Stock price disparity of A- and H- shares in Chinese and Hongkong stock exchange.

深港通 and 扈港通

When trading Chinese stocks through 深港通(Shenzhen-Hongkong Stock Connect) or 扈港通 (Shanghai-Hongkong Stock Connect), we often find companies listed simultaneously on ‘Shanghai and Hong Kong’ or ‘Shenzhen and Hong Kong’ exchanges. Generally, ‘law of one price’ indicates the same product must have the same price applied in any market. However even though the company has the same business structure and performance, the prices of stocks listed on the Shanghai or Shenzhen stocks tend to be overvalued compared to the prices of stocks listed on the Hong Kong Stock Exchange. Why does this happen?

A-Share and H-Share

In order to understand the question, investors need to understand the concept of H-shares and A-shares. H-shares the stocks of Hongkong or Chinese corporates that are listed in Hongkong stock market. Chinese and non-Chinese can trade freely. Meanwhile, A-shares are stocks of Chinese companies that are listed in Chinese market such as Shanghai and Shenzhen stock exchanges, mostly for Chinese investors. Foreign-only stocks are called B-shares. They can be traded by foreigners through the 扈港通 and 深港通 system. However, B-shares are very limited to specific firms. 

The A-H premium index is an indicator that needs to be checked in order to determine the relative price level of companies listed in both markets. The AH Premium Index is an indicator of the relative price gap between Shanghai or Shenzhen A shares and Hong Kong H shares for the same company.

Since A-shares are traded in RMB and H-shares are traded in Hong Kong dollar, AH premium index is calculated at the exchange rate of the day in order to compare in the same currency. If the index exceeds 100, it means that A is relatively overvalued, and if it is less than 100, it means that H is overvalued. 

In the modern financial market, when a price difference occurs due to a temporary market imbalance for the same target, it is a common phenomenon to close the gap through arbitrage trading. The price gap is resolved because transactions are constantly attempted to obtain profits by buying undervalued objects and selling overvalued objects.

Based on this theory, the prospect that the AH premium will almost disappear from the market was prevailing with system of 扈港通 in November 2014. This is because both Chinese and foreigners in China can buy and sell A and H shares.

However, as the mainland stock market continues to fluctuate, the AH premium index has also been volatile, and the price gap has continued to arise during the fluctuation. In the last decade, the AH premium index has moved between in the range of 90-150. 

Why does the price gap between share-A and H occur?

First, capital movement is not completely free due to differences in investment applied to mainland China and Hong Kong markets. In order to be able to trade arbitrage, foreigners must be able to short sell A and buy H shares, but short selling of A-shares is prohibited. In addition, Chinese may have to buy H shares without restrictions through 港股通(Southbound), but individual investors must have 500,000 yuan cash in their stock accounts, and there are limitations in accessibility to investment like such as credit transactions.

Second, the difference in the liquidity environment between the two markets is also causing the price gap. The continued efforts of the Chinese government to open the stock market for foreign capital, such as the implementation of the 扈港通 and 深港通 systems and the expansion of the QFII investment limit, created a favorable environment for the liquidity reinforcement of the mainland stock market. The policy to expand A-share investment opportunities for foreigners is expected to continue.

Third, the difference in the share of major industries between the two markets can be said to be a factor of the price gap. H shares have a high portion of the financial sector at 72%, while A shares have a relatively high share of consumer goods, information technology, and industrial goods that are expected to benefit from the Chinese government's policies. In addition, the willingness to foster mainland Chinese stock markets compared to Hong Kong should be seen as having an impact on price gap.

Finally, degree of perception by investor in both markets such as the direction of the currency rate, and the level of risk-required return can be seen as factors affecting the A-H premium and the gap between the two markets.

According to the Hang Seng Stock Connect AH Premium Index, as of September 2020, companies that were simultaneously listed in China's A-shares and Hong Kong's H-shares are trading at 43% lower levels in Hong Kong's H-shares.

Source: Investopedia

https://www.investopedia.com/ask/answers/062315/what-are-differences-between-hshares-and-ashares-chinese-and-hong-kong-stock-exchanges.asp

Difference between traditional IPO and direct listing.

Spotify and Slack Technology were listed in a slightly unusual way called ‘Direct Listing’. Airbnb, a vocational rental online marketplace company is also set to be listed directly no later than year, is also considering listing directly. Investors may heard of IPO a lot, but the concept would be quite unfamiliar. What are the advantages and disadvantages of direct listing? What made Spotify and Slack to choose untraditional way of ‘Initial Public Offering’?

Traditional IPO

IPO means that the company's shares officially begin selling on the Stock Exchange. Being a listed company means that it has become one of the large and reliable companies whose shares are quoted on a stock, so many companies strive for it. The usual method of listing is to raise funds by issuing new shares and selling them on the market. The process is called IPO, Ant-financial raised $34.4 billion recently.

Advantage of direct listing

If listed directly, the process of raising funds through the issuance of new shares will be omitted, and only the listing process will be carried out only to sell the shares held by existing shareholders on stock exchange. New investments will not be raised, but it has the effect of officially trading process as normal listing companies do. The advantages are below:

Firstly, direct Listing saves the cost. IPO process costs a lot of money. Seven percent of the funds secured by the IPO are usually paid as commission to the security companies that handled the process. Price of stocks exchanged during IPO is usually measured higher than normal, which likely to have more commission fee to the security firms. For example, if a company raises one billion dollars by IPO, the fee costs over 200 million dollars.

Second, existing investors can sell their shares right after listing. For traditional IPO, there is usually a 180-day limit on the sale of shares that are held by existing investors to protect prices. So existing investors or executives and employees with stock options can't make a profit no matter how much the price goes up for six months. However, in the case of direct listing, there is no such restriction, so the existing shares can be traded right away.

Furthermore, additional financing is also available. Unlike IPO, it is not possible to raise funds once it is listed, but further fund raising is possible through the issuance of new shares. Furthermore, the cost of it is much cheaper. According to Spotify CFO, additional financing was available at a 1% discount on transaction fees and a 4% discount on sales.

Finally, it has effect on rewards to existing investors. As startups grow, the employers promise their employees a share reward, such as a 'stock option', but if they don't go public, they'll be useless. Of course, there is alternatives if the company is acquired by another company, but it's hard for a fairly large company to do so. A listing is required to compensate employees and investors who worked for a startup. Unlike the IPO, there is no issue of new shares, so the value of the existing shares is not diluted.

