Tuesday, 25 December 2018


Note : The 'Trade of the Week' series showcases an interesting recent trade to highlight winning strategies in a basic, short form format. Not all trades deserve a long form writing treatment; some readers may also prefer a quick read. 

There will be no external links in these posts; we also hope you can read candlestick charts to get a better sense of our market timing. 

The Hang Seng Index (HSI) is a perfect proxy for all that is happening in the world's markets right now.

Like Japan's Nikkei, most of the time it takes its cue from movements in the US markets (S&P 500 and the Dow Jones). There are tangible reasons for this - many HK-listed companies have direct business interests relating to the US, like Apple's parts suppliers. It is also proxy to the ongoing trade war, given that the largest HK-listed companies tend to have sprawling businesses in mainland China; Tencent and the biog property developers, for instance.

We are not experts on Hong Kong or China's markets. But we do study the index movements closely. We especially like the correlation between how US markets perform and how the HSI would be impacted as a result.

We are of course aware of all the headlines generated out of the US, and the current fears in the market. We read the same papers and check the same Twitter accounts as you do.

To overly simplify our approach - and without giving our secret sauce away - this is what we tend to check before deciding whether to trade (Editor's Note : the timezone is Malaysia, +8 GMT) :

1) Last night's US markets performance (any decline of above 1.5% will trigger alarms for us).

2) The top headlines over the past 24 hours globally - we get everything we need from Twitter.

3) US markets futures after closing - the crucial hours between (1) and Hong Kong's market open.

4) 'Pre-market' prices for HSI warrants, both calls and puts - the crucial 30 minutes when Bursa Malaysia opens (9AM) prior to Hong Kong's market open (9:30 AM).

Because of the direction of the global markets right now - you know which way that is - we are more interested in trading put warrants. The reasons:

1) Liquidity and volatility is assured (unlike Malaysian stocks/warrants during this current market phase)

2) Real momentum exists (unlike Malaysian stocks/warrants, whose upward trajectory tends to be interrupted in a bad market).

3) Nothing else is gaining (when everything is declining, only put warrants look attractive. Hence, other people would be inclined to trade them too, resulting in situation (1)).

In December 2018, the put warrant that we usually trade, HSI-H4O, tends to be heavily and actively traded. It is incredibly sensitive to movements in the underlying - the actual Hang Seng Index - while liquidity is virtually assured. It is a good product; we take our hat off to Macquarie Capital Securities for producing such a reliable, tradeable warrant.

You may be wondering: why choose this warrant? To us, it's simply because it has good liquidity and constantly reflects actual movements in the underlying index. Many call and put warrants out there tend to have one or the other but not both. Through painstaking research and observation, we chose this particular put warrant.

And one last thing : we trade put warrants on an intraday basis. Hence, we don't have to look at the technical characteristics of the instrument (things like exercise price, theoretical breakeven point, implied volatility etc). Our time frame for trading this is very, very short.

One last, last thing : trading HSI put and call warrants is very risky. You need to be certain you know what you're doing, otherwise your P&L may be down to sheer luck. The approach that we're describing here is just one way of trading them safely and profitably. Your risk appetite may differ to ours, but we hope this trade can generate some ideas for you and lead you in your own research.

Here we will describe two separate trades for the same put warrant, HSI-H4O.

The Hang Seng Index, daily price movement in December.

TRADE #1 : 20 DECEMBER, 2018

5-minute candlestick chart, 9:00AM to 11:25AM.

We wanted to be in a trade on this date because the night before, the Dow closed at a new low for the year. At 9AM, HSI-H4O opened at 36 sen to reflect this, an increase of 9% from the previous day's close.

While wary of the potential fallback, we were keen to take a position. Hence by 9:21AM we bought in at 35.5 sen and 36 sen for a total exposure of 60,000 shares.

But in the next hour we were swept into a wave of unwanted downside volatility. The actual index rallied for a short period, driving down put warrants to an intraday low. Our put warrant position was suddenly staring at a 7.5% paper loss.

Actual Hang Seng Index price movement, 30-minute chart. The downwards movement means profits for us.

In moments like this, we don't panic (although the inclination is there).  We took emotion out of the equation and made a logic-driven decision: if prices do not recover by 11AM, we will exit this position. The movement in the put warrant already threatens to invalidate our expectation for going into HSI-H4O in the first place - we had expected it to hit a peak of 38 - 38.5 sen.

By 10AM, it was clear that the upsurge was shortlived; the put warrants went back to 35.5 sen. Seeing this, we were willing to stay a bit longer in the trade.

Then the moment came : at 11AM the Hang Seng dropped 1% (see the big red candlestick right above). On this day, the correlation exists: the Dow Jones fell 1.5% the night before, after all.

HSI-H4O also rocketed upwards to 37.5 sen; a 5.6% gain in 10 minutes.We decided to exit at this price.

The reasons for exiting are simple: we were indeed fortunate to have derived profits at all. The downward volatility showed that we didn't enter at an optimal price point, thus undercutting our potential profits. And because of that volatility, we didn't have the luxury of waiting until the put warrant hits 40 sen (our best case scenario). Short term upward bursts are the perfect selling opportunity; indeed, it is when everyone else is buying.

