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“Is rising inflation more worrying than slowing growth?”
“Inflation and growth seem to remain the two biggest concerns for investors as the world emerges from the COVID-19 crisis.”
Since the COVID-19 pandemic began in late 2019, central banks and governments all around the world have embarked on aggressive fiscal and monetary stimulus in a bid to support economies that have been so badly hit by the crisis. Although the virus remains a lingering concern – especially with the rise of the delta-variant, vaccination rollouts have been mostly effective in preventing further outbreaks.
Figure 1: US CPI Year-on-Year Index (Source: Bloomberg)
As economies recover from the pandemic, the focus now rightly shifts to inflation and growth concerns. US Year-on-Year inflation reading hit 5.4% in June, the highest it has been for more than a decade. This has no doubt been a result of the accommodating fiscal and monetary policy introduced by the central banks and governments. The US Federal Reserve’s balance sheet has more than doubled from 4 trillion USD to more than 8 trillion USD since the pandemic.
The question remains, how long can we sustain these accommodative policies before we must start tapering down? And what happens when we do so? Will our economies be able to sustain the recovery and growth?
In the short term, the FED has signaled that it will remain passive when it comes to revising their policies and will likely stay behind the curve, allowing inflation to run further before taking any action. They are unlikely to put on the brakes too quickly and stop the economic recovery. Any rate hikes will only take place earliest in 2023 and will be gradual in nature.
In spite of this, the situation remains very dynamic and fluid, investors should remain cautious as we do not expect to see a straight line path to recovery, volatility will be here to stay. Investors should continue to shift funds to parts of the market they believe will be helped by the economic reopening and adopt a balanced and diversified portfolio.
Investors seem to be turning their attention to Treasury yields as a form of precaution. We anticipate FED Funds rate to be kept 0% – 0.25%, with two rate hikes by the end of 2023. The 10-yr US Treasury dropped to 1.21% as at21 July 2021 from 1.44% as at 6 July 2021 and is expected to be around 1.0% to 2.0% for the year of 2021.
The credit default swap (CDS)index for Asia ex-Japan Investment Grade entities rebounded slightly to 87 as of 21 July 2021 from 84 as of6 July 2021. Asia IG credit spread increased to 133as of 21 July 2021 from 130 as of 6 July 2021. Credit spreads are expected to be to widen slightly in the coming quarter. However, Asia HY credit spread maintained at a high level of 690 as at21 July 2021. Sentiment continues to remain weak and we might see a further decline in the coming month.
Highly leveraged HY bonds may face refinancing risks, several onshore/offshore bonds have defaulted recently including bonds issued by Yongcheng Coal, Huachen Automotive Group, Tsinghua Unigroup, China Fortune Land Development and Tus-Holdings Co. Ltd. As the government supportweaken, four Chinese AMCs (Huarong, Cinda, Orient & Great Wall) may be downgraded and their credit spreads may widen. We caution investors holding marginal investment graded bonds (BBB-, Baa3) to be wary of downgrades. For investors with an investment grade bond portfolio mandate, we recommend bonds with BBB+ ratings or higher, and portfolio duration of 3.5 – 4 years.
Figure 2: CDS Asia ex-Japan Index 1-year Chart (Source: Bloomberg)
We again recommend investors to stick to short dated high quality (BB Rated) High Yield bonds excluding bonds issued by Chinese issuers with a duration of less than 3 years which would offer the best value. Investors should be prepared to hold these bonds to maturity. Geographically, we are overweight Emerging Markets’ bonds (Investment Grade and High Yield excluding China) and neutral on Developed Markets’ and Chinese bonds.
Further, we recommend investors to match their exposure of high-beta bonds such as: CoCo Bonds, Perpetuals, and high yield bonds to their respective risk appetites. It is also recommended for investors to hold a more diversified fixed income portfolio or to reduce leverage of portfolios due to various uncertainties across sectors and particularly to reduce/control portfolio exposure in high leverage BB-rating (e.g. Greenland, RiseSun) & all B-rating Chinese real estate bonds.
We recommend investors to continue to monitor low beta bonds. For reference, the purchase yields for 3–5-year low beta IG bonds are at 1-2%, and 3-5-year low beta HY bonds are at 3-5%. Overall, we recommend a balanced and more diversified portfolio of high quality (BB rated) high yield bonds and short duration IG Bonds.
Although the absolute returns in the fixed income market may be low, it is still advised to maintain a portion of the portfolio in fixed income given the heightened volatility of the markets.
