the economy and the stock market?
4. Investing Basics - Low Cost Index Fund investing (Passive Investing)

Betting on a recovery?

Will the economy recover? This is something that analyst and retail investors alike have been specualting. There has been much discussions on the ending of QE in the US and this means that the low interest rate environment will end soon. It also means that the US federal reserve is predicting that the global economy will recover and QE is no longer needed. To know more about QE, read my previous post: Quantitative Easing - how it affects the economy and the stock market?

Whether the stock market continues to rise or fall will depend on the economy. If the economy recovers, companies will have higher profits and higher profits most of the time lead to higher stock prices. Investors who bought in early expecting a recovery are still waiting for that day to come. The Stock market has been rather flat this year after the correction in June which wiped out most of the gains in the first few months of 2013. REITS which had generated rather high yields for investors over the past 2 years had either declined or remained stagnant at the top with limited upside. Some investors have sold off reits to profit on the returns. Read: why reits are on a downward fall again?

I'm also betting on an economic recovery. I'm slowly buying into cyclical stocks like shipping and looking at construction companies. Food industries are on my list of investments too which I favour more on companies owning restaurants. What if I'm wrong and the economy doesn't recover? I think it will be even better if stocks fall lower so I can buy them at an even lower value. I do not have all my money in the stock market now. Still have another tranche ready to deploy if circumstances changes.

This post is written while I'm travelling back home on the mrt. Its good that we've living in an age where we can access to the internet everywhere. Information is always on our finger tips. This is made possible by mobile network technologies like the 3G and 4G LTE.This was not possible many years ago. Till then, invest safely and profitably. :)

P.S: My blog has achieved slightly more than 10000 page views since i started actively blogging 1.5 months ago in June. Thank you to all my readers for your support and comments. It has been a great journey thus far. Do let me know if there's anything I can improve on my blog.

Remember to subscribe to my blog to receive new updates of blog post from me by entering your email address at the top right side bar of my blog. :)

Thank you for supporting SG Young Investment

Has Singapore achieved the Swiss standard of living?

Singapore is ranked 4th in the world by GDP per capita surpassing the United States, Hong Kong and even Switzerland. Does this mean our standard of living is higher than the people in Switzerland and Hong Kong?

GDP per capita is calculated by the value of all final goods and services produced within a country in a given year , divided by the average (or mid year) population for the same year.

Source: http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)_per_capita

The world bank ranks Singapore as the 4th and the IMF ranks Singapore as the 3rd. The Singapore government once said that they strive to achieve the Swiss standard of living for Singapore. It does look like we have surpassed Switzerland currently.

However, with such a high GDP per capita, are Singaporeans enjoying the results of this success? Have the hard work of previous generations benefited the current generations in Singapore? Truthfully, our lives in Singapore is much better than in the past. We enjoy the clean environment, a safe place to live and the convenience to travel around. Singapore as a nation has also become very wealthy and in fact the rich are getting richer.

How about the poor? Do they benefit from all these wealth? The Gini coefficient, used widely to measure the level of income inequality in countries, shows Singapore ranking on the high side. Singapore's Gini coefficient was 0.459 in 2012. The highest in the world is Hong Kong at 0.537 and lowest in Norway at 0.256. (http://sg.finance.yahoo.com/news/singapore-income-inequality-rise-dept-135226813.html)

This shows that the rich are getting richer and the poor stays poor or even poorer in Singapore. As the cost of living rises, the poor have even a harder time to adapt to the rising cost of living. There are people earning less than S$800/month in Singapore.

We are no doubt already a developed country. Should we be relaxing like the rest of the developed countries like Switzerland and Norway and enjoy the fruits of our success? If you go to Switzerland, their city is not so crowded and the pace of life is much slower as compared to Singapore. Even in developed countries like Australia, they enjoy retirement and welfare benefits and they have short working hours. Most of the shopping centres close by evening 5pm in Australia.

In my economics class this week, we discussed on this issue. One reason Singaporeans still need to work harder is because of our small population and a lot of workers need to play multiple roles in their jobs, also known as multi task. One way to solve this problem of labour shortage is to increase productivity. Switzerland population is small at about 7.4 million currently. Singapore has a population of 5.3 million. But Switzerland's productivity is much higher than Singapore.

    

Singapore's productivity has been declining according to the ministry of manpower. This is a concern for the government and they are increasing efforts to increase the productivity level in Singapore. If productivity increases in Singapore, we should see shorter working hours but still producing the same amount of output or even more. This will enable Singaporeans to have a better work life balance. With productivity at a negative now, Singaporeans are working longer hours and doing more work but not producing much to sustain our economic growth.