Disadvantage of direct listing

There are many advantages of direct listing, but there are limitations and disadvantages as well. Above all, direct listing is only possible for companies that are well-known and whose business models are widely known. To do IPO, companies need to attract investors. So, the companies have to be often mentioned in the media, like Spotify and Slack.

IPOs have the effect of forcibly supplying the market with a few dozen percent of all stocks, but there is no guaranteed volume for direct listing. When existing shareholders can supply sufficient quantities, demand including institutional investors can be activated and normal transactions can continue.

And most of all, there should be no need for financing. In the past, large-scale financing was difficult without IPOs, but these days the venture capital market has grown big enough, and startups have been able to raise funds through various methods. 

Source: Investopedia

https://www.investopedia.com/investing/difference-between-ipo-and-direct-listing/#:~:text=Direct%20listings%20are%20also%20known,without%20getting%20help%20from%20intermediaries.

Market Never Forget - Ken Fisher

In average, people misunderstands commonly about the stock market based on confirmation bias. In the book ‘Market Never Forgets’, written by Ken fisher, an American financier and founder of Fisher Investments, refutes to the common errors that market thinks by showing actual market history data. However, Ken Fisher indicates that all of these explanation based on past data cannot explain the future of certainty or possibility, but can provide various probabilities that investors can select.

The book consists of 11 chapters:

1. Fooled by Averages

2. Normal Returns Are Extreme Not Average

3. Getting Average Returns Is Hard Really Hard

4. Volatility Is Volatile

5. Stocks Are Less Volatile Than Bonds?

6. Never a Dull Moment

7. Secular Bear? Secular Bull

8. Debt and Deficient Thinking

9. Long Term Love and Other Investing Errors

10. PoliTicking

11. It’s Always Been a Global World After All

This time is different

Ken Fisher accentuates the idea of ‘This Time is Different’ is always wrong. “The four most expensive words in investing are: 'This time it's different,” said Sir John Templeton, the legendary investor and mutual fund pioneer. Various economic phenomena (ex. economic downturn) are somewhat different, but not very unlike from those experienced in the past. Investors have to bear in mind and evoke the history of the market, which is to find similar events in the past and learn the lesson from it. It will let investors have ability to recognize and respond the uncertain environment better in near future.

Errors: New Normal / Recovery without employment / Double dip fear

During Covid-19, analysts and economists feared of double dip, which did not happen yet. People think that when the unemployment rate is high, the economy can be stagnant, which is usually false. (Unemployment is economic lagging indicator) People usually misapprehend that the economy needs to grow before the stock price rises, which is another false presume. Usually stock prices rise first since it is a leading indicator. 

Don't be fooled by the average

The market average rate of increase is just average. In the actual bull market, the stock price rose much more than the average. Therefore, if investors cannot adhere to the strategy while entering/exiting the market at the wrong time, the outcome is relatively negative. In the beginning of the bull market, especially, the initial trend should not be missed because the rate of increase exceeds the market average. However, many people feel anxious at this time and delay their investment. Conversely, about 2/3 of the entire falls occurs at the end of the bear market.

In the stock market, the author indicates that the average rate of return is not important. It is to buy the dip during the entrance in bull market. However, it is very difficult to determine the timing of seize a chance. Even if investors miss the beginning of the bull market, they should not give up their investment since double dip is unlikely to happen. There is no such thing of limit on the share price hike allowed in a bull market. The market cannot predict even one inch ahead, and this is very normal.

Volatility is normal

The stock market is fluctuating now, has been, and will be forever. Investors may think that the recent volatility has increased and it is painful and difficult to bear. However, the investment gurus are not worried about the daily fluctuations. For novice or people who is deeply affected by his or her atmosphere, TV and Internet should be turned off during the day which will reduce wrong decision making and lead to improved performance by reducing useless trading. Anything traded in a free market economy carries the risk of loss in itself. To overcome it, investors need to train themselves to withstand volatility. If the investment strategy is long term, the worries of volatility is diminished regarding the market will recover in the longer run.

Fear of debt

It is not a surprising news that the government debt crisis has emerged. The debt cycle has been repeated and will recur the same way in the future. It is often thought that an increase in government debt or fiscal deficit will negatively affect to the stock market, but the data is more often reversed.

Intelligent investor will deeply consider of what is likely to happen in the future. They find out that fiscal deficit is not a real problem since the government is boosting the economy by releasing the money. In contrast, when austerity is set by government, then the money in the market will be absorbed and investors won’t be easy to borrow. Most people think deficit can lay negative impact, which is absolutely false.

As long as the debt is at a manageable level (for emerging countries which have massive dollar debt), the ratio to GDP has nothing to do with the stock market. Even defaults are common in emerging countries.

Why stocks

Investors may think gold and real estate can be safe-haven. However, it may not be practically safe assets. And sometimes investors think that stock market can be risky. However, the book disputes about it. History tells that small-cap stock prices rise larger in the section right after the bottom of bear market. Growth stocks such as information technology sector stand out when the short and long-term yield spread (gap) narrows, and value stocks rise when it widens. (When interest rates are low, then it is good for growth stocks since it can strengthen the competitiveness of companies by reducing funding costs.

Political ideology

There is a content that socialist policy is not good for capitalism. Yes it is true, however, some people make bias which is very bad for their investment. When a specific policy comes out, it is necessary to objectively distinguish between the industries that will benefit or suffer according to the policy, not just negatively because the ideology is different. Discarding ideology in decision making must be implemented. No matter which political party does president belong, there is no significant effect on long-term stock market returns.

To think globally

Expanding portfolio globally is one of the most significant. In a global world, all countries are connected to some extent despite the movement of de-globalization. Investors should take a good look at the economic situation of other countries than United States. There might be sudden rise on stock market in individual market when the government reveals its policy including tax cuts. However, there is more chance for intelligent investors to have global insights since cycles circulates internationally. 

The past never predicts the future, because it is about probability not possibility. If investors study the history of the market regularly, they can see the world more accurately and lower the probability of failure. Investing is a game of probability, not certainty, and investors somehow have to work on calculating rational probability.

