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Taking stock

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Looking to profit from the coronavirus-fuelled market volatility but don’t know where to start investing your money? DB finance expert Boon Tiong Tan has some advice for the 99% (Photo by Baljit Gidwani)

Stocks from A to Z have seen heaven and hell this year. Apple stock’s year low is US$212, while its high is US$499. Zoom is even more impressive, zooming from US$66 to US$296. And it’s not just technology companies that have had all the fun. One of DB’s favourite brands, Lululemon has risen from US$128 to US$370. If only we’d all bought the stocks as well as the yoga apparel.

Crisis in Chinese is made up of two words, 危 which means dangers and 机, opportunities. So, is investing in a time of pandemic highly dangerous or a fantastic opportunity? For millions of investors from Germany to Japan, the US to Singapore, it’s proving to be the latter – the number of people trading stocks is soaring globally. Whether it is because of government handouts or boredom at home, companies like Netflix and Tesla have attracted and excited a new generation of investors.

A number of new developments have contributed to the ballooning stock trading by individual investors. Last year, Charles Schwab cut the stock commission to zero. Others followed. When trading is free, traders trade freely. Banks like HSBC and Citibank are still charging as high as 0.25% commission. It might not seem much but, for active traders and over the years, the savings are not small. Think of what that money could buy you.

A single share in Tesla costs about US$1,500 and Amazon US$3,000. Not everybody can afford one share. In response to this, firms like Interactive Brokers have rolled out fractional trading. Customers can specify a dollar amount – for instance, spending US$100 to trade a slice of Amazon, or they can specify what percentage of a share they want to trade. While fractional shares are not new, what’s new is
the ease with which you can trade them during market hours. Technology has made opening a stock account fast and easy, and you can buy and sell stocks anytime, anywhere on your phone. Robinhood has become the app of choice for millions of millennials.

Understand what’s happening
The US stock market was breaking highs at the beginning of the year. Then COVID-19 struck. The stock market entered a bear market at record speed. Perplexing to some and insane to others, the stock market has since recovered all its losses and a bit more.

While one can argue the stock market is overvalued, it is not insane. Not yet. The question is how can the stock market perform so well when the economy is plunging and unemployment surging?

First and most importantly, the Federal Reserve decisively cut the interest rates to zero in March this year, which unleashed massive bond buying. As Warren Buffett explained, interest rates act as gravity to stock prices. With interest rates near zero and even negative, the stock market has little resistance to flying higher. Zero interest rates entice investors to move their money out of banks and into the stock market. Zero interest rates also lower the cost of borrowing for companies and makes their future earnings more attractive.

Second, early on in the outbreak, the US, Eurozone and other governments put together trillions of dollars of rescue packages at an unprecedented speed and size. Unprecedented fiscal and monetary stimulus was unleashed to support economies floored by the pandemic. In March, the G20 promised to inject more than US$5 trillion into the global economy to limit job and income losses and “do whatever it takes” to tackle the pandemic.

Third, S&P 500, the market capitalisation-weighted index of the 500 biggest US companies, is already positive for the year. Why? The top five (technology) companies listed – Apple, Amazon, Microsoft, Google and Facebook – have all experienced a rise of over 30%. Other sectors like oil, banks and airlines are in a bear market. The huge disparity in performance between these sectors makes sense. Technology
companies are making even more money in the midst of this crisis because they are facilitating our move from the real to the virtual world. As they generate huge cash flows and have solid balance sheets, they are now also seen as defensive stocks.

Finally, the stock market looks ahead as well as reflecting what’s going on. Will there be a vaccine soon? Surely the governments and central banks will do more if things get worse?

Some in the media are talking about a stock market bubble. Clearly there are signs of a bubble. Hertz, a bankrupt company, saw its shares shoot up eight-fold in three days in June. Kodak shares closed at US$2.62 on July 27. Two days later, they almost reached the sky at US$60.

Meanwhile, the S&P 500 P/E ratio is above long-term average but it has yet to reach the highs of the late 1990s dot-com bubble. A bubble
usually lasts longer than most people expect. Ex-chairman of the Federal Reserve Alan Greenspan famously said the stock market was suffering from “irrational exuberance” in 1996. The dot-com bubble lasted another four years.

Diversify and think long term

While the coronavirus-fuelled volatility creates many short-term trading opportunities, you should never forget diversification and the long term.

For diversification, ETFs (Exchange Traded Funds) are a good option for investors. When you buy an ETF, you’re buying a basket of stocks. For instance, if you buy a S&P 500 ETF, you buy into all 500 companies. Diversification reduces your risk since you are not putting all your eggs in the same basket. You can trade ETFs just like stocks and they pay dividends too. What’s more, the annual management fees are generally below 1%.

Know that individual stocks, no matter how big and reputable, can go into a long-term decline. Eastman Kodak and Sears Roebuck, both
part of the Dow Jones Index for nearly 100 years, went bankrupt in the 2010s. A favourite share among DB investors, HSBC’s share prices
have declined 80% from their peak in 2007.

The US stock market has an average annual return of about 10% over a century. This might be scorned by the Tesla stock traders but a dollar will compound to US$6.73 in 20 years. This performance can be achieved by simply buying a S&P 500 ETF. The tough part is to sit tight for 20 years, come rain or shine, thunderstorm or typhoon. Too often, investors try to time the market and end up selling low and buying high.

Long-term investing requires discipline to stick to the buy-and-hold strategy and the patience to let compound interest work its magic. If you are able to make 30% annually for 13 years, you turn US$1 into US$30. If you think that seems easy, Warren Buffett’s average annual return over more than 50 years is ‘only’ 20%.

Enjoy a free lunch
Most investors who want to buy a stock at a lower price just place an order and wait. Alternatively, while waiting, you can sell a put option
to earn a premium – aka the free lunch. These premiums earned, unlike dividends, are tax-free.

Say Netflix is trading at US$550 and you want to buy at US$500. Instead of placing a buy order at US$500, you can sell a one month put option at exercise price US$500 to earn a premium of US$5. If the share price is below US$500 in a month’s time, you will own Netflix at US$500. If the share price is above US$500, you miss the chance to own it. Either way, you’ve earned your US$5 free lunch. This is 1% return in one month or 12% annually.

You can also sell put options on ETFs. Take SPY, a S&P 500 ETF, which is trading at US$330. You can sell a one-year US$260 exercise price put option to earn a premium of US$13. The 5% return is way better than a time deposit. And you get to own shares in 500 of the biggest US companies if they drop by more than 20% in a year’s time.

For the free lunch to work, make sure you have enough money in your account to buy the stocks if the options are exercised. And
remember, only sell put options on stocks you want to buy.

DB resident Boon Tiong Tan (CFA) has worked as a trader with banks like HSBC and Morgan Stanley for over 20 years. The author of A Stock Investment Book For The 99%: By A 99%, BT’s aim is to educate regular folk about the stock market and how to invest successfully. His book is available at Bookazine, Amazon and Book Depository; for information about the finance courses he offers in DB, email [email protected].

 

 

Comment(s) on - Taking stock

  • WIL Reply

    Thats a great book, must read for any level standard investor!

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