HSI-H4O closed at 38 sen that day. We were happy to exit from this trade, lasting all of 2 hours and 20 minutes. Thematically, we would be looking at the put warrant with a fresh perspective the next time we decide to jump in.

As we explain here:

TRADE #2 : 21 DECEMBER, 2018

5-minute chart, 9:00AM to 4PM. Notice the huge range and volatility!

US markets went through another bad day, losing around 2% in value overnight. This spelled trouble for Asian markets.

As expected, HSI-H4O opened higher at 40.5 sen, or a 6.5% gain from the previous day's close. It actually went further to 42.5 sen by 9:10AM.

But this time we weren't too eager to go in. For obvious reasons - if you're into technical analysis - 40 sen and above is not a good price point to enter; there may be selling pressure to drive it below this resistance point. It would be ideal for us to get a position in below that, so we nibbled a bit.

When the put warrant headed downwards, it presented a buying opportunity. We bought small positions at 38 sen and above based on simple parameters; either it goes back to 40.5 sen or it doesn't. For reference, we would be happy to cut our losses at 36 sen, coincidentally our entry point from yesterday's trade.

Based on experience, we were acutely aware of two things:

1) If the warrant quickly went back from an intraday low to a position of strength (in this instance, from 38 sen to 40.5 sen), there is a real possibility of further strengthening. This is the characteristic of the underlying index, of course, not just the put warrant itself. Fear is a key driver for the market during times like these, so this kind of volatility is to be expected.

2) But if the move happens, and happens quickly, it is time to sell. It is the only moment to know for certain that we are selling when everyone is buying - it is a limited window of opportunity.

So HSI-H4O subsequently went back up to 40.5 sen. We managed to buy some more at 40 and 41 sen, expecting the put warrant to at least reach the prior intraday high of 42.5 sen (this principle is based on our description of (1)).

Being aware of (2), we decided to count our blessings and run. We sold at 42 sen for a profitable trade lasting just over an hour.

Remember that volatility is not the same as momentum. We have learned from bitter experience that holding on for longer translates to much more risk assumed (Editor's Note : on this note, we also believe that you should NEVER hold on to any overnight position in HSI warrants, no matter how strong the momentum is. What happens the next day will be a 50:50 option between profits and destruction; there's just too much risk involved).

It was the right decision to exit. For the rest of the day (after we sold at 10:08AM) the put warrant practically collapsed. It fell to a low of 33.5 sen by 4PM. Had we stayed, we would've risked a 14% loss.

At the end of the day, in each of these trades we took the safest route possible. There is no point waiting for bigger gains if you're risking even bigger losses.

We didn't say it was easy, but if you have the opportunity to make RM1,000 in an hour from trading, would you take it?


Gross profit : RM2,880 from two trades
Average Return on Investment (ROI) : Above 4.5%
Duration : Intraday

Thursday, 20 December 2018


Note : This is our first installment of the 'Trade of the Week' series, where we showcase an interesting recent trade to highlight winning strategies in a basic, short form format. Not all trades deserve a long form writing treatment; some readers may also prefer a quick read over lunchtime (the same time it took us to write this post). 

There will be no external links in these posts; we also hope you can read candlestick charts to get a better sense of our market timing.  

Why VS? Basically it's due to the fact that the stock has been under immense pressure lately. Its recent earnings report suggest future weakness in terms of overall growth. The company itself warned investors about this, swiftly followed by downgrades by the research houses.

Why growth weakness? It's due to the company highlighting that a 'key customer' is expected to place lower orders in the coming quarters. We suspect that this is Dyson, the UK appliances company and a huge source of contracts for VS (and its smaller peer, SKP Resources) in recent years. VS's stock was on a high earlier this year, but has since plummeted from RM2.40 to below 70 sen.

It got a lot worse on 17 December as VS hit its limit down price immediately following the earnings disclosure. The stock stopped trading at 82 sen on that day.


5-minute charts for VS, from 18 December to 11AM on 19 December (our trading period)

18 December, 2018

This was when it got our attention. We immediately sensed an opportunity to make good contra trading profits. But to go into this stock required a calculated approach, and the entry point must be well timed. Otherwise the volatility will cause our position to swing into a loss.

We contemplated a few possibilities on how the stock would trade the next day after it hit limit down. Obviously the stock is expected to trade lower than 82 sen, but how low?

We would have been quite excited to pick up the shares if it got close to the next day's limit down threshold, which is 52 sen. At 8:59AM on 18 December, it looked like it was going to open at 66 sen - 16 sen below the previous day's price.

We decided against going into the trade immediately at the opening, as we were concerned that the stock could go lower. But VS showed serious buying strength and immediately hit the 70 sen mark, or a 6% increase from the open.

Our first move is to go into the stock at 70.5 sen, as buyers cleared the 70 sen selling queue easily (thousands of lots). We anticipated a rally to 75-78 sen, a best case scenario and a good exit point for us to make significant profits.

However, 70 sen is typically expected to be the resistance point. The risk is that the trading could just stay there for the rest of the day. After VS hit 72 sen, the momentum shifted. Now there was a lot of selling pressure concentrated at the 69.5-70.5 sen mark.

Sensing this, we exited our position at 69.5 sen by 10:30AM for a small loss - by this point we understood that it is more likely that the stock will decline as opposed to going up. We put a time limit on this trade to work; when it was reached, it was clear that the stock will not move up quickly.