Mastering the Market Cycle: Getting the Odds on Your Side - Howard Marks

For the past few months, asset market was overly volatile. The rise of pandemic cycle has attributed to the wide range of fluctuation; sentiments of buying the dip and sell-offs were mixed in the market. The book “Mastering the Market Cycle: Getting the Odds on Your Side” written by Howard Marks, co-founder and co-chairman of Oaktree Capital Management has been helpful to the investors to have more of an insights for the big frame of economic and market cycle. The cycle can be 5 years, 10 years, or more, but pattern of leaps and falls repeats not exact the same but very irregularly. 

The book consists of 18 chapters; the author may repeat his underlying sentences over again, yet each words or phrases are very inspiring. 

Contents

1. Why Study Cycles? 

2. The Nature of Cycles 

3. The Regularity of Cycles 

4. The Economic Cycle 

5. Government Involvement with the Economic Cycle 

6. The Cycle in Profits 

7. The Pendulum of Investor Psychology 

8. The Cycle in Attitudes Toward Risk 

9. The Credit Cycle 

10. The Distressed Debt Cycle

11 The Real Estate Cycle

12 Putting It All Together The Market Cycle

13 How to Cope with Market Cycles

14 Cycle Positioning

15 Limits on Coping

16 The Cycle in Success

17 The Future of Cycles

18 The Essence of Cycles

Cycle

When the position in the cycle changes, so does the probability. If investors do not modify their investment views in response to the change of circumstances, they are vulnerable to so called ‘Mr. Market’. Individual investors might lose their opportunity to make a great profits when reacting passively into so called ‘market efficiency.’ On the other hand, if investors have insight into the cycle, they can invest more aggressively by increasing investment when the odds are in their favor. In addition, when the probability is unfavorable, investors can act defensively by withdrawing cash.

The best way to optimize the positioning of your portfolio at any given point in time is to determine the balance to maintain between investing aggressively and defensively. Rebalancing on their asset is the keyword during the cycle. Investments, asset allocation to various possibilities, and holding risks must be adjusted continuously depending on position of cycle. Investors have to be aggressive when buying the dip, but retreat when the market is irrationally overheated.

In the field of investment, there is no universal answer for how to behave in the certain situation. Investors understand the position of the cycle differently. Suppose the cycle is moving downwards. Some of the investors will think the position of currency cycle is in high risk of losing money, while, others might think it is their great chance to have huge benefits. In consequence, those two parties will act differently based on their own idea and thoughts. However, investors acting passively do not fully understand the nature and importance of the cycle. They don’t invest long enough, do not learn about the finance, do not read the cycle; instead paying attention to the recurring reasons behind a story. Overall they do not understand the importance of cycles.

Smart investors thrive to understand the beginning and end of the cycle, pay attention to the dangerous phase. They are able to make decision independently whether to be greedy or fearfully. Perceiving risk in overheated market is one of the strength of intelligent investors. Making aggressive bets are possible depends on the situation where investors confronts for the intelligent. 

Risk

The core reason of investing is to obtain a profit depends on the how investors act. Investment is a bet of future; risks arise in any situation and the future is unknown. If future is predictable, then the investment will be easy and the profits will be certain. Since risk is a source of important issues in investment, the ability to understand, evaluate, and deal with risk is a hallmark of an outstanding investor and is essential for successful investment.

Real Estate

The real estate cycle can be amplified by specific factors. There is time difference between project plans and the completion. Usually, very high financial leverage is needed in real-estate business. The fact that supply is generally not flexible enough to adjust to fluctuations in demand since it needs time to make a great deal. It is not the development company which benefit from the investment nor a banker which lends construction funds and seizes projects. It is intelligent investors who gain profits by purchasing real estate assets during difficult times when the cycle is at the bottom and has possibility to go upwards. Oak Tree Capital was one of the party who had a great gain on this field.

Three Stages

The book indicates "three stages of a bull market."

Step 1: When only a few usually perceptive people believe things will get better,

Step 2: When most investors realize that improvement is actually taking place

Step 3: When everyone concludes things will get better forever 

The tree does not grow to the end of the sky, but normal investors behave as if the tree will grow to the end. And they pay for the infinite potential they think of. There are no worse investment than paying the most overvalued assets in paying costly price. From this point of view, it is concluded that the investor in the first stage, who hardly finds out the reason for optimism, buys the asset at the low point where a significant price increase is possible. However, the person who buys in the third stage always pays excessively high prices at the peak of the market and suffers losses as a result.

Howards Marks does not believe in predictions. Few people are enough to know what will happen in the future. Even for the investors who sometimes nailed the direction have poor records overall. However he emphasizes that the future direction is unpredictable, nevertheless, investors should know where about where they are located currently."

Sir John Templeton highlighted to buy the assets when others are disappointed, and sell when others are acting in greed; it takes tremendous courage, but the reward is the greatest. When a price rises above its fair value, the following important factors usually emerge: Good news in general, satisfaction of what is happening now, optimistic news media reports, and loss of skepticism, lack of risk aversion, credit market easing, and positive mood. On the other hand, when a price collapses from an appropriate value to an inexpensive level, it generally exhibits some or all of the following characteristics: Generally bad news, dangerous alerts, negative reports from media, bad stories, skepticism over optimism, increase in hedging, credit market crunch, and overall stagnant atmosphere.

Oaktree’s portfolio that was positioned in response to the cycles contributed significantly to its success. It invested aggressively in 1990-93, 2002, and 2008. Also it invessted cautiously and passively in 1994-95 and 2005-06, and recent years. He tried to take advantage of the cycle and add value to it. Positioning its stance in appropriate location never misses a major opportunity.

Human's Psychology

The fundamental reason that cycles exist in the market is that humans are involved. Physical things can move linearly, and time continues to flow forward. The same is true for machines as long as they have adequate power. However, humans are involved in processes in fields such as history and economy. When humans get involved, the outcome becomes variable and it creates a cycle again. The main reason is that humans are emotional, inconsistent, sentimental, and not objective.

The cycle will continue to occur. But if there is something like a perfectly efficient market, and if people really make decisions with computationally excluding emotions, then the cycle will probably be gone and will never happen again.

Benjamin Graham, the father of value investor.

