One of the things which good analysts look at is something called ‘Competition Structure’. This means understanding the forces of competition affecting a company and how that may change in the future for the better or worse. The investment community generally breaks these forces down into: ‘threat of substitute products’, ‘threat of new competitors’, ‘intensity of competitive rivalry’, ‘bargaining power of customers’ and ‘bargaining power of suppliers’. You can read more about that all here.

Entire books have been written about the so-called “five forces of competition” and there is already a lot on the web about this subject so I’m not going to repeat all that. Instead I will summarise a quick method for performing a similar analysis to help you come up with your own view of whether the company you like will continue to grow or not.

1. Sketch out the supply chain. This means understanding what goes on from start to finish in the production process.

Let’s take palm oil for example: In this industry there are upstream producers who grow and harvest the stuff, then there are downstream producers who operate the mills to process the fruit and then there are exporters and finally customers who buy it.

2. Figure out where your company fits into the supply chain. Sime Darby for example, owns plantations and mills and can be considered an upstream and downstream producer. CB Industrial however, supplies equipment for mills and can thus be classed as a downstream operator.

3. Understand the most important factors which will affect these forces. This is actually the hardest and most important part. A textbook example of this would be how IBM in the 80’s opened up its computer architecture to third parties and found itself having to compete against Intel for processors and Microsoft for the operating system, whilst Apple in contrast has kept its architecture pretty much under its own control and has not suffered in the same way. By trying to drive down its own costs, IBM inadvertently increased the threat of substitute products in its own industry and managed to decrease its own growth in an industry which was itself still growing.

In the context of palm oil, the main factors affecting competition are a) supply of land and b) customer preference. Diminishing availability of agricultural land on the peninsula has meant that planting has shifted to Sarawak and further to Indonesia. Also environmental concerns are prompting more and more customers to source palm oil from plantations that “have not been established at the expense of tropical forests”. And finally, there is of course the possibility that palm oil can be used as biofuel, which opens up an entirely new market.

4. Identify the industry life cycle. The life cycle of an industry can be split into several phases - pioneering, growth, maturity and decline (You can read more about it here). Green energy, for instance is in the pioneering phase, whereas the fashion retail business is in its maturity phase.

The palm oil industry, which began in Malaysia almost a century ago has created fortunes and allowed companies such as Sime Darby to diversify into property development, manufacturing etc. Therefore it can be regarded as an industry in its maturity phase. However, with the growth of demand for agricultural oils from India and China and the possibilities over biofuel, there is the possibility that a new phase of growth has occurred, much like the same situation regarding oil and energy. This helps explain the recent correlation which palm oil prices have had to energy commodities such as oil.

It is hoped that these four steps will help impose some structure into your analysis!

The Anwar Juggernaut would have continued no matter what the by election results

This is a man who came from a politically active family and was himself a student leader, committee member and president of various political organisations. He has also demonstrated strong beliefs, leading to detention  under the ISA for a significant amount of time, two politically motivated criminal charges and falling out with the most powerful man in Malaysia.

Now, I have been fortunate enough to speak with people who have had the misfortune to be detained under the ISA, and I can tell you it is not an easy thing to go through psychologically. Imagine being locked up in a cell without a hearing, not knowing for how long and deprived of information about your friends and family. For all you know, the world could be falling. You get no phonecall and don’t receive any correspondence. Sometimes you get beaten up and you have no idea how long it will last of even if you will survive.

Anwar Ibrahim and been through these this. Despite what I think of him and his political beliefs (or lack thereof), this is a man with extraordinary physical courage with no other career to speak of (in business or other profession). Therefore I believe that even if he had lost the by election he would have kept on fighting to get into power. No matter what.

Therefore BN has completely underestimated the determination of this man, and they continue to do so by bringing Sodomy II and waging the political campaign they did against him with Arif Shah. In order to defeat this man, they would not only have to bury him - they would have had to obliterate him.

BN did not go far enough to take this man down. And they will pay the price, because Anwar is like the Terminator.

Anwar’s victory is good for the economy

BN has been propagating a myth that there is political stability in the country. because they still hold the majority. International investors are smarter than that and know that this is not the case, which is why the KLSE has been punished even more that is warranted by the global slowdown.

But what many investors fail to realise is that this process is creating more meaningful competition in parliament, and that competition always improves efficiency. Unfortunately, investors don’t usually have the luxury to wait until the process, which could take years, to complete. However, the rakyat are not as short sighted. They have demonstrated that they are more than willing to live through a temporary period of turbulence in order to improve future prospects. That is why, not only in Malaysia, but other countries too, the common vote tends to go towards the opposition in by elections which are held fairly.

This mismatch in expectations creates an arbitrage opportunity, because as members of the rakyat and an investor, you know what is going on.  At times when the international community is only focussed on the  political instability which BN is failing to correct, you know that Anwar is for real, and the process that the country is going through will result in a greater good.

