Market Outlook - September 2021

Medium-term, resilient economic and earnings growth and excess liquidity are likely to remain the dominant market drivers.  Nevertheless, the strongest economic momentum is peaking, which leads to more challenging terrain.  With the positive earnings season catalysts now behind us, it might mean some of the macro headwinds we have just mentioned, could be spilling over into equities.

The current issue for the financial markets is how fast Central Bankers are going to pull back their bond market support.  That will also set the timetable on how soon they will raise interest rates.  Looking back, the Federal Reserve tapering which was announced in December 2013 and began the following month, lasted less than one year.  It went on to raise interest rates one year later after tapering.

We believe the developed economies of the world would continue to be more tentative and leaning on a looser focus in tapering their balance sheets. In the Jackson Hole Symposium, Federal Reserve Chairman Jerome Powell announced that tapering could probably happen before year-end but mentioned that it would not be in a hurry to raise interest rates after that.  Markets took this as a signal that the Federal Reserve would continue to support the economy with low-interest rates.

In Asia, China set expectations that further monetary policy easing steps are in the works after the People’s Bank of China (PBOC) reduced the banks’ reserve requirements ratio recently.  Additionally, PBOC will be providing RMB300 billion of low-cost funds to banks for the purpose of lending to small and medium size companies.  We see more scope for some fiscal support given general government revenue well ahead of expenditure, and that infrastructure projects will enter the implementation stage at a faster pace at the end of this year and early next year.  Furthermore, Vice-Premier Liu He said the government would continue to support private businesses despite a regulatory crackdown across the technology and education sectors.

As an extension to our discussion in our previous month’s newsletter on the regulatory tightening in China, it was announced that the government will emphasize the strengthening of anti-monopoly measures and deepening the implementation of fair competition policy.  This shall be the medium-term objective for deepening overall reform. The next phase of the country’s economic development is about promoting high-quality development and promoting common prosperity.

In the long term, we believe the Chinese market continues to promise growth amid the potential for higher domestic consumption and continued gains in investment.   In the short term, we are at least seeing the government being proactive in shoring up the country’s economy with tweaks to counter the headwinds.

An issue worth talking about is China Evergrande Group.  It is one of the largest property developers in China. Presently it is in the unenviable spotlight of experiencing a liquidity crunch after regulators curbed their funding access to control property prices and sector leverage.  It is struggling under massive debt loads built during the boom years in the property market.  This has a negative effect on the financial markets and economic contagion from a default event of this scale.  We are relying on the policymakers to get it right, and in our opinion, their track record has been extremely good as shown in how they have gone about handling the Asian Financial Crisis, which gives us a lot of confidence.  To begin with, the government’s fiscal position is also strong.  We will be monitoring this event closely in the medium term.

We are probably in the mid-cycle of economic growth globally.  There are current and new topical issues we are encountering each day.  In our view, this is a natural course we should expect if history were to be of any guide.  So far, the financial markets have already discounted a lot of these issues with some of the major Asian companies’ share prices declining sharply in the process. This is a market repricing process mechanism and it presents us an opportunity to scour for good ideas at more reasonable valuations.

Market Outlook - August 2021

The debt ceiling issue of the US government may lead to higher volatility of asset prices. When the US government hits its debt ceiling, the overall performance of the market depends on the duration of the potential crisis and the level of potential default risks. We believe the Congress will ultimately come to an agreement in the next 2 months, after some hard bargaining and strong words from both the Democratic and Republican parties. To us, any weakness in share prices is a buying opportunity. 

China seeks to fulfill its ambitions as a world-leading economic and technology superpower, and to transition from an export-led growth model to achieving more sustainable and high-quality growth. To do so, the government is aggressively addressing a mix of critical challenges related to excesses and weaknesses in various markets and sectors, an ageing workforce and tensions with the US. Its latest efforts to put in more regulations are not dissimilar to the US and European Union’s antitrust efforts on the big internet companies. The key difference is that under the China model, the measures meted out are performed clinically with least resistance from the corporates. We need to recognize the manner at which China has gone about its regulatory moves will create volatility in the markets. In general, investors value a steady operating environment underpinned by market-oriented policies. 