Benjamin Graham is considered as most successful investor of all time. Not only he had countless victories on the investment field but also was a father of so many successful investors like Warren Buffet, John Templeton, Irving Kahn and so on. The reason Benjamin Graham is regarded as historically greatest value investor can be found back in days in early 1900s when speculative trading environment was mainstream. Stock market was not kind of what we know now. During the days, investors were anxious of uncertainty since absence of internet provided insufficient information.

As Benjamin Graham was working in NHL, he had his heydays working on security analyst. He was not momentum or day-trader seeking for profit gains in short-term. His investment style is known as the “cigar-butt” which is the “approach that picks up discarded business cigar butts laying on the side of the road, selling them at deep discounts to book value with one good puff left in them.” Warren Buffett was influenced the way Benjamin Graham did in the past to find the firms that were barely out of attention from media.

By reading his book, I was inspired by several investment philosophy which lead present investors to direct themselves in the right path. I will list four principles Benjamin Graham emphasized.

Diversification

Portfolio divergence is the most important for not only for mom-and-pop investors but also the ones who regard themselves as gurus. Benjamin Graham has diversified his portfolio in many different areas. He mentioned finding companies which has significant ‘safety margin’ is the best way to make profit, however, it is not easy to discover such a stock. Some of firms which he regarded as underestimated compared to the present price were invested heavily and concentratively. However, for unknown situation, he invested in various companies to hedge the risk. He invested about 70 different companies to diversify his portfolio because if a company makes a loss, then others will cover it. (Warren Buffett was influenced by Benjamin Graham, though he did not select diversification investment method.)

Intrinsic Value (Cigar-Butts)

Sometimes inexperienced investors tend to follow the trend of stock market. If the market is in upward cycle, then they don’t try to miss out the chances. If opposite, then investors try to sell off their assets. That is what Mr. Market entices innocent investors to join the party. It can give them delusion as they are the successful investors when the market is irrational floated. However, it can lay investors into fury when they think they are deceived by Mr. Market. Sometimes the experts of analysts can allure them to lead market melt-up. Nevertheless, Benjamin Graham puts weight on intrinsic value. If an investor has a clear philosophy based on intrinsic value, there is no need to worry about in attributing his or her mistakes on personified object that does not exist at all. 

Do we need short-sellers in the market?

Short-selling

It's one of the way of investing in stocks. When considering about long position investing, investors expects the stock will rise in the future and secure the stocks until the price rise in the future. Mostly, they buy value-growth stocks for betting future rises. Short selling is an opposite concept with the usual method. Investors predict the price of a stock will fall and bet against it, earning gains with inverse direction to the long. 

Process

Investors borrow shares in current price, sell them in the market, and return them back in the future. That is why they hope the market to be transacted in lower price so they can pocket the difference. For example,

1) If a person A is deciding whether to buy the shares of a specific company. By analyzing the firm's fundamental, A expects the sales of the company will fall down which will lead to the fall.

2) The person A borrows the company stock from lenders or brokerage firms, and sells in the price of $100 (which is market current price).

3) As expected, the share drops about half which makes $100 into $50. Then investors buy the share again in $50.

4) The investors returns the stock back to the broker. Then the investors gain the gains of $50.

Success stories in short-selling

During the financial recession in 2008, Michael Bury (movie Big Short) was betting against housing market rise, predicting the bubble would collapse resulting to sharp drop of securities. He made great wealth by a huge amount of short selling (buying CDS) which later made into massive returns. It is about 489% return ($2.69 billion in total). Other than that, George Soros made substantial profit betting against the rise of British Pounds and Italian Lira. 

Do we need short-sellers in the market?

Yes, absolutely. Those forces take essential part in the stock market. They can stabilize the capital market being overpriced or over-heated (bubble). They also can provide liquidity to function the market smoothly. Moreover, short-selling companies scrutinize meticulously whether the company honestly reports their earnings or not, which leads on positive effect on corporate's transparency on their financial statement. For example in the beginning of this year, Muddy Waters started shorting Luckin Coffee, one of the biggest coffee chain firm in China. They found out the possibility of accounting fraud in the company, which later let the world know about the scandal.

Lets be careful

Short-selling can be effective to earn gains only if the investors have strong conviction to the market's direction. Timing is also most important basis that short-sellers need. I read the article related to it in Wall Street Journal. I want to share part of the story: 

Mr. Kullamägi, who has been speculatively investing about a decade has been enjoying himself on volatile stocks for betting against the rise. One day, he captured the prey for his bets on Eastman Kodak's fall in July. When the government announced to grant $765 million loan for Kodak for supporting to make vaccine against Covid-19. The stock had threefold rise, and Mr. Kullamägi thought that the Robinhoods (mom-and-pop investors) will push the shares of Kodak higher, but would not last long. He tried to short 45,000 stocks partially until July 29th, but accidentally clicked the wrong button to double the short amount all of 90,000 shares at once which lead more cost. The shares rose seven times more and he was "stuck for the ride". He has made $1.5 million in his expenses for the trade cost.

Investors like to gain their profits by any method. It is not only individuals but also applies to the big firms like Softbank and Berkshire Hathaway. The method can be differed since there are various types of betting, however lets be careful before we put into the movements.

Source: Short Selling Stocks Proves Costly for Some Investors

https://www.wsj.com/articles/short-selling-stocks-proves-costly-for-some-investors-11599645600?mod=mhp

Call option and Softbank's aggressive bets.

Softbank, which is one of the world’s leading venture capitalists which manages about $100 billion Vision Fund, has been making considerable bets on major tech companies. The report from Wall Street Journal (WSJ), indicates that the Softbank Group is probably behind the rise of the stock market of IT companies in U.S. Reportedly, SoftBank bought about $4 billion worth of stocks and ‘call options’ of tech companies such as Amazon, Microsoft, Netflix, and Tesla this spring.

See the blog: https://techongstudy.blogspot.com/2020/09/bigger-correction-of-market-after.html
One of the three most essential derivatives (Plain Vanilla; futures, swaps, options). An option is a contract conferring the right (not obligation) to buy and sell an underlying asset at specified strike price at maturity. The right to buy is called a call option, and the right to sell is called a put option. Here is example from Investopedia. If Apple is trading at $110 at expiry, the strike price is $100, and the options cost the buyer $2, the profit is $110 - ($100 +$2) = $8. If the buyer bought one contract that equates to $800 ($8 x 100 shares), or $1,600 if they bought two contracts ($8 x 200). If at expiry Apple is below $100, then the option buyer loses $200 ($2 x 100 shares) for each contract they bought.

