On Target Newsletter

In this issue:

  • The virus
  • Threat of recession
  • Climate policy crisis
  • Guarding against market crashes
  • Chips war
  • Burden of government
  • Investment opportunities
  • Singapore metrics

Anti-Virus Measures Now Killing More Than Covid

There’s increasing evidence that the delayed consequences of lockdowns imposed by governments to combat Covid-19, with the almost complete support of political parties, scientists and mass media, could now be killing more people than the virus itself.

Britain’s Office for National Statistics is reporting around a thousand a week of “excess” deaths – that is, from diseases other than Covid, above and beyond the normal level to be expected, judging by historical experience.

In America similar data is emerging. Academics at Duke, Harvard and Johns Hopkins universities have concluded that there could be around a million excess deaths in the US over the next two decades as a result of lockdowns. Stanford’s professor of medicine Jay Battacharya says that in years to come lockdowns will be looked back upon as the most catastrophically harmful policy “in all of history.”

The excess deaths are blamed on delays to and deferment of treatment for life-threatening conditions such as cancer, heart disease and diabetes. People were unable to get treatment when they were ordered to stay at home. In the UK, for example, its first lockdown resulted in a 33 per cent fall in diagnosis of early-stage cancers.

It’s estimated that by the end of this year the number of non-Covid excess deaths will exceed those from the virus for the entire pandemic.

The National Health Service is still trying to clear an enormous backlog of treatments and appointments created by the lockdowns. Last month a record number of patients – nearly 30,000 – were forced to endure 12-hour waits for treatment in hospital accident and emergency departments.

The damage caused by lockdowns went far beyond medical suffering. They had little or no favourable impact on mortality despite their enormous economic and social costs. Millions of small businesses were ruined. We are starting to see the long-term consequences of children denied adequate education.

“Considering the endless ways in which the pandemic and our response to it have changed the lives of every human being on the planet, it’s astonishing to consider how little is actually known about the origins of the virus,” comments ZeroHedge. Efforts to get to the bottom of the mystery have been “systematically thwarted” by the world’s two most powerful governments: America and China.

Global Imbalances Magnify Threat of Recession

The biggest theme for stock-market and bond bulls has been the fountain of liquidity gushing out of central banks for the last 14 years. That has compressed yields and boosted the share valuations of companies that make the best use of cheap capital. But the situation is changing as central banks raise interest rates and withdraw their support from bond markets. It’s why valuations of high-growth giants have been falling.

As liquidity becomes more expensive, that “favours the outlook for companies that have clear visibility on revenue growth, Eoin Treacy says in FullerTreacyMoney. Those are more defensive sectors like pharmaceuticals, consumer staples and energy. It is generally a very-late-stage phenomenon. That suggests the potential for a deep recession to correct the anomalies in the market is becoming progressively more likely.

“The surge in liquidity during the pandemic was designed to support demand [in economies]. It worked. China’s exports surged to new heights, and even then could not keep up with orders. The supply bottlenecks are as much about outsized demand as an inability to keep up or expand quickly enough to avoid bottlenecks.

“The lack of investment in both onshore and offshore oil supply over the last half decade has placed control of the market back into the hands of OPEC+. They have every incentive to support prices at close to record levels.” Experts suggest that Saudi Arabia, the most powerful supplier, whose marginal cost of production is only $10 a barrel, now seeks to keep world prices stable at around $100 a barrel.

On a related matter, how essential natural gas is to manufacturing industry, utilities and food production has become increasingly obvious. It puts energy exporters like Australia, Canada and the US in a stronger position than importers.

Raising interest rates and reducing the size of central bank balance sheets will help correct the excess demand issue… albeit in a painful manner.

“Much greater investment in additional supply and transportation infrastructure for both oil and gas will be required to reduce prices on a sustained basis. There is not much appetite for that [by governments and energy companies] with so much focus on climate change in the media.”

