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Most of us generally accept the principle that stock prices will plummet along with an economic recession. For example, during the Global Financial Crisis (GFC) in 2008, the S&P 500 fell by about 56% from 1561.80 (12 Oct 2007) to 683.38 (6 Mar 2009).
This relationship between Main Street (regular people, families, and businesses) and Wall Street (the financial markets) is relatively easy to understand. If Main Street weren’t doing well because of a recession, neither would Wall Street do well.
But is that always true? Not necessarily.
While the COVID-19 pandemic did spook the financial markets, especially when the S&P 500 lost about 30% of its value in a 30-day period from 23 February to 22 March, the financial markets recovered quickly after – and surged ahead – even though most major economies including America (real GDP down 3.5% in 2020) and Singapore (GDP down 5.8% in 2020) suffered a recession in 2020.
So, what exactly is happening? Why is the stock market performing so well while most countries continue to battle the pandemic with businesses and workers struggling to survive and keep their jobs?
To answer some of these questions, we spoke to Chong Ser Jing, the Co-founder and Portfolio Manager of Compounder Fund, a fund that aims to deliver superior long-term returns for its investors through investing in the stock market. Within the fund’s portfolio are stocks like Facebook, PayPal, Shopify, Netflix and Tencent. Along with his co-founder Jeremy Chia, Ser Jing also runs an investment blog – The Good Investors – that educates people about stock investing. Both Ser Jing and Jeremy were previously writers and analysts at The Motley Fool Singapore.
As part of our content series with IG on #TheNewNormal, we spent some time talking to Ser Jing about why such disparity between the financial markets and the real world is showing, and whether this is part of the new normal we are expecting moving forward.
Timothy Ho (Timothy): As a writer yourself, you wrote on your blog about how this current disconnect between Main Street and Wall Street isn’t the first time that stocks did fine when the economy fell apart. What makes this recession experienced by many countries different from past recessions such as the GFC and the Asian Financial Crisis?
Ser Jing: You mentioned the GFC, and I have looked at how stocks recovered during the crisis. Interestingly, it follows a similar pattern to what I wrote about in the blog post that you referenced. Although the S&P 500 reached a low in early-March 2009 during the GFC, many individual stocks bottomed months before that, in November 2008. And it turned out that the US’s GDP and unemployment rate continued to deteriorate for months after these individual stocks reached their crisis-lows. I wrote about this in a blog post linked here. So, I think a takeaway here is that stocks tend to – though not always – look ahead into the future. While things may look bleak today, stocks may already be racing ahead in anticipation of a better tomorrow.
This COVID-19-driven recession has caused pain to many economies around the world. In response, central banks in these economies have at times intervened in unprecedented ways. Some market participants may point to these interventions as the reason why stocks have risen so much from their pandemic lows. But I want to point out something interesting. In my blog post that you referenced, I wrote about how US stocks did during the Panic of 1907. This was a period of immense economic pain for the USA and was one of the key reasons why the US government decided to set up the Federal Reserve (the US’s central bank) in 1913. During the Panic of 1907, the US economy was still in shambles even in 1908, but the US stock market had bottomed in November 1907 and then started climbing rapidly in December 1907 and throughout 1908. And here’s the interesting thing: The US central bank was not even established back then. So perhaps there’s more to the recovery in stocks from the pandemic lows that we’re seeing today than just the actions of the central banks.
You also asked what makes the COVID-19-driven recession different from past recessions such as the GFC and Asian Financial Crisis. One key difference is that most past recessions were the result of excesses in the economy (both the GFC and Asian Financial Crisis were caused by excessive borrowing – on the part of households and financial institutions in the case of the GFC, and on the part of countries in the case of the Asian Financial Crisis). The COVID-19-driven recession, on the other hand, was caused by disruption to our daily work and ceasing of many economic activities to halt the virus’s spread. It was not caused by excesses in the system. This is a point that Howard Marks, an investor I deeply respect, has made. So, I think a lot of the playbooks that investors have developed based on the lessons from past recessions may not be very applicable in today’s context.
Timothy: It will be easy for us to simply say that investors are starting to realise the importance of investing (or investing more) even during a recession. But is there an element of FOMO (fear of missing out) that is creeping into many retail investors? For example, we see meme stocks, NFTs and cryptocurrencies being incredibly volatile, not to mention, speculation of many pump-and-dump tactics at work. Are these factors contributing to this surprising bull run?
Ser Jing: It’s hard to tell what are the psychological factors that contribute to the current bull run in stocks. I don’t have a good answer. But I do think it’s clear that there are speculative actions being seen, as you rightly mentioned, in some corners of the financial markets. If these speculative actions lead to excessive, widespread optimism about stocks soon, then another crash may be around the corner.
Timothy: While it’s good to see people getting interested in investing and trading in the financial markets, I realised that many new investors I met these days are more open to investing or trading, even when they recognise that they don’t have the knowledge they need. It’s like the desire to get started on their investment journey outweighs the need to learn first. In your opinion, is this good or bad?