Traders can strike deals of derivatives contracts to make directional bets on assets (mostly stocks) or hedge their portfolio. Option holders can make big win if market skyrockets, but can lose a sizable premium and down payment if stock market drops.
In case of Softbank, the stock rises above the strike price. Brokerages or banks who arranged options get themselves to the exposure of risk. To offset the risk, option dealers buy more stock and derivatives, which leads another jumps to stock market. When shares soar, brokerages need to add fuel to the fire to hedge more. Buying more of stocks will reduce the loss a little more than doing nothing. That is why Softbank is said to be behind the surge in technology stocks.

U.S. stocks overall has increased since March as the gambling market closed due to pandemic and the number of individual investors trading stocks options through online brokerages such as Robinhood increased. Softbank generated an exposure of around $50 billion for its bet this year by using growing optimistic sentiments of investors backed by massive liquidity under Fed and U.S. Treasury. However, stocks fall for the fast few days after the news, rising concerns of Softbank’s dangerous attempt of unfamiliar area according to Bloomberg. Also, the Financial Times (FT) raised worries that investing in options that rely too much on the market could be risky. If the U.S. stock market falls in the future, Softbank’s earnings may decrease,
Source:
https://edition.cnn.com/2020/09/07/investing/softbank-stock-options-intl-hnk/index.html
https://www.investopedia.com/terms/c/calloption.asp
https://www.wsj.com/articles/softbanks-bet-on-tech-giants-fueled-powerful-market-rally-11599232205

The Most Important Thing - Howard Marks [1]

"What is the secret of success in investing?"
The answer to this question is simple, "having a philosophy of effective investment strategy".
You may ask "Where does that come from?"
Well, it needs time and experience. No one is perfect from the beginning. Of course, someone may be lucky, novice mom-and-pop investors may be lucky enough to earn money from concentrated investments. The experience comes from lessons whether it is directly from investor's own harsh encounters of a great depression or indirectly from book which was written by investment gurus.

The important thing is to be aware of what's going on in the world and how it affects in the stock market. When a similar situation recurs the lessons can be very useful for developing the market insight. Otherwise, most investors are volunteered to be a victim to repeated booms and bust cycles. The most valuable lessons come from recession. I have not experience most of the depressions in the stock market. However, by taking lessons indirectly by useful materials such as books, newspaper, or podcasts, I could encounter the notorious events happened during the great depression (1929-1933), oil crisis (1973, 1979), Nifty Fifty (1969-1973), death of equities (1979), Black Monday (1987), Russian financial crisis and bankruptcy of LTCM (Long Term Capital Management) (1998), Dot-com bubble (2000-2001), large scale corporate accounting scandals (2002), great recession (2007-2009), and COVID-19 recession (great lockdown). By encountering these incidents, it is inevitable for investors to learn the lesson of great leaps and falls.

In the book 'The Most Important Thing' has twenty parts of principles in investments. The lessons that Howard Marks gives can be very meaningful for the investors whether they are experienced or novice. I will quote or summarize the most impressive parts short and briefly [1 - 4 parts].

Second level thinking
The field of investment is not always regular and contains many variables. Environment is impossible to control, never happens exactly the same as the past. Sentiments from investors are unpredictable leading to market volatility. The field is more of art than science. Howard marks emphasizes second level thinking which needs strategy of being unconventional, intuitive, and complex can achieve more than benchmark return such as index funds. Thinking beyond and stepping further market prediction is key to succeed in the investment field.

Understanding market efficiency
An average return can be achieved if the price of an efficient market already reflects the market's forecast. However, to win the market, investors must have a different view that is contrary to the market's predictions. There is a term called alpha and beta.

"Alpha helps reveal how a stock or fund might perform in relation to its peers or to the market as a whole. Beta or often referred to as the beta coefficient, beta is an indication of the volatility of a stock, a fund, or a stock portfolio in comparison with the market as a whole." - Investopedia

Accepted wisdom which is other expression of market efficiency. Getting over the idea of being an average needs the skill alpha. It should always be countered that investors cannot beat the market. Having deep and adaptive second level of thinking will help investors getting over it. “Many of the best bargains at any point in time are found among the things other investors can’t or won’t do.", explains Howard Marks.

Estimate intrinsic value
The buying price must be lower than the selling price. In other words, buying cheap and selling stocks at a high price is a general principle of the stock market. However, since selling is performed in the future and buying is carried out now, it is difficult to approach the stocks which have appropriate price. There must be an objective criterion for defining what is expensive or what is cheap, but it is most effective when it is valued based on intrinsic value. Measuring intrinsic value leads the way for investors to purchase a stock.

There are two ways for evaluating intrinsic value. One is analyzing the corporate value, the other is technical analysis.
Technical analysis is obsolete method due to random walk hypothesis. According to the hypothesis, past stock movements are not helpful at all to predict future stock price. “We all know that even if a coin has come up heads ten times in a row, the probability of heads on the next throw is still fifty-fifty. Like wise the fact that a stock’s price has risen for the last ten days tells you nothing about what it will do tomorrow.”  Momentum investors are the best example of investing in technical analysis. When TMT (tech, media, telecom) stocks rallies, they put their investment in very short term.
Value analysis has two types of investments: value and growth. The purpose of a value investor is to invest when the price of a security is lower than the present intrinsic value (margin of safety), and the purpose of a growth investor is to find a security whose value will increase rapidly in the future. Value investors believe present value of the asset is lower than the price. Growth investors buys stocks when they consider the stock of future will rapidly grow.
Value is more of present, growth is more of future. In my opinion, value has never lead to bubble or great falls. In opposite view, value stocks sometimes frustrate investors because they don't give the excitement that prices will skyrocket. However, value investors like Warren Buffett must have solid belief of value in order to withstand without profit for long time.
See my blog about Warren Buffett's recent value investment on five Japanese trading companies.
https://techongstudy.blogspot.com/2020/09/sogo-shosha-and-berkshire-hathaways.html

The Relationship Between Price and Value
To understand the relationship between value and the price is to know about the sentiment of the investors and technical factor. Technical factor may include margin call when inevitable situation comes out during collapse of stock market. Second factor is sentiment of investors.
"Psychology plays a key role in investing. Emotions that affect investing include fear and greed, but are more diverse and can significantly impact results. Investor psychological profiles affect how an investor's portfolio performs because investing decisions are directly linked to emotions." - Seeking Alpha
The error that investors claim can be based on excess liquidity and growth of the firms. However, it can lead to the trap of the greater fool's theory when the bubble starts to burst. An investment strategy based on sturdy value is most reliable. As John Maynard Keynes points out that markets are not rational as investors thought, it can remain irrational until investors run out debt repayment capabilities.