We stayed on the sidelines to watch the stock; our original theory was already disproved. VS weakened steadily thereafter and hit a new intraday low of 63 sen at 3:50PM; as you can see, we saved ourselves from a further 9% loss (and a lot of grief). The stock closed at 65.5 sen on that day.

19 December, 2018

The key to trading is finding the right windows of opportunity to trade. If there isn't one, just don't go in. Sounds simple enough, but it's easier said than done - speaking from experience, we know that people have a tendency of seeing signals that simply aren't there. Some people trade for the sake of trading, or worse, for the 'fun' of it.

We consciously try to avoid such bad behaviour. We were wrong yesterday, so we reassessed the potential outcomes. It was plausible that VS could continue to fall further or stage a rally; this is obvious, so we had to refine our thinking to formulate a scenario where we can reasonably go in.

It's a bit like a computer program command: execute if, and only if. To simplify our next approach for trading VS (yes, we still saw trading opportunities here despite the previous day's activity), here's a distilled version of our analysis:

1) If VS opens below 65.5 sen : don't trade.
2) If VS opens at 65.5 sen : don't trade.

Both 1 & 2 are signs of weakness, not momentum. But if there was upwards momentum, we expect to see volatility quickly. In this trading scenario (volatility trading), this is what really mattered.

But there's also Scenario 3:

3) If VS opens much higher than 65.5 sen : put on a moderate size trade.

We were hoping for Scenario 3 because of this : On 18 December, a lot of investors would have attempted to buy VS at the lows. Because the stock didn't move, they may also have thrown in the towel (like us), and some may have been forced to sell at the lowest prices (not us).

But if the stock rallies immediately on 19 December, it is highly suggestive of real buying interest. In numerical terms, we could capture a profit opportunity at any point between 65.5 sen and 72 sen (yesterday's intraday high). And if the buying interest is sustained beyond 70sen, there's a chance of the stock breaching the 72 sen mark; this would be a bonus for us.

With this in mind, we waited to see how the market would open. Basically Scenario 3 unfolded, and having noticed that quickly, we put on a position at 68.5 sen (our order was keyed in at 9:01AM). The stock rallied further as we expected, quickly hitting yesterday's 70 sen resistance point.

At this juncture, we could have got out with a 1.5 sen per share gain. That would be a reasonable thing to do. But we sensed further upside for the stock based on our observation of the buy and sell activity.

We were committed to two zero-sum outcome possibilities.

1) Exiting at 68.5 sen (our entry point) if the stock weakens. Basically break even, but a small loss due to the brokerage fees.

2) Wait and see if the stock can test the 72 sen mark.

Basically, we were willing to give up 1.5 sen in gains for the chance to achieve a 3.5 sen per share gain. Our thinking was clear; there was literally a price for the consequences of our actions.

Again, the time stop is important. To avoid the recurrence of yesterday's trading activity, where the stock lost momentum at the 70 sen mark, we decided to set a two-hour limit to our angle. If VS doesn't rally further by that time, we would happily exit.

Fortunately we didn't have to wait long. By 9:55AM the stock hit the 70.5 sen mark on heavy buying volume. Our best case scenario expectation was unfolding.

By 10:30AM, the stock hit a high of 74 sen. Anywhere above 72 sen is a bonus for us, of course. We got out at 73.5 sen, a point which we thought was the highlight of the buying frenzy. To us, it was likelier that the stock will not continue its rally. We were also close to our mandatory 10% profits per trade target, so getting out was the sensible option.

So good returns all around. Nothing better than a well executed trade, and profits that came as a direct result of proper planning.


Gross profit : RM2,500
Return on Investment (ROI) : 7.3%
Duration : Intraday, 1.5 hours

Wednesday, 19 December 2018


 They will maul you, kill you, and worst of all: force you to liquidate your margin share financing account.

2018 will be known as the year that we, the Malaysian investor, decided to get rid of the 'stupid premium' accorded to stocks once and for all.

Having been an article of faith since practically forever, we have finally awoken from our delusions and have started assigning proper valuations to these companies.

The stupid premium is simply this ; rich valuation given to stocks with simplistic business models and previously held monopolies. We loved tech counters which dominates government contracts via murky direct tenders, assuring them of fat profits at the expense of the government's coffers i.e. taxpayers (MYEG, SCICOM, PRESBHD, DSONIC). On average, these four counters have fallen by 60%.

Tech - screwed

Or how about the upstream oil and gas service providers that we used to love so much? While oil prices staged a brief recovery this year, these companies' debt loads threaten to swallow them whole. Remember that BARAKAH used to be worth RM1.50 barely four years ago (now trading at 5 sen, or a 96% loss). And the lovely SAPNRG, which is now worth about 33 sen from its peak of RM4.50 five years ago (92% loss). We have already told you about the dangers of investing in oil and gas counters.

Very smart people (institutional funds, pension funds, bankers, etc) are fully invested in these stocks and have committed to holding them until near-worthlessness, it would seem. These companies have lost roughly half their value this year on average.

