Good evening everyone! This is investment program of SVC Media, Inc. I am your host, Loh Zhou. Today is Friday, 2nd Jan 2015. How is the market? Anyone who is interested in stock market wants to know the market situation at the beginning of 2015 and the future direction it will take. Today’s guest is Dr. Dong Hao Zhang who is the Chief Investment Officer of Evla Hills Investment Management. Dr. Zhang has PhD from Stanford University, Department of Physics. He was a former mutual fund portfolios manager. He now offers his advice to individuals and companies with their investment strategies and financial planning. Investment is very critical. Dr. Zhang investment strategy focus on return, risk, taxes and cost. If you would like to contact Dr. Zhang, please call 408-689-2509 or visit www. evlahills.com.
Dr. Zhang: Hello, everyone, Happy New Year!
Ms. Zhou: Today is the 1st trading day of 2015. In order to analyze the situation in 2015, it is better for us to review the market for 2014, which may affect the market in 2015. Stock market in 2014 was pretty good. In 2014, the Standard &Poor’s 500 Index gained 11.83%, the Dow Jones Industrial Average gained 8%, the Nasdaq Composite Index gained 12.77%, but the Russell only increased 3.8%. The Dow Jones Transportation Average increased 24.33%, but crude-oil price declined 46%.
Dr. Zhang: In 2014, S&P 500 performed better, it increased 13.6% including dividend; but small company index like the Russell 2000 only increased 4.9% even including dividend. We can see even though market performed well in 2014, not all stocks gained equally. Treasury bonds increased a lot due to the decline of the interest rate. Corporate bond with better credit performed well, but high yield bond did not do well. In general, large cap stocks appreciated more than small company stocks. Stocks selection was critical.
Ms. Zhou: So do you think that in each year, some stocks perform better in certain selective sectors?
Dr. Zhang: Yes in every year, some stocks in certain sectors will perform better than others. However, what I want to explain is that in 2014, divergence is not only among sectors, but also between risky and less risky. High yield bonds and small company stocks were riskier than treasury bonds and big company stocks. So in 2014, lower risk bonds and stocks grew more.
Stock prices was pretty calm in 2014, and stock prices never dropped more than three consecutive days. This was extraordinary. There were no major corrections, and minor decline recovered quickly. However, not all markets were calm in 2014, e.g. currency market. US dollar was strong, Euro and Japanese Yen were weaker, and Russian Ruble collapsed. Despite volatile currency market and crude oil, stock market was not affected much.
In 2014, two major things happened that no one predicted. At the beginning of 2014, Wall Street Journal surveyed 49 economists. 48 of them predicted that the interest rate on 10 year Treasury bonds would increase above 3% by the end of 2014. At that time 10 year Treasury bonds was 2.9%. So they expected the interest rate to increase, but instead it fell to 2.17% at the end of 2014. At the result, long term Treasury ETFs increased about 30% in 2014. This was one big surprise.
Another surprise was that crude-oil price fell. For the same WSJ survey, majority of the economists predicted that oil price should be around $95 at the end of 2014, but actually it was around $50 instead of $95. As we can see at the beginning of 2014, most people believe interest rates should increase and oil price as well, but the reality was interest rates dropped and oil price dramatically declined.
Ms. Zhou: So in 2015, how would bonds and interest rates affect U. S. stock market?
Dr. Zhang: Well, we need to understand the relationship between increased bond prices and decreased oil price. At the beginning of 2014, most people thought bond prices would increase because American economy was growing and recovering, people also believed the Federal Reserve would end Quantitative Easing program, and interest rates would increase. In fact, in 2014 QE program did end. How come bond prices rose higher with the end of QE program?
We should observe the impact of global financial markets. Even though the U.S. ended QE program, Japan and Europe just started QE programs. If 10 year government bond rate is 2% in Spain, so how can the U.S bond keep 3%? It is impossible. A lot of foreign money came to the U. S. bond market because the U.S. bond market could give higher return. Even though the U.S. is in the process to reduce the liquidity, but global liquidity rose dramatically. This also caused the U.S. bond yield to fall. I think decreased bond yield was the most important reason why the U.S. stock market rose in 2014. The basic fundamentals of American companies also strengthened, also this growth itself support stock market appreciation. I also think global currency liquidity stimulated stock market as well.
Ms. Zhou: it was not easy to see one country’s currency exchange rate increased by 12.77%. In the New Year, some people like to choose stocks which dropped the most during last year. For example, IBM dropped the most in 2013, so some people chose IBM in 2014 and expected IBM to bring better return. However, IBM still did not do well in 2014. So Dr. Dong Hao, do you think if “Ugly Duckling” stocks like IBM, Starbucks or Disney can be a better choice as “Popular Star” for investors in 2015?