If we compare the productivity of Australia, we can see an increasing trend as shown below:
 

Now, this may be the reason why they can have a slower pace of life, shorter working hours but still a growing economy. Switzerland's productivity level is even higher than Australia at more than 107.

  

We are no doubt ranked higher than Switzerland in terms of GDP per capita but our productivity levels is still far from those of a developed nation. I do think that Singapore is on the right track of training workers to have better skills and increasing productivity. We cannot belittle the negative effects of slower economic growth. It does affect the country and also individuals living in it. Look at the situation in Europe especially Greece, Portugal, Spain and you will know.

If we want to have a better work life balance but still strong economic growth, working lesser but producing more is the key. Technology plays a big part in this. We should increase our skills, learn new technology to enable us to be more productive. Singapore has no natural resources and a big portion of our economy is generated through the services sector. Financial services is important to a country like Singapore as a lot of money is invested in Singapore.

Increasing our financial knowledge and learning how to manage and compound our money makes the economy grow as cash flows through the economy. In finance classes, we learn that a good financial system is vital for businesses to grow in a country as funds can be raised through the bond and stock markets and liquidity can constantly flow in the economy. We can help to increase the financial literacy in Singapore that many people can benefit from good money management habits.

Analysing a company - The importance of R&D

Just ended my economics class awhile ago and there were some interesting discussions today. Some of the discussions include

1) the problems of ageing population in singapore, 

2) the restriction of foreign workers by increasing foreign worker levy

3) why singaporeans have to retire later as retirement age is constantly increasing.

All these are big topics and it has been debated for the past few years in our homeland, singapore.

So what has this got to do with our analysis of companies to invest? I think as our economy becomes more competitive and we face a shortage of manpower due to ageing population, companies need to restructure the way they do their business in order to stay competitive.

The restriction on foreign workers has impacted businesses in singapore already especially in the f&b sector, the services sector and construction sector etc. Why is the government imposing a higher levy on each foreign worker hired? Won't this increase the cost of the company and result in lower profits?

Yes, it will impact firms greatly especially those that rely heavily on cheap workers. The purpose of this policy is to increase the productivity of firms especially SMEs. In a way, it forces the company to use technology and rely less on workers. If you study economics, you'll know that for a developed country like singapore,  we cannot increase economic growth substantially by increasing capital or labour as developed countries faced a phenomenon called diminishing rate of returns. Developed countries need to grow by increasing technological change which improves productivity.  That is the direction that the singapore government hopes to steer the country into.

Technological growth is costly. Firms who can outgrow competitors are mostly those who invest in research and development (R&D). If you look at most of the successful firms in the world,  you'll realise that most of them invest greatly in R&D. Google and samsung are such examples. The amount they invest in R&D is enormous.

How about firms in Singapore?  Food and beverage firms face higher manpower cost due to tighter foreign labour policies. Breadtalk for example has invested in a new office building which they just moved into. Their central kitchen is located there together with their offices and they have a fully automated production line for their bakery in that building too. This helps to save cost for them greatly. The new building also house their R&D department which they are focusing a lot into it.

On the other hand, if a company does not constantly innovate and change the way it does its business, it may lose out to its competitors and even big market leaders like Nokia which was considered a giant in the telecom industry, is facing huge losses year after year.

We can have many ways of analysing a company and I think one important factor to look at is how much the company is investing in R&D. This will help the company to continue growing and have a sustainable business model.

Why Singapore REITS are on a downward fall again?

Today REITS listed in the Singapore stock market are declining again. This is a screenshot i took from SGX

This is getting unbelievable as reits has fallen over 20% in the last few weeks. Today the top declining reit is Suntec with a fall of 4.56% in a single day. 

Let's take a look at some charts:

They do look like they are jumping off a cliff and still in a free fall mode. All of the big names like suntec, mapletree are officially below the 200DMA which is the long term trend line. 

Why has it fallen so much? This is mainly due to the concern of an increase in interest rates in the US. In fact if you track the interest rates in the US, it has already risen by a lot. Even interest rates in Singapore are rising. REITS are highly leveraged in a sense they borrow a lot of money sometimes about 30% of their equity. Once interest rates goes up, they are faced with higher loan interest payable. Two rates to track in Singapore is the Singapore interbank offer rate (SIBOR) and Singapore Swap Offer rate (SOR). Bonds are being sold off aggressively both in the US and Singapore causing yields to go up. Bond prices and yields move in the opposite direction. 