Oil and Gas - running on fumes

Spare a thought for the parcel delivery companies who were counting on e-commerce (greater parcel volumes) to save them. Turns out they couldn't catch up with rising expenses, a shift in the operating environment, and Jack Ma's declining enthusiasm - we should know, we traded these stocks at their absolute peaks.

Parcel companies - 'bungkus' already

And last but not least, the construction companies that were the toast of the town as recently as a year ago. By virtue of their own abilities and/or connections, they could count on getting the biggest share of major infrastructure projects. That angle has been thoroughly extinguished post-May 9; everything is being reassessed and those heady days are over. Just look at the big players in the KVMRT project and where they are now.

Construction? Go fly a kite.

Collectively, we have put stupid premiums - or, to put it more delicately, rich valuations - to these stocks in the past. We never needed a truly credible angle; any big contract announcement will do. Any link to the latest high concept thematics is OK. We forget that contracts won and contracts executed are two different things. We also forget that a contract is an agreement between the client and contractor - if the client is the Government of Malaysia, it can choose not to continue the contract, because (1) it can and (2) it can't spare any money.

 Sweet dreams (are made of this). Source.

For similar reasons, this is why we don't take seriously companies that have billions of ringgit worth of contracts but questionable abilities to execute them. Upstream oil and gas companies do this all the time - big, fancy contracts used to prop up their stock prices, until suddenly they don't anymore.

Notice the four sectors we highlighted - each used to have a protective moat around them:

1) Oil and gas - Petronas throwing around lucrative contracts, an enthusiastic public market supporting any fundraising efforts.

2) Mail and logistics - friendly government regulation to promote e-commerce activity.

3) Construction - margins managed by the PDP contract structure, companies favoured purely due to historical ability to execute instead of best pricing.

4) Tech - government fully supporting new IT solutions and integrated software systems regardless of pricing, only favouring certain companies.

These moats/protectionist measures are all similar in one way. You guessed it:

Money pump. Source.

Will these protections come back? Who knows; for now it is really every company for itself. There are no longer any handouts and no easy ways out. Not because we have faith in political willpower, but simply because the money is gone.

We believe that the market and the market's participants (that's all of us us) have changed for good. We will no longer put premiums on companies that don't deserve them. For those companies, they are the ones who have to contend with trouble ahead; less contracts, overcapacity but underutilisation, weak sector prospects, and so forth.

We also believe that 2019 will be a serious bear market for stocks. A decline of 10% from present levels is expected... to be just the beginning.

When Google image searches turn into accidental lifelong enlightenment. Source


We specifically highlighted the companies above as their stocks are the first victims of a bear market's vicious self-perpetuating cycle.

Here we outline a progression of events that may already be happening.

Scenario A : Lower investors' expectation ----> stocks lose premiums over net tangible assets (NTA) ---> lousy sector prospects ---- > lower investors' expectation ---> stocks trade below their NTAs 

Scenario B : Global economic growth slowdown ----> Lower demand for key commodities (palm oil and crude oil) ----> Malaysia's economic growth slows down ----> corporate earnings (banks, construction, property companies etc) slows down ----> added pressure from even weaker ringgit (due to our weak fiscal position) ----> [Scenario A] for Bursa Malaysia stocks

And, to cap it all off:

Scenario B ----> Scenario A ----> steadily weaker quarterly GDP growth ----> negative GDP ----> recession scenario.

Blue = Events that are already happening as you read this
Yellow =  Events that are at risk of happening soon (give it six months)
Red = Apocalyptic worst case scenario that will probably cut the KLCI's value by half

How to time the crash tho?? Source.

We may have called the overvaluations a stupid premium, but the market catches up very fast. The collective wisdom of the market has already priced in the weakening growth expectations of companies. 

The ones we highlighted above are just the first stage - they are the previous market champions whose stock prices (justified or otherwise) used to outpace the broader market. Many of them are growth companies with an appetite for expansion (vying for contracts, M&A). But their misfortunes are a sign of worse things ahead for the entire market, and for the economy. 

This bear market is different from the most recent global recessions. It is not triggered by the collapse of some far flung investment bank. There are no toxic assets, loans, or securitised loans threatening the global banking order (we have plugged that gap). Trade wars are noisy and make for good newspaper reading, but even they are not enough to trigger this oncoming economic slowdown.

We are simply reverting to the mean. Global capital markets have been fueled by cheap money over the past 9-10 years (no more of that). This time, a slowdown means exactly that.

During the same period, emerging markets have also been reaping the rewards of ever greater FDIs, championed by China (no more of that, or at least much less).

We have had it so easy that governments and entire countries can cut lousy long term, debt fueled deals. Banks have loosened their standards faster than you can pronounce 'Lloyd Blankfein'. Even the most pious of us have committed sins to cover gaping holes.

Pump priming, something Malaysia are truly world champions at, has occurred at a global scale, fueling industries, global trade, and global consumption.

But in the end, everything comes with a price. A slowdown means that it's time to count the costs of 10 years of nearly unimpeded growth fueled by easy lending and cheap capital. 

Malaysia's Government now has no cash to spare. Neither does the US. China? They won't give a shit about your country; any and every form of protectionism will be for its own people. 

We are heading into uncharted territory as an economy. Without fiscal prodding, how will Malaysia truly fare? With a horrendously low taxpayer base, and still mounting debts, where and how can we finance growth? Don't take our word for it; our Finance Minister has already warned us of at a few years of severe pain.  

