Shanghai's Pudong Skyscrapers

(Source: Jens Schott Knudsen)

Recently the KLSE and the regional stock market seems to be moving in the downward trend triggered by the news of China's tightening of credit. Many investors are afraid that such move will hamper the global economy recovery process.

Will the tightening of credit by the Chinese government cause China's housing bubble to burst? Will this then causes China's banking system to crash and which then causes its whole economy to depress as what happened to the US's economy in 2007/2008?

Let's take a look at what other economists are saying in this article.

I would like to quote some of their points here:

"Many economists say there are good reasons for such optimism. Rapid economic growth, rising family incomes, continued migration to the cities, pent-up demand for housing, and a banking system much less exposed to residential mortgages than banks in the United States or Japan could protect China, they say, from a real estate meltdown for years to come."

"One of the legacies of China's prolonged stagnant growth prior to economic liberalization is an overwhelming shortage of residential property that meets its new living standards," Koyo Ozeki said in a report published by Pimco. "It will likely take a considerable period of time for supply to catch up to demand." That wasn't true in the Japanese or U.S. bubbles.

Ozeki, an executive vice president for Pimco in Tokyo, noted that the total credit for the property sector in China has grown to 40 percent of gross domestic product; in the United States, it hit 80 percent in 2007. For Chinese banks, exposure to real estate is less than 20 percent of assets, much smaller than in the United States. That should reduce the chances of a banking crisis.

In addition, while property prices are soaring in such areas as Beijing and Shanghai, price increases are more modest elsewhere. Government statistics say housing prices nationwide rose only 5.7 percent last year.

Moreover, China's homeowners carry less debt than homeowners abroad and the economy's rapid growth can probably keep incomes rising fast enough to cover mortgage costs. Kroeber said that mortgages issued from 2002 to 2008 equaled only 40 percent of the value of housing sold nationwide."

I personally view that the current move of tightening of credit in China as a healthy move to prevent the housing bubble from bursting too soon.

Back on the KLSE, regardless of whether the China's housing bubble is going to burst soon, as a long term investor I see this as an opportunity for 'bargain-hunting' for undervalued shares ;-)

Source: Hock's Viewpoint - By Choong Khuat Hock
http://biz.thestar.com.my/news/story.asp?file=/2010/1/18/business/5475313&sec=business

The financial crisis reflects the fallacy of the ‘efficient market hypothesis’

IT is amazing that economic theories still consider that markets are governed by the “efficient market hypothesis” (EMH), which assumes rational investors, an orderly market and that all available information are known.

The global financial crisis reflects the fallacy of EMH and textbooks should be revised to reflect this.

In reality, markets reflect the nature of its creators and participants – a collection of human beings who would like to think they are rational but are often enough irrational and emotional.

Quantitative models often fail to model the irrationality of human behaviour during extreme times.

Blind reliance on such models was also the reason why Long-Term Capital Management (LTCM, which had Nobel Prize-winning economists) failed as the restructuring of defaulting bonds in Russia in 1998 caused volatilities beyond what was predicted by quant models.

The extremely high leverage utilised by LTCM hastened its demise. Alan Greenspan had to engineer a rescue as the failure of LTCM threatened to damage the markets and market participants.

One way of valuing securities is to use the discounted cash flow model, which is to discount the expected future cash flows to obtain the present value.

However, in many cases, future cash flows are difficult to predict and the discount rate used would fluctuate depending on the prevailing interest rates and the perception of risk which may vary from person to person.

This method is more useful in valuing businesses or securities with predictable cash flows like utility stocks where cash flows are stable and funding costs have been determined. Another popular valuation method is to compare securities with its peers.

Such comparisons are ingrained in the nature of human beings as we can only determine the value or utility of something by comparing it to another. Shall I buy the latest Samsung or Sony LCD TV? How does a BlackBerry compare with an iPhone?

Similarly, if the price-earnings ratio (PER) of a stock is 10 times and the sector PER is 20 times, it may be considered cheap if specific company factors are attractive.

Using sector PER as valuation anchor is fraught with danger as the sector valuation may be unreasonable.

Such comparisons may not reflect the value of potential cash flows from an investment. At the height of the dot.com bubble, valuations were based on price to sales with no consideration placed on cash flow.

The prevailing belief then was that there was a sucker willing to pay a higher price to sales for the business.

The same happened during the debt fueled property bubble in the US when rental yields from property could not cover mortgage payments.

Banks were willing to provide 100% financing to those who could not afford houses based on the assumption that property prices could only go up and mortgage loans could be repackaged into much sought after high yielding subprime securities.

Behavioural finance has many theories to explain why humans are often irrational but the reality is that irrationality is hardwired into our brains.

The brain can be divided into two parts – the hypothalamus, or primal brain, (a few hundred million years old) which directs our instinctive behaviour and the neo-cortex, or new brain, (a few million years old) which facilitates logical deductions, learning from experience, language and complex social interactions.

In times of panic, the hypothalamus takes over and markets tend to overshoot on the downside due to panic selling.

Since these moves are often irrational, the movements tend to be many standard deviations more than what is predicted by a normal distribution curve, creating black swan events.

Faced with an avalanche of incomplete information, humans use heuristics, a simplification process to arrive at a decision based on their past experiences and prejudices.

In arriving at a rule of thumb valuation, anchoring is employed by imputing a fair value to the initial entry level even if the entry level is high.

Therefore, in a rising property market, anchoring may result in the belief that the price appreciation will continue.

A bubble can thus form as the herd is blinded by cognitive dissonance whereby investors pay credence only to views and opinions that reinforce their beliefs. However when the discrepancy between fantasy and reality becomes too large, the bubble bursts.

Investment is hence as much an art as it is science. In the final analysis, it is the cash flow that counts.

