Chapter Sixteen

The Crisis Bargain Bin

Taking the Long-Term View in the Aftermath of a Crisis

Within just a few months of the start of the Thai crisis, Thailand showed some measurable improvement in a couple of key areas. An irate citizenship forced government changes so that a new, more forceful administration came in. The new government administrators who took over were praised by everyone we spoke to. They generally agreed that they were the most talented group to run the country in a long time. That alone gave me hope for growth.

Tough times bring leaders to the fore. An apt analogy would be Franklin Roosevelt’s famous first 100 days, when the New Deal was ushered in to help rescue the country from collapse.

Only in times of crisis will people change their destructive behavior patterns. Only when there’s a consensus that something is broken will anyone take the trouble to see that it gets fixed.

Many Bangkok blue chips enjoyed pride of place in our portfolio as jewels in our crown and, at the right price, deserved a larger place. It was time to focus on those bargains and winnow out those companies that could not survive and prosper in the new environment. It was time to buy some stocks and sell some stocks, reasonably, rationally, prudently and cautiously. Someone asked me how I was purchasing Thai stocks. My reply: “Like porcupines make love . . . with great care!”

No Pain, No Gain

Looking at the macro picture for the near term, things could not have been much worse. However, from my point of view, that was not altogether a bad thing, because we trade in perceptions as much as reality. When we’re hunting for bargains, we look for stocks that look lousy but are in fact simply being misjudged. By the end of 1997, the Thai stock index had declined 70% from its all-time peak. In 1993, at the height of the Southeast Asian boom, the total market capitalization of the Thai stock market had been US$133 billion. By early 1998, it had declined to a dismal US$22 billion.

From my point of view, even with the index down in the dumpster, there had to be more than a few treasures that were being tarred with the same brush. The Stock Exchange of Thailand index’s calamitous drop clearly indicated that the average investor in Thailand currently regarded Thai stocks as poor bets.

If we’d been looking at the same group of stocks from the same short-term perspective, we, too, would probably have cut our losses and run. But as we saw it, the market was once again overshooting the mark, and opening up for us a rare window of opportunity for increasing our positions in many companies formerly too rich for our blood.

Given the magnitude of the market’s decline, you did have to wonder: Could the index go down to zero? In my opinion, the answer was: Not very likely. This was not, I’m afraid, due as much to sound fundamentals as to the sheer volume of money being pumped into the country. The initial US$17 billion injected by the International Monetary Fund to shore up the country’s foreign currency reserves was, we assumed, just the first installment of a program that would in time stabilize the currency. It was not nearly enough money to shore up the country’s ailing financial system, but was mainly a stopgap measure to plug the holes in the dikes to stanch the flow of funds leaking out.

The chance that the Thai index would decline an additional 50% before stabilizing, much less recovering, had to be considered. But when stacked up against the far greater likelihood of a gradual if erratic recovery, I held out for the chance of recovery—sooner, rather than later. This issue was of more than academic concern to us, because we’d been sniffing and snooping around and shifting stocks in Thailand since the market took its first big 40% drop. And because we’d been buying stocks aggressively on the way down, that meant that as the market kept dropping, we were losing money hand over fist—on paper, at least.

In what country, I was asked time and time again during the crisis, did I see the greatest bargains? Without hesitation, I’d reply: “Thailand.”

If you’re savvy enough to buy stocks on the way down instead of on the way up, you need to be willing to rack up losses in the short term. But at certain strategic points in time sometimes you’ve got to take some pain in the short term in order to outperform in the future.

A Few Cardinal Rules about Timing

The best rule about timing is not to do it. Market timing is not a very fruitful investment technique since it is so difficult to do successfully. Although we generally discourage trying to time the markets, during extreme meltdowns a few cardinal rules do apply. One is that a market in free fall will tend to hit bottom and then rebound as much as 30% before collapsing again.

Why? Because markets generally pick up to a point where spooked investors who’ve been holding off on selling because they want to keep their losses to a minimum are ready to take their hits and move on.

When buying stocks during a bust, you need to make sure that you’re picking long-term recovery prospects, not corpses shortly to be found not on an action list but on a watch list.

Prowling through Bangkok’s back streets and alleys and chugging along congested highways lined with half-empty skyscrapers looking for bargains was a bit like panning for gold in a stream of worthless sand. A better analogy might be hunting for diamonds in a bucket of zircons, because although there were quite a few superficially attractive companies out there, too many—if you dug a little deeper or read the fine profit and loss (P&L) print—were deceptively attractive, as opposed to genuinely undervalued.

The two big booby traps, as I saw them, that tend to make trouble during any bust are:

For example, of the 480 companies listed on the Bangkok Stock Exchange, about 40 had already gone belly-up by year’s end 1997. An equal number of sick companies had seen trading in their shares suspended out of fear that if they were traded they, too, would fail. By our calculations, we expected at least another 20 companies to go under before the situation stabilized. We had to keep our eyes out for weak companies and for companies exposed to those companies that wouldn’t survive. Although we don’t mind losing money in the short term, we don’t like it when stocks we own self-destruct in a puff of smoke—and mirrors.