Are you hoping to see a fiscal balance eventually? Fat chance of that - pump priming created the gap between the Government's revenues and expenses in the best of years. In the worst of years (like right now)? The deficit is driven simply by ever increasing expenses to service debts et cetera (Editor's Note : as an alternative, we can also use 'ad infinitum').

If you think a balance budget is nothing but a pipe dream, the following is from 15 years ago.

We're trying not to be scaremongers or doom merchants, but we do implore you to look at the facts and think rational thoughts. 

Lembaga Tabung Haji can no longer afford to pay dividends to its depositors. So how about the rest of our GLC funds? Their pool of unrealised income (paper profits from investments) will dwindle the more the market falls. In many cases, their positions have become so large that they have chosen to go all in with their investment in losing companies. 

One simple example - Malaysia Airlines had RM12 billion in unsustainable debt until it was finally absorbed by Khazanah. At the moment, we have certain public listed companies (*wink*) with total debts of between RM8 to RM14 billion each. Do you really think they will make it out of this bottomless pit? (Editor's Note : PLCs with institutional funds support don't really go through bankruptcy; they tend to get privatised / 'restructured' at fractions of their original value instead)

                                  MAS's last financial statement before its privatisation in 2014.

When the market no longer supports stocks of past champions, their major shareholders will suffer. They are stuck in a liquidity trap with no way to dispose their shareholdings. It is likely that the EPF, KWAP, or what-have-yous, will 'do a Khazanah' or simply hold on to their investments. Aside from real investment savvy, their strength also lies in two things: their infinite holding power in stocks and the faith that Malaysians have accorded to them as custodian of our money.

Our main point is this: don't expect similar dividend yields from EPF and its cohorts. If it used to be 7%, prepare for 3.5% or below in a real bear market scenario. (Editor's Note : at least their market exposure would be hedged by their bond positions, though as the largest holder of Malaysian Government Securities, a rising yield environment will not help with overall investment performance). If the FBM KLCI drops 30-40% in this bear market, any dividend will wholly reflect market performance. Whether that will be acceptable politically, we're not sure.

We may be completely wrong, but right now we are following the smart money; there is little reason to suspect that the current market troubles are over. When corporate earnings justify lower stock prices, there are no premiums to be afforded; expectations would be inverted (lower income due to external factors), thus possibly driving stocks lower. Of course, we may be completely wrong, but ask yourself: would you consider buying TM stock now? How about ECOWORLD? How about GENTING?

And those are just the blue chip companies that make billions of ringgit in revenues. How about the lesser lights and the loss-makers? You know what we think about those, we assume.


The short answer is - no one really knows. Even professional investors are confounded by the worst year for hedge funds in  a decade. How about low-cost, passive index funds? Possible ticking time bomb there too.

The truth is, this current generation has never truly lived through a global recession. We can't play outside the rulebook that has been prescribed to us over the past 10-15 years; buy the dips, stay the course. We think this is misplaced faith - during a crisis scenario, there will be such a severe disconnect between actual value and existing stock prices that most people will end up cutting their losses and give up (Editor's Note : good thing you're not managing billions. Otherwise you'll end up throwing good money after bad via a rights issue ;) ).

We have said time and again that long term forecasting on stocks is no better than guesswork. Even the smartest analysts and quants resort to what is essentially a calculated guess backed by historical data. Not crisis period data or economic slowdown data - perhaps these simply do not exist - but simply past performance of stocks over the past 10 years, a period with the biggest bull market the world has ever seen. But of course, they will tell you that past returns do not correlate to future performance. So is there a point?

It's becoming so comical that one respected research house and another can come to wildly different forecasts for the FBM KLCI at the end of 2019 - on the same day, no less. The deviation between the forecast is 192 points, or about 10%. We don't find these kinds of forecast or information as useful at all. Do you?


It can be 1,900 points or 600 points by end-2019 for all we know. Our advice: don't be primed into thinking that all is well in the economy, or the stock market, right now. The companies that you have seen earlier all have a money problem; less money to service debt, less money to ensure a healthy cash flow, less money coming in as revenue and profits as demand slows down, and definitely less money to make M&A moves to generate more money.

Malaysia's stocks are beginning to fall in tandem, regardless of their catalysts. This is the truly scary part.

Sure, there are good companies to invest in but you will have to take the pain with the gains. Expect dividends but negative capital growth on the stock price. Expect to hold stakes in companies for longer than you thought you ever would. Adopt a five-to-ten-year perspective on investments. Don't leverage yourself to the point of ruin, like these people
Bottom line - the well has dried. The easy money is gone. The crooks are going to jail.

But get your cash pile sorted out. We are patiently waiting for a real shock to the global markets to occur, which is the best opportunity to not just trade, but to build a real long term position in shares.

What you have seen in the markets this year is nothing - it's just a dress rehearsal.

Sunday, 2 December 2018


The last quarter of the year has been pretty lousy for the market, and for traders - we're sure you agree with us on this.  Some say the bear market has already begun. For us this is clear, at least for certain stocks that were market leaders as recently as two years ago. Global economic growth is losing steam - there's no better indicator of pain in the stock market than that.

