Market Outlook - May 2023

The month of April witnessed another major regional bank collapse, namely First Republic Bank. Their assets have since been seized by regulators with JP Morgan taking up most of the assets. The Federal Deposit Insurance Corporation agreed to absorb most of the losses on mortgages and commercial loans that JP Morgan is inheriting, in addition to providing a $50 billion credit line. After reassessing the situation, we maintain the view that the crisis remains contained, primarily due to the prompt actions taken by regulators to prevent contagion. Furthermore, systemically important banks have continued to attract inflows, ultimately benefiting from regional banking outflows. The fallout from this episode would likely lead to a tighter lending stance by US banks.

In contrast to the 2008 financial crisis, assets held by these regional banks are of higher quality, consisting of mostly US treasuries, bonds and investment properties. This is unlike 2008, where banks were burdened with excessive leverage and relatively low-quality assets from subprime mortgage-backed securities. As a result, we also believe that asset quality in US banks is not a major issue at this stage. Monitoring consumer confidence in the US banking system is the key factor for us regarding this issue, which seems fine at this juncture.

Two months after China released their 12-point peace proposal between Russia and Ukraine, leaders from both these countries have had separate talks with China’s president, Xi Jinping. We view this as a potential starting point for negotiations to resume and we will closely monitor developments as they unfold. If the conflict is halted, it would likely have downward implications on commodity prices as supply issues are expected to alleviate. Additionally, this should lead to further disinflation globally, a potential catalyst for a rally in equity markets.

Another topical issue is the US debt ceiling, which is causing concerns regarding a potential default on US debt if negotiations between Republicans and Democrats fail to reach a timely resolution. Drawing from historical events, our take is that both parties would take measures to ultimately avert a default.

Since the onset of the regional banking crisis, US equity market participants have positioned for the Fed to start cutting interest rates in the second half of 2023. This has resulted in rallies for large US-based technology firms. We are cautious about this rally due to weakening signs of economic data and conservative guidance given by most firms. Furthermore, the rebound is not broad-based and has mainly benefited large technology firms, which leads us to believe that the underlying economy in the US is facing challenges.

China’s equity markets on the other hand, have seen a noticeable decrease in investor enthusiasm as their recovery continues to be gradual, rather than an immediate surge in demand. China’s government has also been prudent in taking significant policy actions to stimulate the economy, despite softer-than-expected demand. We believe this conservative policy stance is aimed at keeping inflation and asset prices under control. Contrary to the US however, earnings growth in China continues to improve, while providing attractive valuations. Therefore, we continue to believe that China has a more attractive risk-reward trade from a fundamental standpoint.