We experienced a small pullback in equities this past week on concern a rebound in Covid cases would slow global economic recovery. The Dow Jones Industrial Average had its worst day since last October, falling more than 2% on 19th July 2021 alone. Since then, the markets have rebounded strongly, shrugging off the virus concerns. Authorities are now better prepared and equipped to deal with any reemergence of the virus, continued global vaccine rollout have also alleviated much of investors’ worries.
Figure 3: S&P 500 Index 1-year chart (Source: Bloomberg)
As economies start to reopen, it is in our view that inflation may taper off as supply chain bottlenecks ease, especially in the semiconductor space. Commodities prices, another major contributor to the rising inflation, have also come off their highs from early this month.
Fiscal and monetary policies also look set to remain accommodative in the short-term as central banks continue to adopt a more passive approach. All that being said, we remain cautiously bullish for Equities towards the end of the year. We urge investors to stay constructive and selective in terms of stock selection and weigh their risk-and-reward. Volatility will persist, investors should take major pullbacks as a buying opportunity to increase their exposure in select sectors.
Our investment strategy stays largely intact. We are overweight both Cyclicals and Tech, with more skew towards Cyclicals which will be closely tied to the economic reopening. We like Tech subsectors such as 5G related companies, Cyber security, cloud computing and Ecommerce. For Cyclicals, we prefer subsectors such as Basic materials, commodities and Chinese Auto Manufacturers/Distributors. We are also wary of the anti-monopoly and data laws being introduced by the Chinese Government, therefore preferring geographic exposure in the US market.
It is important that investors adopt a well-diversified and balanced portfolio, with a skew towards cyclicals while maintaining a core thematic position in technology. In short, investors should employ a more back-to-basics stock selection approach and continue to adhere to company fundamentals and strict risk management principles (stop-loss mechanisms and/or appropriate portfolio hedging) to mitigate risks from market swings and uncertainties.
This material is provided for informational purposes only. It is not a recommendation or solicitation of any investment or investment strategy. There is no guarantee that any investment or strategy will achieve its objectives. Unless otherwise stated, all information contained in this document is from Raffles Assets Management (HK) Ltd. and/or Raffles Family Office Pte Ltd (Singapore) and is as of 21 July 2021. The views expressed regarding market and economic trends are those of the authors and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets, or sectors will perform as expected. By acceptance of these materials, you agree that you shall use the information solely to evaluate your investment in this Raffles Assets Management (HK) Ltd and/or Raffles Family Office Pte Ltd (Singapore) sponsored investment opportunity and you shall keep the information confidential.
Mr. Derek Loh is the Head of Equities at Raffles Family Office. Derek has numerous years of work experience from top asset management firms and Banks – 13 Years on the Buy-side across 3 Major Cities in Hong Kong, Singapore and Tokyo. Derek demonstrates in-depth industrial knowledge and analysis, covering mostly listed equities.
Ex-Portfolio Manager for ACA Capital Group, managing a multi-billion dollar global fund for a world-renowned sovereign wealth fund and reputable institutional investors. Previous notable Investors serviced include Norges Bank (Norwegian Central Bank), Bill & Melinda Gates Foundation and Mubadala. Derek holds an Executive MBA from Kellogg School Of Management and HKUST. He is also a CPA.
Mr. Lawrence CHAN is Head of Fixed Income of Raffles, where he is responsible for credit and fixed income investments.
Mr. CHAN has over 15 years of experience in the fixed income industry. Prior to joining Raffles, he was Chief Investment Officer (Fixed Income Investment Department) of Taiping Assets Management (HK) Co. Ltd. to manage China Taiping Group’s offshore bond investments and co-manage MPF & ORSO funds for China Life Trustees. His co-managed China Life Guaranteed Return Fund won various awards from Bloomberg Businessweek (2015-2017), BENCHMARK (2015) and MPF Ratings (2015-2016). He had worked for various financial institutions, including Taikang Asset Management (HK) Co. Ltd., Deutsche Bank AG (HK Branch) and Hong Kong Monetary Authority.
Mr. CHAN graduated with a Master’s degree in Finance from The Chinese University of Hong Kong and a Bachelor’s degree in Accountancy (with First Class Honours) from City University of Hong Kong (formerly known as City Polytechnic of Hong Kong). He is a CFA charterholder, Hong Kong CPA, and a Fellow of the Association of Chartered Certified Accountants (“ACCA”).