The recipe of surging energy prices and tighter liquidity as a solution to market imbalances “will result in a deep recession.”

The Climate Policy Crisis

Politicians are happy to blame Vladimir Putin and his Ukraine invasion for the current disaster in energy markets – natural gas prices up tenfold in Europe, for example. But it comes after two decades of green-energy policies, Joseph C Sternberg points out in the Wall Street Journal.

That includes a fixation with renewables that are incapable of powering industrial economies without battery technologies that don’t yet exist, a refusal to tap domestic fossil-fuel reserves such as shale gas, and a deep and irrational hostility to nuclear power in many parts of Europe.

This has created an energy system of dangerous rigidity and inefficiency, incapable of adapting to a blow such as Russia’s partial exit from the European gas market. “It’s almost inevitable that the imminent result will be a recession.”

Eoin Treacy says that the tide is certainly turning against the green movement. The Sternberg article is representative of “the growing groundswell of disillusionment with how electricity grids and generation has been managed.” This isn’t politically correct, but it does highlight the absurdity of experienced professionals “taking advice from a teenager.”

Five Ways to Guard Against Market Crashes

David Jackson’s Seeking Alpha suggests these ways to protect yourself against stock-market crashes and even turn them to your advantage…

Ask yourself how much drawdown you can cope with. Those who try to time the market to avoid a bad year can easily jeopardize long-term performance simply by being out of the market at the wrong time. Even missing a few good days out of an entire decade can annihilate most of your returns. Fidelity crunched the numbers on what would happen to a hypothetical investment into an S&P 500 index fund from 1980 to 2018 if you missed a few of the best days. By missing the best five, your returns would shrink by 35 per cent. By missing the 50 best days, your returns would be cut by 91 per cent.

The data is clear – there is no point in trying to avoid a bad year when the opportunity cost of missing a good one is likely to be a lot more damaging to your performance over the long term. The solution is simple – stay invested as long as you possibly can.

Drawdowns occur periodically. A drawdown is a peak-to-trough decline during a specific period for an investment, trading account or fund. A drawdown is usually quoted as the percentage between the peak and the subsequent trough.

Recognizing how often market crashes happen can give you a better idea of what you are getting into and the risks you are taking when investing in equities. Since 1928 there have been market drawdowns of at least 10 per cent every 11 months; of 15 per cent every 24 months; of 20 per cent every four years; of 30 per cent, every decade; of 40 per cent, every four decades. Pullbacks of 50 per cent happen two or three times in a century.

According to a research note from Bank of America Securities, the average time for the market to get back to where it was after a drawdown of 20 per cent or more is 4.4 years. This is why most advisers recommend that you only invest in equities if you intend to hold your investment for at least the next five years. Even assuming you have terrible timing and invest just before a bear market, you still have a good chance to be back in the green after five years.

Understanding market crashes and being prepared psychologically to have to go through them without overreacting is possibly the most fundamental part of learning how to invest.

There is no point in timing the market, since it can do more harm than good. Crashes will occur, but as there is nothing you can do about it, you can plan to cope with it. With the right mindset, there is no amount of negativity or bearishness in the markets that can disrupt your strategy.

Part of preparing yourself psychologically for market crashes is to understand your tolerance to volatility. How much drawdown is too much? How much lower can your portfolio get before you would call it quits?

The longer your time horizon, the less market crashes matter. That’s why people who are still building up their nest-egg and are more than a decade from retirement will have a different tolerance for volatility from someone already retired and relying exclusively on his/her financial assets to generate income.

Make sure you have the cash you need. Cash has an extremely important role in the way you can prepare yourself for a market crash. Personal finance 101 always starts with paying off short-term debt; and building an emergency fund.

Whatever life throws your way, your emergency fund should be able to cover it. Loss of income, an accident, home repair, medical emergency, last-minute travel expense… you name it. It usually represents three to six months of expenses for people who are employed. It can become much bigger as you get closer to retirement, based on your personal circumstances.