In China, there is fear that the latest crackdown on the fintech, education, food delivery and property sectors could expand to other industries such as health care, as the government looks to tighten its grip on big companies and reduce the wealth gap. 

The beginning of the regulatory clampdowns started with Ant Group, an Alibaba’s FinTech offshoot and then to DiDi Chuxing. We believe the intervention will reshape the tech industry in China. So far, the case against Alibaba took the Chinese authority only four months to complete, whereas it will take years for the US and EU regulators to tackle Facebook, Google and Amazon, which are ready to fight tooth and nail. 

We do not think the Chinese government is out there to destroy the tech giants, as they are already part of the future growth of the country, where the latest innovations are already underway. A case in point to note in the 14th Five Year Plan, the Chinese government has outlined sectors it wants to prioritize, including semiconductors, 5G, renewables, infrastructure, new energy vehicles and artificial intelligence. 

In the near term, the latest regulatory events in China may cause bouts of volatility and investors should brace for that. Sentiment is likely to remain subdued until investors gain higher conviction that the regulatory reforms are fixing short-term issues for long term benefits. In the medium to long term, we maintain a constructive view on Chinese equities and believe the current pull back and volatility may offer opportunities to accumulate companies that will benefit from long-term structural themes under the 14th Five-Year Plan. 

The global economic outlook will be a key focus for us, as this is the bedrock of what investing in financial markets is about. Following on from our discussion on this topic in the last newsletter, the latest global economic releases increasingly confirm our view that we are entering a mid-cycle phase for several economies. At this stage of growth, it is understandable that talks of tapering of monetary policy keeps coming up. We continue to stick to our views that the tapering would happen in 2022 despite calls from some of the Federal Reserve members to begin the exercise this year. In China, we believe the current market volatility in the Chinese stocks is unlikely to impact China’s macro-economic outlook significantly. The Chinese government has also sufficient dry powder to shore up growth if needed. It has recently begun to inject liquidity by cutting the reserve requirements ratio for banks

Market Outlook - July 2021

We believe that the global economy is on its recovery path with the backdrop of still easy monetary and fiscal policies at play. The fundamentals are still good as compared to the 2013 period, when the US Federal Reserve flagged their intention to taper off quantitative easing. The rebound in global activity is now spilling over more convincingly into rising export demand, especially for Asian products. The Bank of Canada, followed by the Bank of England were among the first central banks to taper bond purchases, and others are expected to follow. The US Federal Reserve has also indicated that it is optimistic about the US growth and employment conditions. These comments prompted financial markets to rethink their expectations of monetary policy and liquidity resulting in several speed bumps in the financial market. However, we believe they will be reassuring in communicating that interest rates will stay near zero for a considerable period. History tells us that as we pass the point of peak growth and stimulus, the days of easy gains would be behind us. 

While new COVID-19 variants are emerging, the pandemic has largely come under control or has started to improve substantially. The governments have generally learnt how to deal with outbreaks of infections through more calibrated lockdowns, accelerated vaccination programs and better medical treatments introduced to reduce the health risks posed by the virus. 

There was a slew of regulatory rules in China tightening up on antitrust/anti-monopoly and fintech-related matters after the 100th Communist Party anniversary. Beijing’s move to crack down on Chinese technology companies, which it perceives as becoming too monopolistic and unsustainable in their businesses, is a multi-year policy response as the government aims to bring technology firms into a normalised regulatory framework. We believe its disciplinary action is necessary for a maturing economy and would bring the companies’ business to a more sustainable path. 

The Biden administration has opted to stick to the tough approach taken by Trump on China. This suggests that political and regulatory risks could become a bigger part of future investment decision-making. We remain constructive on Chinese stocks. Without concrete steps by the G7 to implement similar tough measures against China, global investors still appear keen to invest in Chinese and Hong Kong companies. 