Why is onion future price so volatile?

What makes the market volatile? 
Why is the price of asset so fluctuating?
Is it because of speculative day-trading investors?

The article of <Newsweek> in 2010, mentioned about volatility saying, "By trading vast amounts of stock at warp speed, as many as a billion shares a day, high-frequency traders gobble up fractions of cents at a time. The more volatile the market, the easier it is for them to make money jumping in and out of stocks across exchanges."

Well, does high-frequency trade affects on the volatility on the market? Ken Fisher, CEO of Fisher Investments, indicates volatility during the Great Depression. The stock market was moving upwards and downwards frequently. The reasons for market surge and stumble in short period of time were various; one of them was regarded as lack of liquidity. There weren't that many listed stocks in the market and the trading volume wasn't abundant. Information was delivered much more slowly, which hindered the fast recovery of price. Markets with low trading volumes are usually highly volatile due to insufficient liquidity and supply.

Futures traders are often referred as speculators because they bet money on future prices. There are countless reasonable motives to have future trading deals. Firms use futures contracts to stabilize the cost of purchasing in response of highly volatile commodities. Airlines buy oil futures to stabilize operating costs. Farmers use future tradings to purchase agricultural manure or compost.

Why is onion future price so volatile
If you are curious about a market without speculation, just looking at the onion future market is enough. In 1958, onion farmers claimed speculators were slashing the price of onions. Michigan Congressman Gerald Ford, who later became president of United States, believed in this claim and banned futures contracts for onions. In fact, Ford was the one who has believed in the free market. This ban is not abolished and still exists today. Ford and the farmers did not understand that speculators were contributing to providing liquidity to the market. They didn't even know that their market participation actually makes volatility less.

Onion vs Oil
If you think oil future has heavy volatility, please refer to the chart below. Onion prices fluctuate more frequently than oil prices. The range of fluctuation of onion is even greater. If the price volatility was so high, speculators would need to be invited back to the market to reduce volatility. It is foolish to ban speculation just to protect farmers.

Speculation in forex market
The exchange rate must have a sufficient amount of supply and demand to determine the appropriate exchange rate in the foreign exchange market, which is determined purely by market function, and speculative foreign exchange transactions must exist in order to secure such demand and supply. If speculative trading is prohibited and only underlying transactions are made on demand, the size of the market will not reach a certain level and as a result, the foreign exchange market's exchange rate may be distorted or the exchange rate-setting function may be lost.
For example, lets presume that only underlying transaction is on demand. When the demand of dollar is 2 million and supply is only 1 million, the currency rate will soar up in need for more supply, which will make Forex in extreme volatility.  However, when speculative transaction is traded actively, then the supply problem will be hugely diminished.

Please refer to the blog here:
https://techongstudy.blogspot.com/2020/08/what-is-exchange-rate-and-forms-of-it.html

Source: Market Never Forgets (Ken Fisher)

Stock split and your portfolio.

The stock split of Apple and Tesla has been an issue for a months to the investors; the novice in investment field could be confused with it (delusion that price can be looked cheaply) even though there is not much of a change in a system. When company announces to split its stocks, then it can entice the media and attract investors to buy the shares in nominally cheaper price.

Stock splits have not much proceeded in recent days as it was not corporate playbook. After the dot-com crash in 2000, stock splits by S&P 500 companies became obsolete, while Dow Jones Industrial Average are much less frequent. Stock splits used to happen when shares reached above $100 in the past, however brokerages like Charles Schwab Corp started giving the options to clients for buying a fraction of shares in $5. 

Stock split
Wikipedia explains that "stock split or stock divide increases the number of shares in a company. A stock split causes a decrease of market price of individual shares, not causing a change of total market capitalization of the company." (Different idea against paid-in capital increases)

Shareholders of companies will receive more stocks (the total value does not increase) when shares go into the split. For example, when the company announces for 4-for-1 stock split, then three additional shares will be granted to each investors. So if the previous price was traded in $400, then it would be $100 aftermath.

Company dividend
Board of the company decides what to do with dividend. Normally, dividend is also divided as the ratio of stock split. For example, imagine there is a company which gives a dividend of $1 per share. If the stock is split into 1/4, then the dividend will be from $1 to 25 cents.

Options bets
Option contracts held at the time of division are recalculated through a process of "being made whole". Options Clearing Corp has rules and procedures in place to modify the contract so that the holder is not affected by the division. The contract is adjusted to reflect the new price and number of shares, but the value remains the same.

Dividing it by one to four, a call option contract that covers 100 shares at the strike price of $100 each will cover 400 shares at the strike price of $25.

Fractional shares
Again using the example of a 4-for-1 split, investors who hold less than one share ahead of the split will receive three additional fractional share equivalents. An investor holding half a share before the split will end up holding two shares after the split. An investor holding a quarter of a presplit share will end up with one share afterward. Anyone with less than a quarter share will hold a fractional share following the split.

Benefits for corporate
Company just offer lower stock price and more shares. Above that, there is nothing. It does not affect the value of company at all. However, stocks price usually pop out in short-term as history says. Stocks in Nasdaq rose 2.5% at sight right after announcement of stock split and S&P 500 soared 5% in the year. Apple has added 30% since July 30 after the unveiling of stock split, whereas Tesla's share has climbed 61% since August 11th after announcement.

"Many investors say the outsize reactions to those splits reflect factors including novice traders’ embrace of technology favorites during a year of pandemic-related disruption and the perception that a stock split ratifies a firm’s perceived competitive strength." as Wall Street Journal says.

Stock market
Mostly, there is not much of an impact on overall stock market. The S&P 500 index is followed by corporate's market capital, which means that firm's market value is leading the index. However, the Dow Jones Industrial Average is different. Dow is price-weighted index. The index is followed by the nominal price of the shares. This means that if the index is composed of nominally high value, then it is easier to move upwards when shares rocket up. Blue-chip companies' stock split won't do good influence on Dow since bigger share value rise influences more on index moves.