By definition, you never know when you’ll need to access your emergency fund. For that reason, it should not be invested in equities.

Will you need the money you’re investing today, within the next five years? If the answer is yes, the money probably shouldn’t be invested in shares. If the answer is no, a large equity exposure makes sense.

On a rolling basis, your time horizon should always prompt you to adjust your equity exposure. For example, if you have a big down payment for a house coming up in the next five years, you should start withdrawing the corresponding funds while the market is doing well to avoid doing it at the worst possible time later on.

Retirees who regularly withdraw money from their investment accounts should have a plan to do so from the least volatile part of their financial assets during a market crash.

Having cash ready to seize investment opportunities

The next place where you might want to build your cash reserve is your investing fund.

Do you have cash readily available to take advantage of a market sell-off? In the face of a market crash, investors have the pernicious habit of selling positions in order to “raise cash” to invest in other stocks that have fallen. Raising cash during a market crash is in fact panic selling… the last thing you should be doing.

If you don’t want to feel tempted to try to raise cash at the worst possible time you should have part of your investing portfolio sitting in cash. What that allocation is comes down to your risk profile, time horizon and how well you sleep at night. Maybe that number is 3 per cent, 5 per cent, 10 per cent or even 25 per cent of your portfolio. But remember that the higher your cash allocations, the more you may adversely impact your long-term returns.

Build a portfolio that suits your risk profile. If you have defined the kind of drawdown you can cope with, you can confidently build a portfolio with the right equity exposure. If you can’t stomach the idea of a 20 per cent sell-off in your portfolio, even temporarily, you probably don’t want more than half of your financial assets exposed to equities.

There are clear warning signs that should make you question your existing approach. For example, if you find yourself checking your portfolio or the movements of a particular stock you own several times a day, you may be taking more risk than you can tolerate. A key component of the success of your investing journey is your capacity to stick with it for decades on end. It’s a marathon, not a sprint.

Build a wish list of stocks to buy on sale. Broad market sell-offs are the perfect opportunity to accumulate shares of the best companies. But the reality is that when the opportunity presents itself, investors start changing their expectations. The price is never low enough to pull the trigger. They think “it’s not the bottom yet” or they assume “it can always go lower.”

By building a wish list of the best-of-breed companies you wish you had owned and at what price, you can make sure you’ll be clearheaded when the time finally comes. You’ll feel encouraged to buy because you’ll recognize that your past self would have instantly bought these shares at their current price, and only your emotions are preventing your current self from doing so.

Set ready to make the right choice

Only with a wish list built when you are at ease will you make the right choice in the heat of the moment.

In the midst of a market crash, without a wish list pre-emptively built you may end up buying stocks that you shouldn’t own just because they have fallen even more than others. Stocks that fall the most in a market crash are not necessarily the best ones to buy. There could be profound secular changes happening that more than justify the sell-off for some industries or categories.

The stocks you are likely to get most excited about in a market crash will rarely be the ones you should be focusing on. Building your wish list when you are calm and collected is the ultimate antidote.

Write down your strategy. Your temperament is the single greatest factor in your portfolio’s returns. There are many ways to fight our natural flaws and avoid the pitfalls. When it comes to preparing yourself to handle a market crash, the most powerful tool is journalling – that is, keeping a written record.

The only way you can practice your readiness for a market crash is by writing down and repeating to yourself what your long-term strategy is. Why do you invest? What is your time horizon? What’s your investment philosophy? What will you do if the market falls significantly and your portfolio along with it? These are not questions you want to answer in the midst of a market crash.

Success comes with homework and preparation. The more you set yourself up with the right mindset ingrained in your brain, the higher your chance to avert a crisis in the heat of the moment.