Geopolitical risk will be a factor we will need to consider in the long term. So far, the risk is still minor, but it is fluid and we have to continue to monitor this issue closely from time to time to assess its impact on the global economy and markets. We can only be certain that protectionism and de-globalisation are here to stay, and we should expect markets to stay on its toes while marching upwards in 2021. The US-China upheavals would herald a degree of economic bifurcation as these countries impose financial and technological restrictions on one another. On the other hand, we are also entering a period of wide-ranging technological changes, many of these will be exciting and contribute to a healthier, greener and more dynamic world.

Market Outlook - June 2021

In our opinion, there is upside ahead to the global equity markets. We are at the phase between early-stage recovery and mid-cycle stage normal economic growth. This is a phase where global investors are rebalancing and having a look at repricing market premiums across and within asset classes. We are in some form of market gyration from these actions, and we have been saying for a while that the way forward is to diversify well in various forms in our previous newsletters.

Forecasts for booming economic growth have been brought forward into the first half of this year, and financial markets have rotated, at times abruptly, from last year’s winners into more economically sensitive sectors. With this acceleration in growth, it is natural to expect inflation to rise as well. We shall spend some time discussing the global inflation picture on how it would impact the global markets this year.

Rapid price increases could trigger all sorts of problems. For a start, just the fear of central banks raising interest rates could cause a sharp correction in financial markets given that the global economy is still on “crutches”. There are 2 distinct forms of inflation. One is induced by supply/demand imbalances in the global economy and the other is induced by the financial markets.

At present, the rising inflation rates we are seeing is due to pent-up demand fuelled by excess savings and stimulus money as well as inventory restocking even as various bottleneck issues are disrupting supply. Examples of these issues manifested in the form of chip shortage, port congestion and container shortage. Prices of oil have recovered while those for other commodities too have recovered from stronger demand and liquidity-induced speculation.

There are now ongoing efforts from all quarters in resolving these issues relating to supply/ demand. Firstly, China announced a crackdown on commodity price violations on companies, and this has resulted in the cooling of key commodity prices in recent trading sessions. Secondly, the shortfall in the level of payroll growth, indicates that there is still slack in the employment situation in the US. Thirdly, there is also a lot of excess capacity outside the US. In these circumstances, excess demand in the US will simply go into higher imports of goods from the rest of the world. Lastly, given the disruptive trends we have experienced in the last few years, we should continue to expect productivity enhancing techniques which have a deflationary effect on the final product pricing, hence tempering inflation. We are of the view that recent inflationary pressures will prove temporary, and it probably also explains why Federal Reserve officials will hold the line on their ultra-easy monetary policy.

On the other hand, inflation induced by financial markets is distinguished with looseness on the monetary and fiscal fronts. We can probably see easing in the US/Europe in some form or another, but China is already beginning to adopt a tighter policy stance. Financial market assets are volatile and fickle. With low interest rates and plentiful liquidity in the system but without any sign of sustained economic pickup, there may be a risk of speculative excesses and unsustainable valuations. We are vigilant towards this second form of inflation (induced by financial markets). So far, we believe this risk factor is still low and remote.

In the latest Federal Reserve meeting, the officials are signalling that interest rates will rise sooner than expected. We believe this is a natural course at this stage of the market and economic cycle. A higher inflation, coupled with more normalised liquidity and interest rates cycles should also normalise in tandem with the stronger US economic growth.

Market Outlook - May 2021

We are expecting some profit-taking when the global equity markets continue its ascent in 2021. We remain optimistic, with the vaccine rollouts that are going extremely well.

The US administration’s plan to raise individual and capital gains taxes on the wealthy to fund long-term fiscal initiatives is a net positive for the US economy in our opinion. The spending would be implemented over a 10-year period with the tax revenue collections over a 10–15-year period, slightly expansionary for the US economy. It however remains to be seen whether a substantial part of the plan would be implemented.

On the positive side, the economic recovery would be fueled by the planned fiscal spending of about US$4 trillion in the long-term. The notable spending on businesses in the proposals are long-term spending on electric vehicles, healthcare and semiconductor manufacturing.