Popularity
Splits are not a fad now despite the announcement from Apple and Tesla. About 41% of stocks in S&P 500 are trading above $100, which was considered high enough to be split. There are 3 plans for stock split, which as 102 in 1997, seven companies 4 years ago. (Schwab) Alphabet and Amazon have not split its stocks for 20 or more years. Berkshire Class A has never been split after its foundation. In 1996, Berkshire Hathaway created another class to help individual investors to trade in around $200. It was split in 2020.

Stock split in the past
Stock splits were more likely to happen in the past since the trading wasn't very well developed. It wasn't traded quickly by digital system and was expensive to small individual investors. Normally in the market, when buyers purchase in large quantity, then the compensation of it can be discount. Investors willing to buy 100 shares at a time, then the commission fee could be discounted. Commission fee is not a big problem contemporary, due to the development of digital trading system. Target Corp and PepsiCo denied of stock split with these reasons.

Options for the stocks that are not split
They have three options: paying up; buying shares of other firms that trade for less; or purchasing a fraction of a share, an alternative recently offered by some retail brokerages. Fractional shares are not the real share. It is a product from brokerage to help investors to buy cheaply. Proportional dividend and voting right can be performed in accordance in the contract.

Source: https://www.wsj.com/articles/what-is-a-stock-split-and-how-does-it-affect-your-portfolio-11598616477

FOMO (Fear Of Missing Out)

David Choe is not a financially expert, and he is not even in an economic field. David was a graffiti artist. He was scouted by Sean Parker who was working as a vice president in Facebook. The project he had to do was to paint the office in receiving 60 grands which is $60,000. However, Mr.Parker offered him stocks options instead of giving him cash. Later on when Facebook went public, he became a $2 million shareholder of Facebook making him be a millionaire. The only thing he did was to choose the right decision between stocks and cash and hold it for a while.

With the precedent example of an artist becoming a millionaire, a large influx of investors were lead into the stock market, making them be frenzy into buying Facebook stocks. In this blog, I am not talking about Facebook, I'm talking about these irrational investors.

Investors were seeking for riskier assets with high return. There is a phrase called ‘There Is No Alternative (TINA)’ which implies that investors have no choice but to buy higher yields than the bank deposits. Mostly it applies to the stock or high-yield corporate bond market, since the stance of FED was super dovish (central banks all around the world are also holding interest rate low) and FFR remained permanently near-zero. (Mainly stocks are the main target from investors because it is very sensitive to the news. Most news are positive to allure investors to get in to the field.)

However, the market seemed to have shrunk for a while when the COVID-19 crisis broke out, but the combination of the FED's monetary policy and the Treasury's fiscal policy revived the asset price and market significantly.

Shares of Blackrock has risen sharply for profit rise amid economic downturn during COVID-19. It surely means that investors are now looking for ETFs to buy stocks passively and indirectly, since they are looking for higher returns. Please see my blog about Blackrock’s profit rise.

https://techongstudy.blogspot.com/2020/08/how-blackrock-is-making-during-covid-19.html

The term FOMO (Fear Of Missing Out) becomes talk of the town again when the investors are worried to miss the rallies that are ascending fiercely. The phenomenon first came out 1996 by marketing strategist Dr. Dan Herman, who conducted research for Adam Bellouch and published the first academic paper on the topic in 2000 in The Journal of Brand Management. (Wikipedia) Later the term 'FOMO' was coined by Author Patrick J. McGinnis let the world know the phrase in a 2004 op-ed in The Harbus, the magazine of Harvard Business School. The term FOMO was first applied as marketing term, "Don't be left behind by trend or fad".

Later the term FOMO is also seen in article or opinion section of stock market explaining the phenomenon about investors seeking for the assets that others are looking for. Paul Krugman used it later in stock market. The term implicates similarly with examples below. (quotation from Wikipedia and Cycling Tips)
Herd Behavior: The behavior of individuals in a group acting collectively without centralized direction. Herd behavior occurs in animals in herds, packs, bird flocks, fish schools and so on, as well as in humans. Demonstrations, riots, general strikes, sporting events, religious gatherings, everyday decision-making, judgement and opinion-forming, are all forms of human based herd behavior. [Wiki Quote]
Lemmings: are small rodents that have been known to follow each other as they charge to their deaths off the edge of cliffs. [Cycling Tips Quote]

Mostly the procedure of FOMO phenomenon (also called behavior) about stock market starts from cognitive bias where people are to follow the crowd, animal spirits to be part of them, participate in the fierce rally and finally lead to irrational exuberance. FOMO causes most of the bubbles and the crash incidents.

The bubbles were also existed in the ancient financial market. In ancient Babylon, commodity prices such as barley and wool took sudden leaps and fall which can't be explained whether the bubble formed due to the weather or the war. However, it is surely clarified that irrational buying and selling shaping the bubble.

In 1720, shares in the South Sea Co. and 88 of other leading stocks skyrocketed all-time highs as speculative investors to chase instant market gains. (The South Sea Co. roared 650%, Royal Exchange Assurance surged 1,243%, London Assurance created 4,220% incline) They had the story which can upend their stocks such as "trade in hair", "import a number of large jack-asses from Spain", and develop an "air pump for the brain". These stories look very unspecified and could be in vain, however, the media spread the market gossip through newspapers. South Sea was "all the talk and fashion" in London. King Goerge I, half the members of Parliament, genius Newton, the poet Alexander Pope were eager to be in a group of popular companies' shareholders. However, those companies took sudden leaps and fall, crashing down between 81% and 96% off the peak.

Nifty Fifty is also the example of the bubble collapse during 1960s when blue-chip companies were trusted by absolute public confidence. The 50 companies included IBM, Coca-Cola, GE, McDonald's, Disney, Xerox etc. Investors were fenzy about them, believing there is no such high price and could afford to take in account whenever risk might occur. They were absolutely sure they could thoroughly earn the profits. The average p/e ratio was formed from 80 to 90, which was sold in 8 to 9 later in 1973. The investor learned the lesson; FOMO will never happen again.