Below is a chart of the 3 month SIBOR rate for the past 12 months ending may 2013:

This is the rate that banks lend to each other. Local housing loan interest rates track movements to the SIBOR. If this is increasing, home loans interest rates are increasing in Singapore also. Those taking up a housing loan have to watch out. Either take a fixed rate loan or take a loan from HDB which offer a fix rate at 2.6% currently.   

Below shows a comparison of the 3 month SOR vs the 3 month SIBOR:

This is the average cost of funds used by banks in commercial lending. In Singapore most banks offer housing loan packages either pegged to the SOR or SIBOR. This is like a "cost price" to them and they add a margin to earn a spread.

The essential cost of the rising interest rates globally and in SG is the potential ending of QE in US.

You can read my previous post on QE and why it affects interest rates here: 

Quantitative Easing - how it affects the economy and the stock market?

Elsewhere in the biggest asian country, China, they are facing a possibility of a credit crunch. There are fears that the china banking system may run out of cash soon and face liquidity problems. Shortage of funds cause banks to raise interest rates. China key stock index closes down 5.30% today as reported by channel news asia.

The recent market correction is an opportunity for bargain hunting of good stocks. Choose stocks which are not highly leveraged on debts and have cash to invest and ride on the recovery in the economy. Examples are shipping and industrials. In fact, banks will also benefit from the increase in interest rates as they can charge a higher interest rates on their loans and transfer the risk to borrowers. The only worry is that there will be people who will default on their loans due to over borrowing. 

I have been anticipating this interest rate movement since last year. This is a good experience for me to see what happens and learn from it.   

Quantitative Easing - how it affects the economy and the stock market?

A 2 day fed meeting ended yesterday with US federal reserve chairman Ben Bernanke concluding the meeting. This is a very important news every investor was waiting for as it determines the next step of action for most investors.

QE
So why was it so important? The discussion was on the hot topic for many years: QE. Quantitative easing or QE is a bond buying program that the fed has been implementing for the past 3 years. They will go into the open market and buy up bonds in an effort to keep interest rates in the economy low. A lower interest rate stimulates more loan lending activity and thus provides ample liquidity in the economy.

However, yesterday, fed chairman Ben Bernanke said that: "The Fed will probably taper its $85 billion in monthly bond buying later in 2013 and halt purchases around mid 2014 as long as the world's largest economy performs in line with Fed projections". (Quoted from bloomberg news)

The Fed also said that it is confident that unemployment will lower down to 6.5% soon. Currently unemployment in the US is still above 7%. With such strong words, the market got a clear direction and sold off aggressively wirh the Dow Jones index declining 200 points. Asian markets are selling off also at the moment with most asian indices declining more than 1.5% and STI declining -68 points currently.

Interest rates
With interest rates expected to rise later this year, banks,  property stocks and reits are the most affected. Reits and property stocks have already sold off 2 weeks ago and is still on a decline currently. As interest rates rise, loans become more expensive causing lending activity to decrease. Reits have already sold off around 15-20% the past few weeks mainly because institutions like goldman sachs are selling. Why are these institutions selling off? The reason is most institutions borrow money at low interest rates to buy into reits with high yields. This is called a carry trade. As interest rates rise, the value of yield asset reduces as institutions have to pay higher interest rates.

Opportunity is here
My view on this is that the sell off is an opportunity to pick undervalued stocks at a bargain. Interest rates will only rise when the economy starts picking up. It is actually good news but the market sees it as bad news because we have been so reliant on a low interest rate environment for many years. Since we know that the market is always irrational in the short term, this gyration now presents a perfect opportunity for investors who know how to pick companies to buy.

As the economy recovers, cyclical stocks like shipping, industrials and banks will perform well. Most of the sectors that have underperformed in times of low growth will start picking up from here. During recessions and periods of low growth, defensive stocks like medical, telcos, reits tend to outperform the rest. Now the tide is changing.

As the US economy recovers, import and export activity will start to increase. This will benefit shipping companies greatly and many will turn to profit from loss currently. Dry bulk shipping has seen shipping rates picking up as the baltic dry index (BDY) gradually increases from 790 to 995 currently. The index was at a high of 9000 before the financial crisis in 2009.

Apart from the economic news, the main news that encompass our lives in Singapore now is the haze condition. For the past 3 hours, the PSI reading has been above 300. Please take care of your health and stay indoors as much as possible.

One more day to the weekends. Have a great week ahead and invest safely!