With these planned expenditures, inflation concerns began to surface. The US Federal Reserve continues to reiterate its stance of not reducing its quantitative easing (QE) support for the economic recovery. We are of the view that inflation in US will trend up in the near-term with long-term bond yields hovering at a higher level compared to last year. This does not mean we are expecting a runaway inflation in the long-term as the economic growth will be sub-par. Nevertheless, we should be prepared for the Federal Open Market Committee to discuss a “QE tapering” in some form in their future meetings.

The stimulus spending globally is necessary to help affected economies get back onto a sustainable growth path. It is also important that these spendings are going to the right areas like research and development, investments that create jobs, improve productivity and competitiveness. The governments have by and large been on the right track. So far, major economies of the world are notably focusing on Renewables, Healthcare and Digitalization in their planned budgets.

China, being the first country to recover swiftly from the pandemic, continues to be cautious in not wanting to derail its economic growth. We believe the People’s Bank of China and Chinese government will not act to slow growth this year given the yet uncertain outlook on the pandemic recovery outside China. At the same time, inflation is still running below 1%, giving them sufficient room to manoeuvre on the monetary policy front.

Market Outlook - April 2021

To recap, it was on 23 March 2020 when the S&P500 hit its bottom after the COVID-19 crisis sent the equity benchmark tumbling. History indicates that after big market declines, strong bull markets usually follow with gains carrying into a second year. However, we should expect a lower return than the first year with pullbacks along the way. 

In our perspective, we believe the equity market should still be registering positive returns for the year. This is predicated on our beliefs that the global economic growth would surprise on the upside given anecdotal evidence that various governments around the world are putting in their best efforts to open up their economy as soon as practicable. Arguably, investors may still be underestimating the rebound of the economy. So far, we are seeing GDP forecasts being revised upwards repeatedly in recent times. This should filter down to upward revision in corporate earnings correspondingly. April also started with corporate earnings coming in strong from US biggest banks like JP Morgan and Goldman Sachs, the bellwethers of the economy. 

The strong growth will also mean that ultra-easy monetary policies will be reversed at some stage in future where policy frameworks become less business-friendly, to be accompanied by higher taxes and stricter regulations. We will leave these topics to be discussed in our future newsletter. 

On the geopolitical front, we have mentioned in the past that there would not be material changes from the Trump era. The US recently tabled a new bill (Strategic Competition Act of 2021) which, if passed, will lead to a coordinated and comprehensive effort in dealing with China. This supports our view that the Sino-US relationship is unlikely to improve in 2021. The renewed efforts to contain Chinese advancement in technology and manufacturing capabilities should come as no surprise to market participants too. As such, this factor has already been discounted by the markets in our opinion. 

In the latest climate summit of 40 top leaders, they have made a commitment to curb domestic greenhouse gas emissions and tackle climate change. This is an important milestone as major governments embark on a synchronised effort on this matter. For information, this is an investment angle that we have been seriously considering when building positions in our portfolio. 

The narrative of higher inflation and higher growth after the crisis is gaining attention after the easy stance adopted by Central Banks and Governments around the world. This economic regime has not taken hold in a sustainable way yet in our opinion. This also means the process of material rebalancing of risk premium and portfolio reconstruction from our portfolio is still nascent. In a world of stretched equity and bond valuations, our way of assessing the markets remains focusing on relative value within and across asset classes. The Public Equity space is still an attractive investment option for us, and we are adopting a diversified approach in looking for the right disruptor companies for our portfolio.

Market Outlook - March 2021

A new economic cycle has begun with most economies in the world showing robust data underscoring the vibrant recovery.  The release of pent-up consumer and business demand is likely to be very strong, based on recent economic and corporate releases.  The faster-than-expected vaccination has meaningfully reduced the odds of a prolonged economic weakness.

In the financial markets, the magnitude of the upcoming US fiscal policy is a critical factor behind the rise in bond yields.  The market is testing the FED’s resolve in continuing with its easy monetary policy stance when the US 10-year Treasury yields started rising.  In our view, monetary tightening would be premature, as it will take time to develop persistent inflationary pressure and a return to full employment.  We should bear in mind that the healing in the jobs market is a prerequisite for the FED to declare that its dual-mandate has been accomplished before they commence monetary tightening.