 Not sure if Trump is talking about the GDP or his own brain capacity OH SNAP (Source)

See stocks like ARMADA, ASTRO, STAR, and FGV - all have been making new all time lows, and for good reason - fundamentally their business model no longer deserve premium valuations.

So much value destruction in barely a year. 

So what is there to do? We've touched on this topic before - what can you buy or trade in a bear market? Sure, you can express your bearish views by trading put warrants or sell short index futures - the KLCI certainly seems to be heading south. 

You can certainly make money by building up a large put warrant position or by short selling index futures, but it's equally likely that you will get hit by volatility. You shorted when global markets dropped 10%? Congratulations on losing most of your money as they rebounded very, very strongly.

30 November 2018 : the face you make when you recover 1% of your 30% loss. Source

Without over complicating things, these are the usual strategies employed during a bear market:

1) Buy index linked put warrants (you profit as the market falls) - Momentum trade

2) Sell short index futures contracts (you profit as the market falls) - Momentum trade

3) Buy index linked call warrants (you profit as the market rises) in the hope of being at the bottom of a market recovery - Mean reversion trade 

Our thoughts on these? Based on our collective experiences lasting five years and three serious bear market phases (where the KLCI dropped at least 100 points or more), we think the chances of profiting from these approaches are minimal. In fact, it is highly likely that you will lose money, and a lot of it. 

The issue with momentum is that people tend to assume that index linked warrants perfectly follow the direction of the market; but this is not the case at all. Aside from the usual time decay factor (there is less correlation between an index warrant and the market as the warrant approaches expiry), the market volatility will also throw such expectations further off course.

If you felt nauseous after reading that dense sentence, here's a simple comparison of gains/losses between the underlying (the Hang Seng Index) and the linked warrants - one call and one put.

 30 Oct, 2018
30 Nov, 2018
 Price Change (%)
 Price of HSI
 Price of HSI-H40
 Price of HSI-C3W

If on 30 October you had bet on the market recovery (buy HSI-C3W), you'd have made a lot of money. But there was no credible justification for you to do such a trade. It is highly probable that yours was just a lucky guess.

If on 30 October you had bet on the market continuing to fall (buy HSI-H4O), you'd have lost 60% of your capital. There was every reason (and many credible justifications) to bet on the market falling further, but the market can be wrong for a lot longer that you can remain solvent.

We are students of fundamental analysis, and we agree that the market, be it S&P 500, KLCI, or Hang Seng, have a lot of room to fall further in the coming months/years. But you can be right about an angle but wrong about the trade.

The idea is sound but there was no good tool to express that idea (or you're not using the tool properly), so you end up buying put warrants that move like the heartbeat of someone having a cardiac arrest.



There's actually a way to trade these fickle call warrants profitably. But there's a catch: you will have to literally be a contrarian. All the time. But is there a fair likelihood of profitability? Absolutely.

We have looked into our trading records for index linked call warrants, spanning about 45 separate trades in four years, and found that only one method is effective enough to not only make us meaningful profits, but also insulate us from losing massive amounts of money. (Editor's Note : On a long enough timeline, and when your luck runs out, there is a very high likelihood that you WILL lose money from employing strategies 1,2 or 3 as described above).

To make money, you have to show up when the market is in a state of absolute panic. It's an extension of our 'peak fear' philosophy, as you can read about in this post.

We only trade index linked warrants when the market gaps down. Here's a visual example of that phenomenon with a recent daily chart movement in the HSI:

Notice the two long green candles? The bottom is the opening price relative to the previous day's close (the gap down). They represent a decline of at least 1% immediately when the market opens

If you had bought call warrants when the market immediately opens at these gap downs, you would have made some serious profits not only within a day, but also in subsequent days. And it's not down to luck.

We strongly believe that prices are the ultimate manifestation of investors' current fears and hopes. Such sentiments determine the movement of prices, and when the sentiment peaks, you have a 'gap' situation.

When the index warrant gaps down, investors are fully pricing in those fears. There is massive selling activity driven by panic, and this may go overboard. As in a typical contrarian trade, we go in when we believe that an artificial mispricing has happened, as we would when a stock goes to limit down levels (Editor's Note : only in specific cases - not all limit down stocks present a good trading opportunity, obviously).

Or, to put it simply : investors' price in those fears by selling at price points that are excessive. We buy into those fears/excessive selling because the short term profit opportunity is appealing. Peak fear is when everything has been fully priced in; from there it can only go up, at least in the short term.


Here's a real life example of us having this strategy put in practice. This is a trade on HSI-C3W on 21 November 2018.

So we look at several things before committing to a trade. Obviously the risk is that not only is the fall significant, but that it will fall further. We prefer exceptionally large declines to provide us with a bit of a margin of safety.

Looking at the situation from several angles, here was the score on the morning of 21 November.

1) HSI (the index) opened down 2.9%, an monstrous decline triggered by the previous night's tech-driven rout in the US markets.

From this we already know that while Hong Kong takes its cue from the US markets, the decline is more a reaction towards price movements rather than anything with fundamental justification. There are some huge tech players listed in Hong Kong, primarily Apple parts suppliers and behemoths like Tencent - a company so big relative to the Hang Seng's components that its stock practically moves the index around - but we checked; the price reaction is sentiment based.

