Update 2020-08-11

Some general updates regarding how I'm positioning myself.

I'm still remaining long Calls in some depressed stock - it rallied for a burst in May but it was very short-lived. The risks still remain and the play remains viable in the long term (to recap, I'm looking at next Jan). The virus itself may be more long-drawn than initially expected, but it's ok because the market seems ever ready to reward any good news. Keep riding on the disconnect.

The newer idea is OTM Verticals on pharma stocks, since there's nothing else much to do now.

The curve steepener idea initiated some time ago is now expiring for what is likely a small gain or loss. The curve never steepened fast enough for the index to capture it. The only thing wasted on this trade was the tied up capital but that's easily managed.

In the FX space, it seems like the dollar has formed a mid term bottom and I would go long the USD for a bit here. The EUR rally is no doubt warranted so I won't contest that.

I remain underweight SG stocks - it's quite clear that it's an asymmetric play to the downside - has been since the financial crisis.

I think the next 5-10 years or so, we will have to be more active in managing our portfolios - it's hard to see where returns are going to be attractive in the passive space.

The Way Forward

The rally is firmly in place now despite "common sense" that we should be seeing a 2nd wave down. I've mentioned in previous posts that we should find ways we can position ourselves should the rally happen and I've mainly done that through Calls which I believe give the best risk-reward in this lower volatility environment. VIX was then about 38.

Now that some of the Calls are ITM, I have to increasingly take care of the downside. The risks of another downturn are still there - I am still suspicious of the strength of the rally. Some say it's priced for perfection, and so the surprises are to the downside. Given the lower volatility environment we still find ourselves in, with VIX being at 25, we can consider a few things: (a) buying Puts, and (b) rolling the Calls to further OTM ones. I'm using strategy (b) for individual counters which have seen their prices severely depressed e.g. cruise liners for which I've already bought Calls for, so I don't want to be paying double premiums. Strategy (a) is more for general downside protection on indices.

These are just nascent ideas as of now, spurred by Friday's strong rally. Subject to correction in the future when I've thought through them more.

Price prediction using historical trajectories

Was curious what it would look like if I simply scanned through all of history, look for price movements within the same 60-day window that are similar to current movements, and then see what happened to them 30 days later. The results are above.

Each line is a 90-day price trajectory. I used the first 60 days to fit the pattern to current price movements, and selected the top 14 where the patterns matched the closest. The decimal in the parenthesis is the range of the movement, denominated by the starting price (on day 0). The patterns are filtered such that only ranges of >15% are selected.

Some current caveats: is not a quant study - nothing very rigorous about this nor will I place any bets on it. Another caveat: I simply normalized the frame by min and max values - and simply filtered them to be > 15%, judge for yourselves how representative each move is with respect to the current one (35%).

 

Covid19 Marketview

I'm taking the opportunity to think about the future and while I may not be the most qualified / knowledgeable, I think it's good practice to think about such things and pen them down anyway.

TLDR: I think the worst is still ahead of us, and currently the market is not pricing in the full potential effect of this crisis on the economy.

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22 Mar 2020

TLDR

  • Buy US equities later, prices expected to drop further
  • Buy those with a previous strong run, dominance in space, established, but haven taken a good hit
  • EM like India = Hold, China = Hold
  • Oil exposure ok to hold

 

Will US lose its dominance?

Considering the possibilities of a world power shift.

China is in a good position because they have had the backdrop of having that economic clout, and now they are recovering faster than US. But the world system is still quite entrenched, so I think it will take more than just this slowdown and who is faster to the recovery race to overthrow US. It will take a really crippling thing to happen to the US which renders their systems unusable and forcing the incumbent ‘clients’ to switch. Similar to how UK lost its dominance in WW2, US fortuitously gained. It was nothing UK could do. But that alone didn’t do it – it required a surge of innovation in the US to propel it forward.

So maybe this crisis is not enough. But it could be the start of something.

Maybe China will gain grounds it would never have the chance to gain until now. Not sure where though. It could further consolidate its power in being the engines of the world economy by looking to replace other links in supply chains that are now closed (because they were in Europe). Availability in a desperate time is valuable. It’s just too difficult to predict how, where, and to what magnitude this will happen.