To us, the rising bond yields is orderly and the FED would make sure of that in the foreseeable future.  This is because monetary policy is not an appropriate tool to address perceived excesses in the financial market and potential instability. 

The FED will allow some re-pricing of interest rates at the long end of the curve, suggesting that sustained inflation should happen in the long term and tighter policy further down the road.  To refresh, the 10-year bond yields were trading at close to 2.0% before the global pandemic in December 2019. Therefore, it is not unusual for market interest rates to rise to current levels.

From a historical perspective, the stock markets were generally under pressure in the early stages of a US rate hike cycle expectation. However, US rate hike cycles as well as treasury yield increase generally indicate a stronger economic growth outlook in the US.  We are currently at the point of moving into the phase of improving economic and corporate fundamentals from plentiful liquidity earlier. Investors will now need to pay more attention to earnings and valuation of stocks in making investment decisions going forward.  Hence, a stock selection market which plays to our strengths of fundamental-driven investing.

While some stocks may look somewhat expensive, we do not believe global stocks as a whole are close to a big bubble territory.  The US cyclical adjusted PE valuation is currently trading at 35.2x, still lower than the reading of about 45x back in 2000.  The high valuation is concentrated mainly in the Technology stocks, but the rest of the markets is still nowhere near excessive levels.  If we were to look at the rest of the world, especially in Asia where we are weighted heavily in the portfolio, they are still at relatively attractive levels for investors to buy.  It is therefore not surprising to hear that Chinese state funds have stepped in to buy stocks when there is weakness in the market.

We will from time-to-time add new names when opportunity arises to further improve the portfolio mix.  The current environment is one such moment where we can take advantage of stock price weakness due to indiscriminate selling in the market.  We are constantly aligning our forward-looking views on the markets and stocks for any systemic changes in the global arena ranging from economic to geopolitical issues. 

Market Outlook - February 2021

As we entered the new year, we have to continue to grapple with the opportunities and challenges that lie ahead.  We can now focus on fundamentals and global topical issues to assess and determine how the financial markets would be like in 2021. 

With the vaccine rollout ramping up in the coming months, we have a lot to look forward to as we put this virus in the rear-view mirror. The road won’t be easy though, as different virus variants flare up and it could take the remainder of the year, and beyond for the rest of the world to get vaccinated.

The Federal Reserve and its easy monetary policy have been the main underpinning support to markets and that will continue for a while to come.  We believe that they will take their time in removing any of their 2020 easing steps.  FOMC Chair Jerome Powell reiterated his previous stance, saying that it is too early to discuss tapering asset purchases as the recovery path ahead remains highly uncertain, although several developments point to improved outlook later this year.  He highlighted fiscal policy has been absolutely essential and the support from fiscal policy will help weather downturn and limit lasting damage.

 On the fiscal side, the Biden administration has come forth with a proposed $1.9 trillion spending bill. The US debt accumulation is accelerating and becoming a looming issue long term.

The vaccine will certainly lay the groundwork for a return to near normalcy to our daily lives.  Markets will also need to adjust though, particularly interest rates, and we must keep in mind what that could potentially mean for valuations. So while the global economy should see much better economic growth numbers in the second half of 2021 as the vaccine rollout picks up steam, the markets will also have to adjust to possible rising interest rates and central banks that should be talking about tapering their extreme accommodation. We will be monitoring this closely all year. 

The pandemic is not the only problem confounding policymakers.  To refresh, firstly the growing conflict between the US and China raises the possibility of developments in areas such as trade or technology that could hurt world trade.  Secondly, protectionism is likely to continue to undermine the global trade regime.  Thirdly, competition will accelerate technological transformation in multiple areas offering new business opportunities.  Fourthly, the extreme monetary policies have increased financial vulnerabilities.  These are the medium to long term issues we will talk about in our future newsletters.  As of now, we are optimistic on the financial markets as a whole, but these are issues we need to consider before deciding on how and where to invest to achieve good returns.