Ser Jing: Great question! My answer is “it depends.” If the new investor is young, with decades ahead to make full use of his/her human capital, then getting started on an investment or trading journey even without the requisite knowledge is not a bad thing. The best teacher for such lessons is the mistakes we make ourselves. By starting early, the new investor gets to make the important mistakes, when her capital for investing is small and when she has plenty of time to recover from her mistakes by making more money in the future from entrepreneurship or employment. On the other hand, if the new investor is approaching retirement, then starting to invest or trade without the requisite knowledge is a bad idea.
Timothy: What are some things about the stock market that have surprised you over the past 18 months?
Ser Jing: I am generally not surprised by what happens in the financial markets, not because I can predict the future (I absolutely cannot – I have no crystal ball), but because I am aware that surprising things happen all the time in the financial markets. But I am still in awe at the magnitude of the rebound in stock prices from the pandemic lows.
Timothy: With decentralised finance (DeFi) taking center stage (pun intended), do you personally expect to see a financial world in the future where prime assets to hold go beyond just stocks and properties, and include other asset classes like NFTs and cryptocurrencies?
Ser Jing: I am still very much a novice when it comes to NFTs, cryptos, and blockchain technology. I am still learning, and it’s a fascinating area. I don’t know what the chances are that NFTs and cryptos will become prime assets in the future. But I’ve seen some forward-looking venture capitalists compare the state of NFTs, cryptos, and blockchain tech today to what the internet was like 20 years ago. Back then, the internet seemed mostly like an object of curiosity but look at what it is today. For now, I am watching developments in the blockchain space as a highly curious and interested novice.
Timothy: Beyond just individual companies, do you look at other traditional asset classes like indices and bonds in your investment portfolio?
Ser Jing: I don’t have my own personal investment portfolio. I set up Compounder Fund with Jeremy to invest in a way that we would for our own capital. The short answer to your question is that I don’t invest in other traditional asset classes for the fund.
Now for the long answer. First, when it comes to indices, I think it’s a great starting place for an investor who’s new to the financial markets. But for someone with expertise (and a very important part of the expertise involves having the right temperament), investing in individual stocks can generate much higher returns than investing in indices. There’s no guarantee that Jeremy and I have the expertise. But at the very least we have discipline – we’ve written about our investment process and methods in detail, and we intend to stick to what we’ve discussed. Second, when it comes to bonds, I don’t think I know bonds well enough to be able to form an investment opinion on them. I only want to invest in things that I understand well – and for now, it’s only stocks.
Invest Or Trade In Products That You Understand
As a seasoned investor, Ser Jing is certainly someone who could have spent his time investing in a wide range of asset classes if he wanted to. At the same time, however, he also believes in investing in what he knows best – stocks.
Similarly, when it comes to financial trading, we should also focus on understanding the various types of asset classes well before we get started with trading them. These may include stocks (also known as shares), indices, forex, commodities or even cryptocurrencies. Each of these asset classes has its own idiosyncratic risks, so traders need to be mindful of these risks when trading the assets.
Despite the volatility that the financial markets have experienced over the past 18 months, Ser Jing remains generally unfazed by how the markets have been, and he accepts that the financial markets do surprising things all the time – in the short run at least. For traders who have a shorter time frame for their trades, CFDs are a type of instrument we can use to take both long/short positions for our trades, and to generate returns from either direction of the market.
With trading, leverage is also often used. Leverage is a double-edged sword as it can increase both our potential returns and risks. This also means it’s vital for us to practise good risk management habits when trading. We want the upside gains, but this doesn’t mean that we must be exposed to unlimited downsides. For example, by putting a guaranteed stop-loss on our trades, we can ensure that we will never lose more than we want on any trades.
One such product we can consider for our trade is knock-outs. As explained in our previous article, knock-outs, which are currently offered only by IG in Singapore, are similar to limited-risk CFDs. When a trade is made, the trader will set a “knock-out” level which will be below the current market price of the asset if it’s a Bull knock-out (or above the current market price for Bear knock-out). Think of this like a stop-loss level. If the asset reaches the knock-out level, the trade position will automatically close and the trader will incur the loss, plus a small knock-out premium. The knock-out premium is only payable if the knock-out is triggered. Otherwise, the premium will be returned back to the trader.
Beyond just knock-outs, IG also offers Singapore traders access to more than 17,000 markets to trade across the world.
Ser Jing also shared the advantages of starting young, preferably with a small capital, as this would allow us to learn and improve on any mistakes that we make (and can afford to make). For new traders, it might be sensible to start with a demo trading account first, as it would allow us to practise trading and get familiar with the platforms and the asset classes that we trade.
To get started, we can start a virtual trading account with IG and get S$200,000 in virtual funds. With a virtual trading account, we can also enjoy exclusive content on IG Academy that includes webinars and online courses. We can also be part of the IG Community to engage with other likeminded traders across the world to collectively improve as a trader.