Market crashes are not something you should fear. They are unavoidable and a necessary trade-off to your benefiting from the outstanding returns equities can deliver over the years. By knowing stock-market history and defining how much drawdown you can cope with, making sure you have enough cash on hand, building a portfolio in line with your risk profile, maintaining a wish list of best-of-breed businesses you hope to buy in a market sell-off and writing down your strategy, you will be immensely better-equipped to go through the next market crash. You will empower yourself to be a true investor focused on the long term, unshaken by the vicissitudes of the market in the short term.

Battle for Dominance in the Chips War

Manufacture of semiconductor chips is a huge and fast-growing industry, with sales of $580 billion last year. They’re increasingly important components of personal computers, smartphones, cars and data centres.

As 80 per cent of them are made in Asia, this dependence has alarmed the rest of the world, particularly as the most advanced models come from Taiwan, which faces military threat from China.

Governments have been panicked into introducing big subsidy programmes to encourage companies to build “fabs” to make chips in the US and Europe, although it’s China that’s doing most. America is increasingly using its political clout to discourage semiconductor companies from doing business with China.

Attention has focused on the thinnest chips, made using EUV lithography. But very few of them are needed. You don’t need high-end processes for most things. The average modern car uses thousands of chips, but all of them are manufactured using old processes. That is even more true for military and space applications. They use chips of very old designs that are known to be reliable and secure.

An industry expert says that China is quickly catching up with the leading international chip companies elsewhere in Asia and the US. With abundant state support, its fabs and tool makers can hire top people from the rest of the world. It has already developed a working EUV lithography prototype comparable to those made by the world’s leading supplier, the Netherland’s ASML.

The Burden of Politicians

The most expensive purchase you will ever make isn’t your home, a car, or your children’s or grandchildren’s education – it’s your government.

Dominic Frisby writes in his book Daylight Robbery that for a typical British middle-class professional, over the course of his or her life the government tax bill totals the equivalent of $5 million. “You will spend a full 20 years of your life in obligatory service to the state. In exchange, you receive the protection of the state and its services: defence, healthcare, education and so on for yourself and others.”

Some people are content with this, others are not, “but whatever your political leanings you have no choice. If you want to work for a living, you must work for the state as well as yourself.’

At the beginning of the 20th century the UK government was spending about 10 per cent of the nation’s income. Then came the First World War. The trend has been upwards ever since. Now the UK government spends 50 per cent or more of the national income. And there is no real difference in government spending plans between each of the major political parties. As one analyst says: “The politicians scramble to bribe us with our own money.”

Identifying Opportunities

It’s sensible to take a look at what shares other investors own, especially if that introduces you to opportunities that you might have overlooked, advises investment commentator Tim Price.

“If you find something in somebody else’s portfolio that has genuine appeal, the trick is (a) to conduct sufficient research whereby you can feel as strongly about the benefits – and potential liabilities – of ownership as that other investor did, and (b) to exercise sufficient patience to buy that investment when it meets your own specific investment criteria.”

The screening criteria he uses are…

► A price-to-book-value ratio of less than 1.5x

► A current and prospective price/earnings ratio of less than 15x

► An enterprise value divided by cash-from-operations ratio of less than 8x

► Cash from operations growth over the last five years

► Return on equity of at least 8 per cent on average over recent years

► A history of buying back stock – but only in the right circumstances. “If you can find companies whose management buys back stock when it trades below book value, hang on to those companies like a limpet.”

American Property Prices

America has been experiencing the strongest inflation in house prices since 1946 – they’ve risen 46 per cent in nominal terms, 28 per cent in real terms, over the past three years. However, it now looks as if the good times are over as property faces a perfect storm of rising financing costs, squeezed demand and increased supply.

People’s real incomes are contracting as pay increases fail to match inflation. The house price to income ratio is now at a post-war high of 4.8 times. Affordability is at its lowest since just before the sub-prime crisis. Consumer confidence about this being a good time to buy a house is now lower than at any time since 1980. Potential supply – homes started but not completed – is at record highs.

