December 21, 2015: Distressed Assets

Holiday Greetings

We wish everyone have a wonderful holiday. May the force be with you in the coming year!

Due to upcoming holidays, we will not have a newsletter next Monday and will resume the publication on January 4th, 2016.

Distressed Assets

In our last year’s newsletter December 15, 2014: Beaten Down Assets., we stated the three reasons why one should look at asset valuation with respect to one’s investment portfolios:

Valuation helps to understand the general market conditions and thus re-enforce one’s risk profile or risk tolerance.
Similarly, valuation helps to set one’s return expectation.
Valuation helps us to find good possible investment candidates.

We believe it is a good practice to periodically look at the distressed assets. However how negative the ‘distressed’ sounds, it actually presents some potential opportunities. In fact, when an asset is really in a distressed state, it’s actually less risky and becomes a ‘good’ asset for purchase.

It turns out that this year, we are seeing more assets are joining to the group. What’s more, whatever beaten down last year are still languishing or getting even worse.

Commodities: Oil, Gold, Silver and Mining Stocks

Perhaps the most talked about asset this year is the crude oil price: it continued to descend from its 50’s level last year, now sitting in the 30’s level:

Not only the oil price is now lower than the most recent low in 2009, it hasn’t shown any sign of slowing down either. The oil shock reveals how an important commodity can be inter played with geopolitical situation. Its distress does not bode well with the global economy and political stability.

Gold, silver and their mining stocks continue to decline this year, now lower than their 2008-2009 lows:

Year to date:

Fund	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR
GLD (SPDR Gold Shares)	-9.2%	-10.1%	-13.9%	-5.1%	7.5%
SLV (iShares Silver Trust)	-10.9%	-12.0%	-24.1%	-14.0%
GDX (Market Vectors Gold Miners ETF)	-25.8%	-26.8%	-32.6%	-25.2%
GDXJ (Market Vectors® Junior Gold Miners ETF)	-19.3%	-21.5%	-37.4%	-32.6%

Similarly, the general commodities and their segments have had more than 20% loss this year so far:

Fund	YTD Return**	1Yr AR	3Yr AR	5Yr AR
DBC (PowerShares DB Commodity Tracking ETF)	-28.1%	-29.9%	-21.7%	-12.9%
DBA (PowerShares DB Agriculture ETF)	-18.0%	-19.9%	-10.5%	-8.1%
DBE (PowerShares DB Energy ETF)	-38.0%	-40.8%	-26.9%	-16.0%
DBB (PowerShares DB Base Metals ETF)	-27.0%	-27.6%	-15.6%	-12.8%

In a word, what went down in 2014 have continued to go down. A gigantic deflation in natural resources.

Just as Oaktree’s Howard Marks said (see this interview): the problem with crude oil is that no one knows its intrinsic value. At the moment, we see no sign of recovery in the short term. However, it is definitely an asset class worth continuing watch.

High Yield Bonds

After our last week’s review on high yield bonds December 14, 2015: High Yield Bonds And Their Correlation With Stocks, even after the Federal Reserve faith showing or confidence boosting rate raise, high yield bonds continue to be dumped:

It is noteworthy that HYG is now approaching the low in 2008-2009: it is at the lowest level since the 2008-2009 crisis for sure. The price of HYG is now at -0.24% discount of its Net Asset Value (NAV), due to some illiquid bond pricing issue. However, it is still no where close to the double digit discount it made during 2008-2009.

We wouldn’t call high yield bonds are in a distressed state right now. But the energy debts are close or even worse than in 2008-2009.

Emerging Market Stocks, Europe & Japan

Emerging market stocks continued its weakness in 2014, down 16% year to date:

Fund	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR
EEM (iShares MSCI Emerging Markets)	-16.3%	-14.7%	-7.6%	-4.9%	3.0%
VGK (Vanguard FTSE Europe ETF)	-3.4%	-5.1%	3.9%	4.1%	3.3%
EWJ (iShares MSCI Japan)	8.2%	6.2%	9.4%	4.0%	0.4%

Emerging market stocks are now the lowest since 2009, but still not reaching the low in 2009. Notice that even though European stocks are weak in terms of US dollar, they have done reasonably well in their local currency, Euro. Similarly Japanese stocks have been propped up by the government stimulus. However, both of them are seriously impacted by US dollar strength. However, in emerging markets, many stocks are down even in their own local currencies, indicating a dire situation (think about Brazil, China, Russia).

US Stocks: Oil & Gas Stocks

Even though US stocks have encountered some weakness, they are in general still the strongest among all stock major assets. However, energy stocks, especially oil & gas stocks are now approaching the 2008-2009 level:

Summary

As 2015 is closing out, it is amazing to see not only the beaten down stocks in 2014 continue to be weakened, new assets including high yield bonds and oil & gas stocks are joining the group. However, even these assets are becoming more and more attractive right now, we don’t believe the carnage stops right now. As to whether one should be a bargain hunter or not right now, we believe it is important to adhere to your investment plan and act accordingly. Catching a falling knife can be painful.

Finally, we quote the following from our last year’s newsletter. They are still applicable even after the volatile year!

Subjectively, other than commodities, all other assets are far from a distressed valuation level. With US stocks are still at an elevated valuation level, markets are again far from a panic on sale state. Furthermore, a momentum based tactical strategy will only buy an asset when it again exhibits an upward trend, a more risk averse way to invest in undervalued assets.

Market Overview

Now that the (uncertain) Fed rate hike is out of way, it is alarming that stocks and high yield bonds faded its short lived rebound and now they are back to the down trend. At the moment, not only long term Treasury bonds preserve their strength, REIT stocks are also withholding the downturn relatively well. This indicates that investors are worried about the long term aspect of the economy (long term bonds), but they are still holding a hope that the Fed will be extremely accommodative in terms of financing (REITs).

For more detailed asset trend scores, please refer to 360° Market Overview.

We would like to remind our readers that markets are more precarious now than other times in the last 5 years. It is a good time and imperative to adjust to a risk level you are comfortable with right now. However, recognizing our deficiency to predict the markets, we will stay on course.

We again copy our position statements (from previous newsletters):

Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible.

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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