Dr. Zhang: If we do not look at anything else, it is better to choose “Popular Star” than “Ugly Duckling”. If a good performing stock performed well, it tends to maintain its performance in short term. It takes time for a poor performing stock to turn around. However, if we consider price and value, it is better to choose undervalued stocks. This is the secret of investment strategy.
Ms. Zhou: OK, thanks Dr. Dong Hao. (Now it is commercial time).
Ms. Zhou: We back again. Today is the 1st trading day in 2015. I still remember January 2014, the market fell at close.
Dr. Zhang: Some people thought if it fell in January, the whole year would fall too. However, 2014 market broke this spell.
Ms. Zhou: The last two days of 2014, the stock market decreased. The market on today and next Monday are important.
Dr. Zhang: Today has no major change in market because everyone is still enjoying vacation. Actually, the 1st real trading day should be next Monday, 5th Jan.
Ms. Zhou: Yes that is right. Let’s check out today’s market. S&P 500 decreased 0.7% and closed out at 2058. We can ignore the fall. Dow Jones gained 9.92%, still maintaining under 18000, and closing at 17832.99. NASDAQ fell 9.24%, closed at 4726.81. Next Monday when people return from vacation, it will be important for stock market.
Dr. Zhang: In 2014, there were two major occurrence. Interest rate fell leading to gains in stocks. Oil price dropped, which was a surprise. Majority of the experts believe that the main reason for oil price is too much supply. Due to the U.S. shale oil revolution, the oil-drilling boom in the U.S. had increased oil production quickly. For example, now the U.S. does not need to import much oil, African oil supply has shifted from the U.S. to Asia. This African oil supply replaced some of OPEC’s global oil market share. In the most recent OPEC’s meeting, Saudi Arabia announced that they won’t cut oil production. So, oil price fell fast. As we know oil is a consumable product, daily oil consumption is 92 million barrels. So oil price will increase, but we do not know when.
We should not only consider the factor of supply, investors should also be on the alert for global economy. Oil supply had been increasing for a while, but why did oil price suddenly fall so fast? Maybe the problem is the global economy. So, the major risk in 2015 may be the global economy. European and Japanese economies were very weak. China’s economic growth has slowed down.
The global economy could face “too cold” risk and “too hot” risk. Too hot risk is inflation, and too cold risk is recession. In 2015, the major risk may be recession. The big question is if QE Program in Japan and Europe can bring economic recovery. American QE Program did not help grow the economy much, but it did increase asset value. At this point, some think investors should focus on investment in Japan and Europe. However, American investors may not gain much. In 2015, European and Japanese currencies may continue to fall. Even if European stock market would gain 20%, American investors may only gain 10% with 10% fall of European currency. Investors may have better opportunities in Europe and Japan, but they also face higher risk. It is hard to tell if Europe and Japan’s economy will recover, because economic structural problems in Europe and Japan are more serious compared to the US.
Ms. Zhou: Yes, I agree. Now oil price is $50 per barrel. I wonder if this is the capital cost for each country or it is a still profitable price.
Dr. Zhang: It could be profitable, if an oil field had already been explored and oil wells had been set up. The oil production cost is $40 per barrel, so there is $10 profit. However, the cost of discovery for new oil capital project will be very high. Many American oil companies can still produce oil, because these companies hedged for volatility in oil price. So, they can still sell oil at $80 or $90 per barrel instead of $50. However, the hedge may only cover production for certain periods of time, e.g. it may cover 2014, half of 2015, and one quarter of 2016.
American shale oil is different from oil in the Middle East. Most shale oil in the U.S. will deplete much quicker than oil in the Middle East. Since depletion rate of shale oil is much quicker, shale oil companies must keep looking for new exploration and new project. After the first quarter, productivity of the American shale oil would drop fast. Oil inventory would be used up very fast, and then oil price would go up. I cannot say oil price would go back to $100, but it might go up to $60, $70 or $80.
Ms. Zhou: I noticed that there was an airline company stock soaring, which is Southwest Airlines Company stock. In 2014, it soared 128%, so it can be called “Super Star” stock. Biotech stocks also performed well. Actually the world’s top performing equity market was in China. Shanghai Composite Index ended up 52% for the year 2014, and most of gains came in the last six weeks due to the drop of interest rate. In Chinese economic structure, stock market grew so much with small interest rate fall. So what do you think of Chinese stock market in 2015?
Dr. Zhang: I think Shanghai stock market is more dangerous than casino, because it is very speculative.
Ms. Zhou: If Chinese Company went public in the U.S., ADR, it should be OK to invest.
Dr. Zhang: Yes, right.
Ms. Zhou: Thanks to Dr. Dong Hao for coming here and see you next time.
Dr. Zhang: Thank you.