2) HSI-C3W opened down almost 30%, obviously a huge decline in itself. It's an immediate reaction to the HSI's opening, as well as the HSI's futures prices.

We have a separate rule on trading index warrants : we don't trade them unless they have declined at least 20% on an intraday basis. We never buy at strength as we've stopped using any momentum strategies; we've found that they don't work.


In the first half hour of trading on 21 November, we bought into HSI-C3W with a substantial position (100,000 warrants) at 27.5 sen. Note that the Hong Kong markets open at 9:30AM, so there's a 30 minute window where you won't find much liquidity; the panic selling usually occurs around this time.

Given the large losses in the US markets, we had an idea of how the HSI would open - we expected a decline of around 1.5-2% in the index, based on previous observation on how it correlates with the S&P500.

We thought there was a minimal possibility that the HSI would fall by 4% or even 5% - this has only happened once this year, and twice in the past three years. But just in case, we even set a time limit : if the HSI falls to 4% by 10AM, we would immediately cut our losses and exit.

Our trading parameters were somewhat simple. We set our stop loss thresholds on a case-by-case basis, but our risk-reward ratio tends to be at least 2:1 (we're willing to exit with a 1 sen per share loss for the opportunity to gain 2 sen per share or more).

For HSI-C3W, we were willing to cap our losses by exiting at 26 sen. Our profit target? 30.5 sen. Aside from meeting the 2:1 profit criteria, we also have our usual 10% capital gains target, as we do in every trade. If this trade doesn't bring our expected outcome (10% in profits or more) by 12:30PM, we are out of the trade. (Editor's Note: we are insulated from further losses by the loss thresholds and time limit)


On 21 November, not only did the HSI recovered ALL its losses (from -2.9% to zero), it closed the day with a 0.5% gain. Our expectation was not just met, it was exceeded. We met our targets and were happy to exit.

RM4,000 in 5 hours? We can't complain. But HSI-C3W actually closed the day at 33 sen. The trade worked because we put ourselves in a situation where not only can losses be managed properly, the downside risk was limited - simply because the downside has been priced in.

And best of all, it doesn't matter if what you're trading is linked to the HSI. Can you do the same with KLCI warrants? Yes, and we have already proved it.

Sunday, 18 November 2018


A few things in life are inevitable. Among them are death, taxes, and Bursa Malaysia's oil and gas stocks simultaneously going up (and later, down). It's hard to anticipate, but you will see it when it occurs. It can be driven by something totally sentiment related, or it can be based on underlying fundamentals of the companies. But they are cyclical, and many of us do not truly understand what this means.

The most popular oil and gas counters on Bursa Malaysia currently are the downtrodden, money losing companies who were kings in the glory days of US$100 oil but are now burdened by onerous debts. In some cases, they are unfairly valued due to sentiment. In others, their operating models are fatal in the long run; too much leverage, but too little cash flow to show for it. They are doomed to issuing ever larger rights issues to fill their cash deficits, resulting in ever larger dilution of shares.

This is the fate faced by these companies, specifically firms with exposure in the upstream oil and gas segment.

But a cyclical sector such as oil and gas always provides new opportunities. There are moments when you can buy any counter indiscriminately to capitalise on the catalyst. Alternatively, there are instances where an internal catalyst in the firm's business turns it into a value investing opportunity. And there are  also those crazy times when you can just buy DIALOG without thinking of these trading and short termist angles. Seriously, just buy DIALOG.

 How can you disagree with a doctor? Check out his slides.

But in this post we will focus on a few of these upstream firms and how their stocks react to external, or internal, stimuli.

But first, a brief digression on global crude oil prices.


The short, uninformed answer is yes: you must always pay attention to crude oil prices. But they are only effective as indicators up to a point. That's the thing about catalysts; they are temporary.

The oil market is notoriously cyclical, and are fundamentally dictated by the supply and demand situation. They are also influenced by real secular trends; cycles can take as many as 20 years to complete the boom and bust phases. The most recent ones? Six years (2008 to 2014) and close to three years now from trough to recovery (2014 to the second quarter of 2018).

Business planners and budgeting managers at the oil and gas companies you know and love so much do not look at absolute prices of crude oil on any given day. They look at the quarterly or (if they are smart) annual average prices for crude oil.

The upstream segment is an inherently risky business; you're basically forced to guesstimate / anticipate the long term price trajectory of crude oil. You then commit to invest vast sums of money on assets that you hope will generate enough cash flow to pay off existing debts.

For companies with oil and gas vessels (ships, drilling rigs, tender rigs, floating storage offshore production rigs, and other exotica), they will go into debt to finance these rigs, and then generate cash from these assets to pay off long term debts. Residual income will be counted as profits, if any, after excluding operating expenses.

In an environment of steadily rising oil prices, this business strategy works wonders. Higher demand for upstream services brings charter rates for these ships through the roof. As crude oil becomes more expensive, companies can make a lot of money from fees gained for their services. This is the upcycle.

Guess how it's been from March 2016 onwards? Source.

But then the obvious happens (you do realise what cyclical means, right?). In an environment of steadily falling oil prices, the business model is turned on its head. Now your debt load and repayment obligations are rising faster than cash flow generated from the assets you have. Your interest payment on the debt for this quarter is RM50 mil, but your company doesn't earn enough to repay this amount.