Scoping Out the Banks

So where did we start our search for bargains? The financial sector. Why? Because that’s where the damage was perceived to be the greatest and where recovery could come the fastest.

If you watch a bank like a hawk, you’ll see in the patterns of its lending practices a blueprint of the macro picture.

During a downturn, banks are always the first to take the hit, and usually the first to recover. Banks, as lenders to individuals and businesses that either can or cannot pay them back, are the canaries in the coal mine of any economy. Coal miners used to carry canaries (in cages) down into deep mines, as early-warning signals of any dangerous level of toxic gas. Since canaries are more sensitive to toxic gas than humans, they’d keel over at the first whiff of gas, long before any coal miner would be affected. Banks, despite their often bloated size, are highly sensitive gauges of any economy, assuming you know how to read the dials. Investors call them proxies for the economy at large.

In times of uncertainty, banks make excellent catchall stocks, because if you buy a piece of a bank, you’re buying a piece of every loan on its books, which subsumes the whole economy. Let’s say you learn that a bank is pulling back in a certain sector. That could be a sign of weakness in that sector and it will be necessary to investigate carefully before investing. But if you find out that a bank is suddenly extending itself to service a certain sector at a time of widespread distress, that means the bank has found some bright spots in an otherwise dismal picture.

Bankers tend to get a bad rap whenever things turn really sour. Think of the international banker as a guy with a monkey wrench who mans the valves through which money flows, like oil in a pipeline. When times are good, he opens the valves. When times turn bad, he tightens up or even shuts down the valves. With the flow of money frozen, he starts hunting down everyone and anyone capable of funneling some of that money back into the tank. During the sad, sordid saga of Southeast Asia in the late 1990s, international bankers poured some US$400 billion into the region—excluding substantial loans to Hong Kong and Singapore—before abruptly shutting off the valves, throwing the debt engine into reverse, and leaving the poor rejected countries gasping for air. “There was a huge euphoria about Asia and Southeast Asia,” a spokesman for one of Germany’s major banks admitted to the New York Times. “It was the place to be.”

The problem is always that when the going is good, it tends to be great. But when it gets bad, it gets horrid. International flight capital—money that can be moved in and out of a market at a moment’s notice—is poured in at the first sign of strength, and yanked out at the first sight of weakness. What disturbed even the most hard-core free marketeers in the financial community about the Asian contagion was the deadly speed with which this money tap could be turned on and off and, what’s more, turned into a kind of financial vacuum cleaner, sucking its victims dry. When the taps get turned off, it’s like a deep freeze: No one can budge until the guy with the wrench turns the tap on again.

Another reason to invest in banks when a declining currency is bound to stimulate exports is that it is an easy way to benefit from the growth in exports and how that growth will impact the entire economy positively. There can also be opportunities to benefit from the direct export sector.

A prime example was Delta Electronics, a diversified manufacturer of electrical components whose products would at that point in time have been 50% cheaper than they had been six months before, making their prices highly competitive. Delta was an excellent company, well managed, with a profit growth of 20% for the year. But Delta was also one of a handful of Thai companies clearly in a position to benefit from the currency collapse, and had therefore seen its shares soar 150% since the devaluation of the Baht six months before. But soon Delta was too expensive and it was necessary to turn to the banks. I was more inclined to buy the banks, because—contrary to popular perception—this would be the most efficient way to make an export play, because the banks were financing the exporters. When an entire country goes bad, sentiment usually quickly sours on the banks. But all the banks, one could safely presume, in a position to do so would be doing what Thai Farmers Bank affirmed as its policy: shifting the bulk of its loans from importers to exporters.

The shares should in time reflect the gathering strength of the export-driven recovery. But we were also on the lookout for export plays that were not quite so painfully obvious as electronics.

Looking for Patterns

One key point to always keep in the forefront of your mind while suffering through the bust end of the boom-and-bust business cycle is that the first country to get hit, and hit hard, is typically the first one to recover.

A corollary to that: The country hardest hit is forced to confront the deepest root causes of its problems, and will therefore be forced to improve its behavior most dramatically in order to attract now-edgy global investors.

Economic recoveries are no different from any other form of recovery: They follow a classic trajectory of a high high, a low low, and an upturn that could be dramatically rapid.

Thailand had gone on a binge—which in this case had been to gorge itself on cheap credit—and was now going to have to go cold turkey. But it didn’t pay to sit on the sidelines in Asia and do nothing while waiting for the storm to blow over. In my opinion, it always pays to take direct action. Reason: Stock markets move before the economy. Stock markets anticipate that economic movement is coming in a year or two.