However, when the economy is growing and lays positive mindsets to investors, things happen again. Mass media only carries good news and the stock markets surges. In 1990s, an idea that internet will change the world was slogan of investors, considering there is no such high price of e-commerce and dotcom companies. Stocks were traded not regarding to the p/e ratio. Most of transactions were based on the growth of sales or the visitors of the websites which was standard on estimating the price. The craze has reached the realm of bubbles, and investors have finally conceded defeat as they cannot resist the frenzy called 'dotcom bubble'.

Financial crisis 2007-2009 was formed with the belief that the house price will never fall. In fact, there were only three cases when nominal national housing price Index fell until 1997. Twice fell by about 1%, and once by 2.8%. Thus, the decline in the national real estate price index has never been close to 20 percent after the World War II. Banks or financial institutions lent money to the house seekers by issuing subprime mortgages without the lender's minimum proof of income or evidence of employment. Later these mortgages where combined together with other different grades such as prime or lower. These were trenched into new derivatives or complicated funds; most recognized one is CDO. FED lowered FFR to promote housing markets. Regulators eased the Glass-Stigull Act, which led to three times more leverage, and strengthen uptick-rule to prevent downward bets from short forces. Investors were in FOMO phenomenon; they did not want to miss the rally of house market. Due to the rise in CPI, FED could raise interest rate gradually since there was no sign of dollar being stronger. Decline in borrowers made the housing market weaker. Assets related to the market gradually was bear steepening making investors in panic to sell whatever they have, crying to save them from danger.

These were not limited to the examples above but also happened in Japan after Plaza-accord, Taiwan, China (IPO bubble). In January 2018, U.S stocks soar due to tax-cut by Trump administration, which made fall in February. Bitcoin bubble took place in the same year. The investors think this time is different as they regard the event as special case.

I did not find the bubble until 2019 (may be corporate bonds due to the little yield spread between corporate bonds and treasuries with same maturity). However, COVID-19 has spread all around the world making the countries in lock-down. The decline in supply and demand made the economy deteriorated. Nevertheless, assets have quickly recovered due to the fast response from FED and U.S Treasuries. I can see some of the specific stocks and assets that seems to form a shape of bubble such as electric vehicle and semi-conductor companies, commodities such as gold, bonds, and so on in near days. (Kodak is one of them) May be monetary and fiscal policy can help to change in investor's sentiment positively. However, the policy does not have much card to elevate the stocks in the future, if YCT or negative yield won't be proceeded. (Announcement
effect by future guidance won't be a strategy next time)

I love Mark Twain's quote: History doesn't repeat itself, but it rhymes. Howard Marks have repetitively emphasized the market cycle. Positive events amplify investors' risk-taking tendencies, but when the turmoil arrives, they rush to sell, even though it's a low-cost buying opportunity. According to the article of Jason Zweig, behavior of FOMO and bubble is not a bad thing; it is about human nature.

In conclusion, the winner and the loser in the investment field is determined of how they restrain their instinct and have second-order thinking. This is they way to let our portfolio outperform in the market. There is a word I really love from a janitor (Mr.Read) who made 8 million dollars from small amount of money for 65 years. "Investing is not IQ test, it is test of character". Never be a part of a group of FOMO behavior.

Twitter of Mr.Muthukrishnan

"The risk is never in volatility but in our reaction to it."

Thanks to WSJ article from Jason Zweig and books of Howard Marks, I was able to write this blog.

Source 1: From 1720 to Tesla, FOMO Never Sleeps
https://www.wsj.com/articles/from-1720-to-tesla-fomo-never-sleeps-11594994422

Source 2: Why Stocks Are Hitting Records as Economic Fears Rise: ‘There Is No Alternative’

https://www.nytimes.com/2019/07/11/business/stock-market-record.html

Source 3: The Lemming Effect
https://cyclingtips.com/2010/04/the-lemming-effect/#:~:text=Lemmings%20are%20small%20rodents%20that,off%20the%20edge%20of%20cliffs.&text=This%20Lemming%20Effect%20enables%20entire,phenomenon%20taking%20place%20with%20cyclists.

Source 4: Ancient Babylon
https://economics.mit.edu/files/7258

Source 5: Do You Know the Difference Between Being Rich and Being Wealthy?

https://www.wsj.com/articles/do-you-know-the-difference-between-being-rich-and-being-wealthy-11596808802

Source 6: History of Bubbles

https://archive.org/details/anhistoricaland01andegoog/page/n121/mode/2up

Can Gold and Silver be considered as safe-haven asset or great hedge against inflation?

Gold and silver have been attractive asset to the investors recently as the central bank policy interest rates have been low after the emerge of COVID-19. It is considered as 'must have' assets among Robinhood due to their portfolio diversification.

In WSJ article, Jason Zweig calls Gold as yellow metal. Gold looks cheap for investors since they regard gold as extremely safe-assets. This ETF related to gold this year values nearly $215 billion; which is about 2 time more than a year ago. Around one-fifth of cash inflow to the gold asset has been made since January 1st 2020 as reported by World Gold Council.

Gold itself do not go up or down in its own value. The value of gold is relatively determined by the interest rate of cash. That means if Federal Fund Rate is set to be higher, then the value of cash follows that. (Interest rate means price of cash) If cash value increases, then the price of gold becomes relatively low. Gold shines brightest when the phase of inflation soars up due to devaluation of cash.

So investor regarded gold as 1. great hedge of inflation and 2. safe-haven assets. If economic downturns take place, people will look for gold. It makes sense however, not always. If the price of gold becomes relatively higher than other assets, then the price might fall due to the overheat of it.

I do not think gold and silver as very attractive assets than the stocks or bonds since it has storage cost, however produces no income like dividend or coupon(yields). The price of gold is also very uncertain against the economy. When economy recovers up and central banks pushes interest rate higher, then it will hurt gold. 

The similar characteristic asset that gold have would be TIPS (Treasury Inflation Protection Security).

However, I do not raise any problems about the possession of gold for the investment diversification.

Source 1: A Golden Rule From a Golden Fool
https://www.wsj.com/articles/a-golden-rule-from-a-golden-fool-11595599207

Source 2: Silver vs. Gold: How the Two Metals Compare as Investments
https://www.wsj.com/articles/silver-vs-gold-how-the-two-metals-compare-as-investments-11596899825

Source 3: Why Gold Prices Are Hitting All-Time Highs
https://www.wsj.com/articles/why-gold-prices-are-hitting-all-time-highs-11596533550