Therefore if like me, your faith in this country is improving, there is no reason not to put your money in.

But here’s a quick note to medium and long-term investors and contrarians: I repeat my general advice that it’s extremely difficult to time market bottoms, but it is possible to scale into positions as the market hits the bottom and start to crawl its way out, so long as you have patience and are prepared to wait out the highly probably lack of movement in the market that characterises the gloom so common ro market bottoms. Although there is a lot of value out there in blue chips, traders with a higher risk profile might start to look more aggressively at growth companies, and prepare to scale into them with a 4-6 month expectation that a market bottom will form as lower oil prices contain inflation and spur demand (inshah allah)…

1) Volatility: In the US, the VIX index measures the degree of volatility in the market. The theory is that this usually occurs in bear markets, because bear markets are the only markets when traders are forced to sell (i.e. to meet margin calls). That is why bear markets are much fiercer than bull markets. These forced sells cause prices to move fast and volatility to rise sharply. The article then goes on to imply that market lows tend to occur when when the VIX is at its highest (e.g. August 2002 when the hedge fund LTCM was bust and had to be bailed out, when the index reached 35) and extrapolates that perhaps when the VIX reached 31 a few months ago when Bear Sterns was bought out, this points to a similar market bottom.

I personally believe that this indicator is of limited use, because even though the VIX can confirm whether or not a bear market has taken place, it’s still better to look at stock prices themselves. When market events like the failure of LTCM or the rescue of Bear Sterns occur, you can bet that the Vix will shoot up, but that does not necessarily mean that the market is at its bottom. The market can still drift lower under low volatility like it has done since March for the financials. If anything I think it would be better to look at trends, like the moving average line. In doing that, we will see that the S&P is now trading at close to the similar average volatility to the dark days of 1998 and 2000-2002. In those days, the VIX index actually went significantly above the S&P and stayed there for a considerable amount of time, and if things are anywhere near as bad as they were then, according to that measure S&P has at least another 5-10% more to fall. But note that the comparisons against historical correlations should not really be relied on to guide trading decisions for the future as as the attached chart shows. Also, there is currently no volatility index for the KLSE, so we have used VIX which is for the US market. However, given the correlation between the US stock market and the KLSE, the approximation should be fairly reliable.

2) Yields: When dividends for stocks start to pay more than bonds, income investors will be lured into purchases. The theory is that dividends tend to increase over time, and so if the yield today for shares is greater than yields for long dated bonds, then that is a signal for long-term value on income. Today the Malaysian 10yr bonds are now yielding around 4.8% but the yield on the KLSE is around 4.1%. This suggests that a drop of another 10% -15% will make the KLSE attractive from that perspective. But beware that companies can cut dividends as earnings drop, especially in today’s environment when inflation is causing capex costs to rise dramatically.

3) P/E: A simple rule of thumb behind PE ratios is that it represents the number of years for a company to earn the amount of represented in its share price. Therefore a PE of 10 means that a company will take 10 years to earn back the share price on a per share basis. Anything below 10 means that the company is generating returns above 10%. A year ago, the PE for the KLSE was at 19. It is now at around 11. If it drops to 10 or below then the KLSE will start to look attractive from this perspective as well. Note however, that in a similar fashion to the above criteria earnings may also drop, causing PEs to rise even when the market is heading south. Some might argue that in today’s environment with inflation costs and political uncertainty that is exactly what is going to happen, but on the other hand if you believe in the prospect of falling oil prices and the contined growth of China and India feeding into the bottom line then you may not agree.

So whilst it is not possible to always time the market, I hope this article shows how best to position yourself in such a way that you can get a good deal in today’s falling market.

Judging from the sentiment I feel from reading reports, articles and talking to traders, I think that we are currently about to enter that phase. As I speak the KLSE has just given up all its gains from March 2007 and expected to drift lower.

Just like when bears were being ridiculed in 2007  for their unwarranted pessimsim, bulls now risk sounding stupid in the face of recent market action in our current political climate. As the saying goes, it never rains but pours.

If I tell you now that I expect the market to head lower, possibly below 1000 and gloom to deepen even further, I be you may not even disagree. So much for predictions.

So what now for market investors? In the international space, the classic investments during such times are: consumer staples (e.g food producers, tobacco), utilities (e.g. electric companies, water companies), bonds, and high dividend. Consumer staples such as Dutch Lady and F&N are seen to be essentials, and so even during economic downturn, people will spend on food and drink (as well as cigarettes). Utilities like Tenaga provide electricity, which is also seen to be an essential. Besides these 2 categories, investors will also put money into dividend paying companies. Some of them, like Genting and Public Bank are yielding around 7% at current prices (Manulife yielding 10%). Attractive for the income if nothing else. Bonds are also seen as a safe play for similar reasons because yield will always keep prices from going too low.