The science would be in accurately determining the cash flow but the art lies in determining how much investors are willing to pay for the cash flows.

Identifying periods of over pessimism and optimism would help in determining entry and exit points.

In the end, the advantage lies in accurately predicting beforehand where the herd is heading. Understanding the animal in you and others could indeed be a profitableproposition.

Choong Khuat Hock is head of research at Kumpulan Sentiasa Cemerlang Sdn Bhd.

DO'S

1. If you're to follow my 'tips', do have patience for the price to appreciate. I'm more of a Value Investor  rather than a Day Trader and my investment approach is Medium to Long Term (3 months to 1 year and beyond). Therefore, you might have to wait about 3 months for my recommended stocks to appreciate in value. So far, all my 'prophecies' are fulfilled in less than 3 months =P
2. Do continue to save money to invest in shares. By doing so, you'll be ready to 'ride the boat' whenever a new investment opportunity arises. Also, having some spare cash allows you to average down your share if it goes down after you have bought it (provided that the company's fundamental is still good).
3. Do read my Disclaimer at the bottom of this blog ;-)

DON'T

1. Don't invest with money that you need to put food on the table or pay your bills or with loan money. Especially don't borrow from "Ah Long" to play shares because if you loose money in shares, "Ah Long" will chop off your hands and whatever that can be "chopped". If you invest in shares using money that you need in the short term or borrowed money, your investment decision will be very much subjected to your emotional feelings. You could easily throw rationality out of the window and Buy/Sell the wrong stock at the wrong price. If you are to follow my 'tips', you should only invest with extra cash that you don't need to use in the medium to long term because my investment approach is medium to long term.
2. Don't put all your available investment money in one lump sump into one single stock. You should not have more than 30% of your share portfolio invested in one single share.  I encourage that you diversify your investment into 8-10 stocks so that if 1 stock collapse, it will not significantly reduce the net worth of your share portfolio. So far, I've given Buy recommendation for 3 stocks ever since I started this blog in September 2009. More will be coming whenever the opportunity arises ;-)

Fair Value: RM 1.99

Current Price: RM 2.11

Recommendation: HOLD

As the current market is above my Fair Value, I'm revising my recommendation from Buy to Hold.

Refer to previous write-up here for more info on this company.

By Andrew Chia

What You Need To Know About Investing

Business.

Yes, everything that makes money is ultimately linked to business.

Would you like to become an enterpreneur?  Perhaps yes, perhaps not.  Would you like to invest in a successful business like Robert Kuok's PBB?  Or Teh Hong Piow's Public Bank?  Genting?  IOI?  How about Maxis or Hong Leong Bank?  How about YTL or Top Glove?

Now, how would you invest in those companies if you do not know anything about business?  What are the things we should learn about business, by the way?

Well, for a start, you should know some of the reasons why those businesses mentioned above are successful.  At the same time, you will find out why the others failed.

Let's take a look at some factors...

Industry - which are the ones making money

Dividends - you can forget about investing in companies with less than this percentage of dividends

Return on equity - what is the minimum % you should accept

Earning per share - what is the lowest growth rate acceptable

Debt equity ratio - what is the level that is considered dangerous

Turnover - what is the industry's norm

Gross profit margins - what is the minimum acceptable

Net profit margins - how do some businesses achieve this performance year after year

Track record - what is the minimum you should consider

Cashflow - why this is important for a successful business

Management - what are the factors to look for

All of the above will be covered in my Stock Market Secrets workshop, the upcoming one will be on Sunday 10th January 2010.  Details here,

andrewchia.com/workshop

Yes, stock investing is all about business.  A good knowledge about the basics of business will go a long way in fulfilling your dreams of being a great investor and achieving financial independence.

If you are planning on starting your own business, this workshop will be invaluable in giving you ideas on all the pitfalls to avoid, as well as pointers on how to succeed.

I will see you there.

andrewchia.com/workshop

To your success,

Andrew Chia

Company	Recommended Date	Price (RM)	Current Price (RM) *	Gain **
HAIO	15-09-09	5.10	8.47	66.08%
COASTAL	20-09-09	1.96
	04-11-09	1.71
		*** 1.83	1.95	6.56%
TOPGLOV	10-10-09	8.23	10.06	22.24%
Average Gained ****				23.72%

* As of January 1st 2010. For the latest price, go to http://biz.thestar.com.my and enter the stock quote in the upper right search box.
** Including both Paper Gain (still Holding) and Actual Gain (already Sold), not including dividends received.
*** Average Buy Price for COASTAL, assuming that same units of shares had been bought.
**** Assuming equal amount of money had been invested for each recommended Buy date.

As you can see from the portfolio above, an average of 23.72% is gained within a period of about 3 months ever since this blog has started, and this figure have not included the additional dividends received ;-)

If you want to learn how this can be achieved, I highly recommend that you get a copy of the Bursa Winners e-book.

Fair Value: RM 6.64

Current Price: RM 8.47
Recommendation: SELL / HOLD 

As the current price has overvalued the given Fair Value by 27.56% in less than 1 month, I'm giving it a SELL recommendation. Wait for the share price to drop back below the current Fair Value and then buy it back because the company's fundamental is still strong. On the other hand, if you're aiming for the Dividend Yield only, you may want to continue to HOLD this stock. 

Personally, I would Sell half and Hold half. This way, I can experience the best of both worlds - capital gain and dividend yield; and also just in case if the share price shoot back up after I sold it, I would have the other half to enjoy the ride ;-) As I am more of a value investor rather than a day trader, I'm not good at timing the market. Timing the market is a game of chance - either it goes down after you sold it or it continues to go up after you sold it (even Technical Analysis is not 100% accurate all the time). That's the reason why I would Sell half and Hold half ;-)

Refer to previous write-up here for more info about this company.