There's a good chance a recession in Singapore will happen this year. Can you avoid losing money if it does?
By now you may have heard that 2016 is set to be a harsh year. Singapore’s manufacturing sector has shrunk for 12 straight months, and the Straits Times Index is reeling from the impact of cheap oil and China’s slowdown.
Here’s how you can brace for the recession on the horizon.
A Quick Summary of What’s Going On
There are two main threats affecting us in the immediate future--these are the economic slowdown in China, and unsustainably low oil prices. Without getting into the more complex issues, here’s what you need to know:
China’s Purchasing Manufacturers Index (PMI) measures the health of the country’s manufacturing sector. It’s based on factors such as the number of new orders, inventory levels, number of deliveries from suppliers, etc. A PMI of 50 indicates that the manufacturing sector has not changed, whereas a PMI above 50 indicates growth.
China’s PMI has been under 50 (around 49.4 as this being written), which suggests its manufacturing sector is shrinking. This is not just bad news for China--most of the world’s goods are produced in China, so when their PMI shrinks it can be indicative of weakness in the global economy as well.
A shrinking economy in China also means they will buy fewer resources, such as coal, oil, metals, etc. This can be disastrous for countries that rely on such exports, as China was one of the world’s largest consumers for these goods. Australia and Indonesia, for example, are both adversely affected when China slows down it’s consumption of these resources.
In addition, the Chinese stock market has been rocked by sharp crashes, as the government tries to liberalise its economy. Two repeated crashes, one in 2015 and one more in January of this year, has wiped out billions of dollars in China. Singaporean companies, many of which do business in China, can see some spillover effects. The situation has also weakened the yuan, which makes Chinese exports cheaper (and thus more competitive than Singaporean exports).
A poorer China also means a reduction in the influx of wealthy Chinese tourists who haunt the branded stores along Orchard Road, and fewer Chinese buyers in our property market.
Low Oil Prices
The cheap oil prices are the result of a price war between Saudi Arabia, and shale oil extractors. About a decade ago, oil prices were around $100 a barrel (oil prices are always measured in US dollars). Today, prices struggle to stay above $30 a barrel.
This is because shale oil extractors found a new way to produce oil via fracking, and have almost doubled oil production in America. Saudi Arabia wants to bankrupt these shale oil extractors, because the Saudis derive around 97% of their export revenue from oil (they can’t afford to be replaced oil producers).
To do this, Saudi Arabia has refused to cut back oil production. Together with shale oil producers, they have flooded the market with so much oil that supply exceeds demand, so the price per barrel keeps falling.
While this also hurts Saudi Arabia, the kingdom is counting on the fact that shale oil extraction is more expensive. The new oil producers will go bankrupt before Saudi Arabia does.
In addition, Saudi Arabia is in a stand-off against its main rival, Iran (due to religious differences). Trade sanctions were just lifted from Iran, which means Iran can now sell oil as well; and the Saudis are dead set against Iran being able to derive a profit from this.
All of this wrecks havoc closer to home. Most oil companies operate on loans: they owe millions to the banks and financial institutions. They also work on credit when purchasing equipment such as oil rigs, drill ships, and pipelines.
Now when oil companies collapse, the financial institutions that loaned them money will end up losing too. This is to the tune of billions, and it might precipitate the next global financial crisis. It also affects other companies.
In Singapore, companies like SembMarine and Keppel are owed around $6.2 billion by Brazilian oil giant Sete Brasil. But cheap oil has made Sete Brasil’s operations unprofitable, and the company is at risk of bankruptcy. If Sete Brasil folds, SembMarine and Keppel will have to write off the massive financial loss, and it can cost employees their jobs.
Overall, the Financial Outlook is Poor for Singapore and the Rest of the World
None of the problems we’ve mentioned have shown any immediate signs of abating. Chances are high that they will persist for the entirety of 2016, and perhaps the coming year. Here’s what you can do to survive it:
1. Know What Your Mutual Funds or ILP Sub-Funds are Invested In
If you own mutual funds, or have an Investment Linked Policy (ILP) in which you allocate to sub-funds, ensure you know where the money is going.
During the last stock market crash in China, many lazier investors were stunned to learn that they were affected. While they did not buy shares in China directly, many had invested in mutual funds that did allocate resources to China.
Likewise, some people have emphasised Emerging Markets (EM) in their ILP sub-funds. But low oil prices have caused significant problems in some of these countries. Venezuela, for example, is on the brink of economic collapse because they are dependent on oil revenue. This can cause the affected countries to default on debts, or undergo periods of political turmoil.
Review the contents of your various funds with your financial advisor, and minimise your exposure to the more affected countries and businesses.
2. Build Your Emergency Fund
There’s a good chance that many Singaporeans will get retrenched or receive lower bonuses in 2016.
Even if your company is not directly involved with China or the oil industry, it can be affected. For example, many retail stores have been affected by the reduction in Chinese tourism, as well as property developers who once had a significant portion of buyers from China.
Brace yourself by building an emergency fund. Ideally, this is six months of your income; but it is improbable that you will be able to do this fast if you have no savings. If so, try to go for at least three months of your income.
3. Pick Security Over Profit Until the Storm Abates
Contrarian investing is often over-simplified. In the aftermath of the 2008 financial crisis, for example, many assumed it was an opportunity as stocks were cheap. But many of those who started buying immediately after the crisis ended up getting burned.
After games of market timing, and go for safe haven investments.
Conventional wisdom is to beat the rate of inflation by 2%, but given the current situation that may not be possible (speak to a wealth manager to determine what works for your portfolio.) Safer investments like Singapore Savings Bonds or perpetual income bonds have low returns, but they may be the best you can do in this environment.
Gold and silver are traditional safe havens during turmoil in the stock market, and gold prices have in fact risen since the end of 2015. However, there are schools of finance that reject these safe havens as myths. Consult a qualified wealth manager to see how it applies to your specific situation.
4. Do Not Make Panicked Decisions
Do not rush to sell off large numbers of stocks, bonds, etc. because of the bad news.
If you are a long term investor (e.g. a 15 year plan involving passive investing in ETFs), these momentary ups and downs should not bother you. You wouldn’t rush to sell off your house because property values fell this month; neither should you with other long term investments.
Also, remember that if you sell at this point, it is probably too late - the price you receive would have factored in the current situation, so chances are you will be selling at a loss.
These difficulties with buying and selling are precisely why we advise against lay investors trying to trade and time the market--it makes more sense to find a long term passive investment that does not put you through the wringer every time the economic headwinds shift.
But if you are holding on to something dangerous (e.g. EM high yield bonds in net oil exporting countries), it may be time to have a long conversation with a professional and rebalance your portfolio.