Back to the question, I don’t think it will lose its dominance in the tech space nor will its stock market be left in the doldrums as the rest of the world accelerates. I do believe that the main indices will recover and make new ATHs in a matter of 5 years. That’s because this virus changes economic demand, and that is a temporary thing. It is not paradigm-altering. Consumer demand remains the same – people will still buy the same things after the crisis and use the same services.

I don’t think it will lose its dominance, though I do think that China will close the gap.

 

What are the prospects for emerging countries?

A year or a few years back, it was still a good thing to have because everything else in developed markets were expensive – i.e. both stocks and bonds, and we were hungry for yield. We have been since 2016 actually, leading to things like VIX apocalypse.

But now why would we bother with emerging economies when the developed ones are on discount? Looking at India vs US, both are down about 30% and so the relative value goes to US in terms of risk-reward. I doubt India can recover faster than the US.

China looks good given the above reasons, but it has only declined about 12% throughout this crisis, so in comparison to US it’s less of a priority.

I’m just going to keep IN and CN on a hold for now.

 

What’s the plan for loading up?

I expect this downturn to go further because the curve is just starting for US and probably in the middle or about 35% for Europe. Meaning there’s still some way to go which will really put a dampener on consumer demand and prices should reflect that accordingly.

It seems so far that the way the infection spreads is quite uniform in terms of trend in countries, so it’s not unreasonable to expect the same waves to occur in Europe then US.

Depending on how forward-looking the market is, these could have ALREADY been priced in at this -30% level. But only time will tell as the waves materialize whether the above is true i.e. if it’s not priced in then we’ll see further declines as the infections materialize. If it is already priced in, I expect to see some form of a bottom being carved out. Seeing a bounce in the midst of the wave could be something else (random optimism or some behaviour I really can’t explain) because I’ve yet to see a market so efficiently forward-looking.

Again, many market moves cannot be fully explained – I’ve been stumped quite a few times post-move even with the benefit of hindsight and a plethora of news attempting to explain things i.e. the explanations don’t make sense but more commonly no explanation is given “stocks move higher despite XXX” kind of rubbish headlines.

 

What to buy in US?

Major indices and tech companies. Generally, companies that have been solidly established and have further room to go but have been knocked back by this. Dominating tech companies are good buys to me, at these levels, as these will not be going away anytime soon. They also have the ability to tide through the storm.

Avoid stocks which are discount on discounts – i.e. prices have been falling anyway. A simple filter is to look for 10-year annualized total return and compare that against 1-mth or 2-mth change in price. With filter of some market cap.

 

What about oil?

I was a bit too hasty in getting into oil when it collapsed. It took one more hit from 30 to low 20s, which is my lower end of my range i.e. I really did not think it would get this bad.  I had underestimated the contango also – meaning I cannot roll over my positions without significant cost.

Though I think oil will rise back to more normal levels of $30, there is no way to play this as it is already priced that way for the Dec contracts.

Date USO WTI chg chg beta
Jun-14 38 106
Feb-16 8 36 -79% -66% 1.20
Sep-18 16 75 100% 108% 0.92
Mar-20 5 23 -69% -69% 0.99

 

USO looks decent though in riding spot oil. The contango is built in but at least that’s managed for me.

Funny thing about contango is that market is usually pretty correct – after sharp declines, further months are priced to a premium, and at peaks, they are priced to discount.

This is a reliable signal for the F1-F6 premium too.

What to buy in this recession

Just a quick thought - the last recession saw many financial institutions pulled under. But they were too important to the system, and so many never actually went away. Similarly in this crisis, perhaps we should be looking at the hardest hit sectors and ask: are their share prices reflecting the long term prospects accurately? I will be looking out for 'systemically important' hospitality / travel related companies that have been dragged down too much. It's only a matter of time before consumer demand, air travel, and mass events return. Like banks, they can never go away - they are too important, at least for this era.

Similarly, it would be interesting to see a repeat of 2008 in another sector - i.e. a major hospitality company fails and triggers bankruptcies and selloffs in other related companies and then spread to other less related companies.