It pays to have a large chunk of your portfolio in some of these securities at the moment. But remember not to get too wedded to the idea of cheap income as share prices can also fall and dividends can be cut. Also some of the best bargains are to be had during harsh times, so it pays to keep one eye on those growth stocks and start buying them out over the phase - stocks like Notion, Dgate , Maybulk etc.

In reality, the portfolio is actually performing better than that, as I have been adding to positions on a monthly basis, which has averaged down the price of the stock over time in this bear market. However I have not quoted this average price, preferring to stick with just the opening price for simplicity’s sake. I hope you can see that every little thing you can do to make the cost of holding shares cheaper over time the helps the portfolio get itself into a position where it can take into account of any stock market rally.

In addition today I disposed of Penta in favour of KKB, and raised my allocation to 70%-30%. Over the course of this year I intend to increase this to 100% cash.

Happy trading!

tradingmalaysia-portfolio-23-06-08.pdf

1) Were you caught unprepared by the recent stock market plunge? If so then the key lesson to take away here is how hard it is to time the market. (Tradingmalaysia has been bearish on the stock market for over 1 year, and is pleased even to have gotten it right by that margin!). Therefore you should be honest with yourself and seriously reconsider whether your trading tactics will really be able to help you time the next market bull if they failed to help you time this market bear.

If you’re still holding onto positions that have lost money, your signals are broken, and you have nothing but hope then you should get rid of them, go back to the drawingboard and start planning again. As traders we must look to the future and discard trades and ideas which do not work. Remember that you do not need to be able to time the market to make money. You just need to have a good system that you can execute well. The question you should be asking is: do you have such a system?

2) Are you are a long term investor (as in, were you a long term investor 6 months ago and not someone who used to be a short term trader but have since become a long term trader because your trades have not worked but you are reluctant to realise losses and sell - yes, you know who you are!!)? And do you have a regular income and have you been regularly investing in stocks which are fundamentally sound? If so, then then you should stick to your plan and continue to buy. This will average down the cost at which you acquired your shares over time and benefit you in the long run. Remember, the best time to buy is when everyone is selling.

Let’s take Tradingmalaysia’s portfolio as an example. This is a portfolio which consists mainly of companies which I consider to be good and either cheap or pay good dividends, and which I am regularly investing my income into (on a monthly basis). And because I have been bearish the market, only 65% of the money has been invested. Over the next year, I will gradually increase my equity allocation to 100% and continue to invest my regular income into the portfolio, bringing the average cost per share right down so that I am positioned to benefit from the next boom. For more detail on this I will post again tonight with some concrete numbers regarding the portfolio so that you get a better idea of how a long term portfolio should be managed and how it performs especially under duress. I think you will be surprised at the result!

“Four months ago, judging myself to be the next Warren Buffett, I logged on to my Charles Schwab account and did something that in hindsight was astonishingly stupid, even for my own very long roster of financial screw-ups. I clicked over to the trading page and bought shares of Citigroup.

The company, like most of the big Wall Street banks then staring down the subprime meltdown, was limping along. The headlines were bad. The chatter on CNBC was pessimistic. I saw a bargain. I saw a company whose credit card bills and offers show up in millions of mailboxes every day. Just as soon as the banks got their write-offs out of the way, optimism would return to the sector. There would be more buyers of the stock than sellers. I would profit.

Now here I am today: My investment is down 22 percent. And I’m still holding on to the stock. Am I, as my wife and closest friends sometimes insist, the dumbest man walking the Earth?”

What went wrong?

The crux of the problem is that the trader used the wrong strategy for his expected reward. If short term profits are to the object here, the right strategy would be to buy into a company on its way up and not down. Buying on the way down is a contrarian strategy adopted by investors who believe that the company has been unfairly punished and will bounce back. Since there is no way of knowing when the shares will recover, contrarian strategies such as this are only advised by investors who have a medium to long term view and are willing to average down / hold for the requisite amount of time.

This is one falling knife that short term technical trader have no business trying to catch. Logic, which plays a big part in picking strategies, is the best advisor in these circumstances. It’s okay to compare yourself to Warren Buffett, provided that you also think and trade like him.

Also, short term trades must necessarily have short term profits and short term stops. It is possible to survive bad trades like this, provided that targets and stops were set, which they weren’t. Being able to fly from one point to another requires you not only to know where you are going, but to possess an properly functioning aircraft that can takeoff, fly and land without crashing. You must check its wheels, landing gears, navigational instruments, radio etc. In trading terms, these are the targets, stops, bet sizes and formulas for knowing when to increase or decrease positions. Entering into a trade without considering all these things is like taking off in a plane and then worrying about whether it can make it to the other side in mid-air.