The debt load keeps mounting, and you're hurt at the same time from lower demand, hence lower charter rates. If it gets bad enough you may have to essentially go bust, or perhaps find drastic solutions to raise equity. (Editor's Note : Or if you're in Singapore, your company will go into a bankruptcy-but-almost-not-really stage).

In other words, assuming the debt level and asset value is the same,

Oil price upcycle: High debt and leverage + High demand for assets financed with those high debts   = value creation

Oil price downcycle: High debt and leverage + Low demand for assets financed with those high debts = value destruction

Which brings us to the present day and the state of these once loved oil and gas stocks. Just to give you a clue as to the impact that it has had on Malaysian upstream firms: one was unceremoniously dumped by its parent company, another lost billions in market cap but still rewarded its founders richly, yet another had to drastically reinvent itself by acquiring oil fields, and another was caught in a two-year turmoil with shareholders before finally establishing itself as a serious oil and gas firm.

As a group, Malaysian upstream oil and gas counters most definitely have lost at least 70% of their collective market cap over the past three years (Editor's Note : DIALOG and YINSON being the clear exceptions) ; we're talking about tens and tens of billions of ringgit in value lost. But just recently we were finding ourselves in a rising oil environment. Each day brings news about crude oil being the highest since such and such (highest since the big fall in 2014, to be precise).


Just to give one example, indiscriminate buying of oil and gas counters tends to happen when this type of news comes out:

This is what indiscriminate buying looks like. This is a list of top traded stocks by volume from 2 October at 12:30PM, or the midday break. More than half of the companies you see here are upstream oil and gas counters (and their company warrants).

We're sorry to say that this is not a post about trading oil and gas stocks profitably. Consider this a handy reminder that the boom and bust cycles are fleeting. One month everybody's cherishing oil and gas counters; the next month investor sentiment is totally destroyed. And we mean this literally, as you can see below.

The definition of volatility, wild sentiment, and boom-bust: Brent Crude Oil price per barrel chart, mid-August to 17 November, 2018. Source.


Indiscriminate buying is temporary, and in case you don't already realise this, they will be followed by indiscriminate selling in the short term. There will have been a large number of speculations and uninformed investors chasing this easy angle. If you're one of these people, here's our message: if you want to chase the latest and hippest trends, go open your Pinterest account, not your Bursa Malaysia trading account.

We have found that any extensive buying activity in oil and gas stock, specifically as a reaction towards oil prices reaching new highs, is extremely short lived. The average timespan is less than two weeks (10 trading days), or the typical contra period for speculative capital to flow in the market.

At the same time, those holding these counters are exposed to the volatility in crude oil prices. If you bought these stocks simply as a proxy for crude oil prices, you will be king for a day, but a pauper for the rest of your life. You're exposed to the volatility in the stock, as well as volatility in the commodity. And unless you're a wizard at predicting the movement of crude oil prices - you're not - you're exposed on both sides (the volatility of the stock as well as the commodity).

In other words, don't simply buy oil and gas counters as proxy to current oil prices. We think it's a dumb move, and we're also referring to ourselves as we've made the same mistake before.


Remember Part I? Well here are the headlines barely a month and a half after the whole world was rejoicing the new dawn of constantly higher crude prices.

To get back to our original point, this is a lousy cycle to trade. Although it's fairly well-known that HIBISCUS and REACH are the stocks most susceptible to movements in crude oil, due to their oil-producing asset owner status, we thought it's worth putting a selection of oil and gas counters into a comparison chart.

Black is Brent Crude (ICE prices), with HIBISCUS and REACH represented in orange and blue respectively. The two stocks closely follow the trajectory of Brent, with a similar decline of around 15% over the past month.

Note that DIALOG's movement is fairly benign, while SAPRNG started from a low base due to its already low stock price due to other issues. PETRON, another downstream player, is largely influenced by their earnings performance, it seems.

The point is this : it's not worth buying HIBISCUS and REACH if you consider them proxies to crude oil price. Whether in an upcycle or downcycle, speculative capital flows means that their upward movement is not sustainable in an environment of weak oil prices. Even if you buy them to express a long term bullish viewpoint on crude oil prices, your timeframe may be as long as two years.

To know how bad the impact of the recent bust in crude prices has been, check out the following closing prices for selected upstream oil and gas counters on 16 November 2018. These are the ones you can compare with the 1 October prices.

You can see here that the one-and-a-half month decline is between 20% and a devastating 50% or more (look at BARAKAH in particular).  There is little earnings-related sentiment here; we believe that these purely reflect the shift in crude prices for the most part. And for the majority of the companies listed here, in the long term it hardly matters if oil prices go up; they are encumbered by huge debt loads and assets that are not really performing.

So when is actually a right time to buy into oil and gas counters? To put it simply, there are two options.

1) Buy when the stock is experiencing a price shock. We traded this angle profitably with SAPNRG.

2) Buy when crude oil itself is experiencing a price shock. If and when this happens (like in late 2014, or some say, right now), there is still downside to the oil and gas stocks that you see above. If bad enough, even solid companies like DIALOG can come under pressure. The shock must be bad enough that fear overwhelms reason. And when that happens, it is time to buy into fear.

More Tales By The Pelham Blue Fund