The consequences of this demand/supply imbalance are starting to emerge. New home sales of 511,000 in July were down almost 50 per cent from two years earlier. If starts slow by 600,000 in the next 12 months to one million, as models suggest, this could cut economic growth by 1½ percentage points and boost unemployment to more than 5 per cent in 18 months’ time.

The Outlook for Oil

Crude prices have been drifting lower, something welcomed by global leaders battling inflation. But no one “should be too sanguine about the softer market, says the FT’s Derek Brower. Today’s price is easing, not because supply is ample, but because soaring inflation and rising interest rates are giving rise to fears of recession, especially in Europe.

In the US oil from federal emergency stockpiles has been poured into the market, but that is not a natural state of affairs, and the stock release programme ends in November. In December, Europe and the UK are due to ban insurance for ships carrying Russia’s crude, which may sharply reduce Russian exports.

A deep multi-year recession could up-end all the commodity markets’ fundamentals. OPEC’s spare production capacity is dwindling. Wall Street is reluctant to fund more fossil fuel projects that climate policy may render obsolete. The big companies are committing less capital for expansion than they did before the pandemic.

Dramatic Slowdown in China

We’ve become inured to the extraordinary explosive rate of growth of the Chinese economy, which is now bigger than America’s in purchasing power terms. Can it continue?

This is the first year for a long time that the economy has struggled to achieve any growth at all, despite the government’s target of 5½ per cent. In the latest month for which figures have been released (July) retail sales, an important gauge of consumption, increased only 2.7 per cent.

Xi Jinping’s efforts to rid the country of the coronavirus are taking a huge economic toll. French bank Natixis reckons that the policy will shave 1.6 to 2 percentage points off economic growth this year. That estimate does not include the impact of deteriorating sentiment across the housing sector, falling investment and a crippling drought.

Some analysts predict that after next month’s Communist party congress at which it is expected Xi will be given another period of presidency, the radical zero-Covid policy could be eased. But others argue that this is unlikely as it would suggest that Xi isn’t totally in charge.


Gold: The long period of gold’s underperformance at a time when stock markets in contrast have outperformed seems to be going into reverse, says Bloomberg Intelligence’s commodity strategist Mike McGlone.

Although the yellow metal’s price is still weak in dollar terms, it has started to rise in terms of other major currencies. By the ninth of this month on a year-over-year basis it was down 5 per cent in dollars but 24 per cent higher in Japanese yen, 12 per cent in euro.

“The most aggressive Fed tightening in 40 years and strengthening dollar are strong headwinds for gold, but it’s the end-game that typically matters for the metal. At some point the central bank will stop hiking rates.”

Qantas: Australian airline passengers are angry about bad service on their iconic international carrier. It’s blamed on a labour shortage so acute that retired managers have been asked to go back to work on a temporary basis to do ground handler jobs. Qantas says it’s mishandling, or losing, an average of nine out of every 1,000 pieces of luggage – twice the normal rate.

Bad market for luxuries: The prices of second-hand luxury goods have fallen rapidly in China in recent months as the wealthy cut back on their spending and sell their Rolex watches and Hermes bags to raise cash. The selling prices of secondhand Rolex Submariners, for example, are reported to have almost halved since March.

Russia: It’s doing very well despite sanctions that appear to be hurting more the countries applying them. It’s making more than $21 billion a month from its energy exports – far more than before it invaded Ukraine. Its currency is stronger, Its central bank is even able to cut interest rates.

Labour shortage: Britain’s hospitality businesses (restaurants and hotels) have lost nearly 200,000 foreign workers who left the country because of Brexit and the pandemic, but have since failed to return.

Covid: Doctors aren’t recording the vaccination status of dead people, so deaths are (falsely) attributed to “unvaccinated,” says Lew Rockwell, chairman of America’s Mises Institute,

Microchip advances: China’s largest manufacturer of semiconductor chips, SMIC, will soon start shipping out its most advanced 7 nanometre chips.

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