Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
09 November 2021
“Tapering is here!”
“Tapering is here! FED has officially announced the start of the tapering process this November 2021 and indicative of ending in mid-2022. Both the magnitude and pace will be what the market will be focusing on in the near term.”
While there is indication that no rate hikes will be on the horizon until the completion of the tapering process, FED has also reiterated that they are closely monitoring inflation data and they will not hesitate to act if necessary.
The Federal Open Market Committee said it would scale back by $15 billion a month starting in November. The market took this positively without much tantrum, seen with the U.S indices testing new highs most recently.
Having said that, treasuries fell, taking 10-year yields up more than 4 bps to almost 1.5% area. The yield on 30-year TIPS fell as much as 7.1 bps to minus 0.508%, a record low, reiterating the inflationary concern from street consensus.
The FED also cautioned that rising prices of risky assets “remain vulnerable to significant declines” if the economy takes a turn for the worst. The king of value investing Warren Buffett is also signaling caution with the soaring stock market. Berkshire Hathaway was a net seller of equities for the fourth straight quarter, a trend not seen in data going back to 2008.
Figure 1: S&P500 index (Source: Bloomberg)
That said, we are now heading into the year end, with seasonality factors such as thinner liquidity, and various headwinds on the horizon such as supply chain bottlenecks, energy crunch, and inflationary pressures, we urge investors to adopt a more conservative approach towards the year end and raise more cash.
Across the Pacific, China is continuing to face uncertainties across its real estate market as more and more companies face defaults over its debt repayments and refinancing risk.
That being said, the situation remains very dynamic and fluid, investors should remain cautious and expect even more volatility towards the end of the year. We continue to recommend a more defensive and ultra-selective portfolio allocation, stock picking in certain sectors will be of utmost importance. Investors may also consider taking advantage of any volatility through the use of tactical trading strategies.
Fixed Income Overview:
U.S tapering will start this month and end by middle of 2022. We anticipate FED Funds rate to be kept 0% – 0.25%, with three to four rate hikes (FOMC dots median at 1% by the end of 2023) by the end of 2023 based on the September 22nd meeting. The 10-yr US Treasury dropped to 1.48% as of 09 November 2021 from 1.64% as of 26 October 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 to91 as of 09 November 2021 from84 as of 26 October 2021. Asia IG credit spread rebounded to 139as of 09November 2021 from 126 as of26October 2021.We expect IG bonds credit spreads, except for Chinese issuers, to range bound over the coming months. Asia HY credit spread rebounded to 1207 as of 09 November 2021 from 1043 as of 26 October 2021.We expect sentiment in the HY bond market to remain relatively weak as there continues to be adverse news emerging out of the Chinese market. And this could spill over to the Chinese IG space as well.
Figure 2: CDS Asia ex-Japan Index 1-year Chart (Source: Bloomberg)
Highly leveraged HY bonds (B rated) may face refinancing/default risks – several onshore/offshore bonds have defaulted recently including bonds issued by Sichuan Languang Development, Sunshine 100 China Holdings, Fantasia Holdings, Sinic Holdings, Modern Land China. As the government support weaken, four Chinese AMCs (Huarong, Cinda, Orient & Great Wall) may be downgraded by respective credit rating agencies 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 2.5 – 3 years.
We again see value and recommend investors to stick to short dated high quality (BB Rated) High Yield bonds (ex-China)with a duration of less than 3 years and be prepared to hold the bonds to maturity. At the same time, reduce/control their exposure to highly leveraged BB-rated bonds (Greenland, RiseSun) and all B-rated Chinese real estate bonds. Geographically, we are overweight Emerging Markets’ bonds (Investment Grade and High Yield with BB ratings 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 and to reduce leverage of portfolios due to various uncertainties across sectors. We advise investors to dive deeper into the issuer’s stand-alone fundamentals to ensure the strength of the company.
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.
The on-going earnings season and FED’s accommodative positioning in our opinion, despite starting the tapering process, had continued to push the S&P 500 index to all time high. With rich valuations and seasonality factors, we believe the risk is to the downside.
As we head into the year end, with seasonality factors such as thinner liquidity, and various headwinds on the horizon such as supply chain bottlenecks, energy crunch, and inflationary pressures, we urge investors to adopt a more conservative approach towards the year end and raise more cash.
Furthermore, inflationary pressures affecting both wages and raw materials may continue to remain elevated, and this will likely erode the bottom line of many companies, adding further margin pressures.
Figure 3: 1-Yearchart comparing S&P 500 Index and Hang Seng Index (Source: Bloomberg)
Despite regulatory headwinds continuing to hover over the Greater Chinese markets, we think that the worse is likely to be priced in, and now we see value starting to emerge in select sectors.
Geographically, we recommend being overweight HK/Greater China vs the US. Still, investors should hold more cash as a buffer and be prepared for a mid-long term investment horizon. We urge investors to stay constructive and selective in terms of stock selection and weigh their risk-and-reward. Volatility will persist, and investors should lean towards a more conservative portfolio.
Our investment strategy stays largely intact. We are overweight “Growth” vs “Value” and prefer sectors such as cybersecurity, consumer discretionary, select technology and healthcare.
It is important that investors adopt a well-diversified and defensive portfolio, reduce any over-exposure towards equities and raise some cash. 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 9 November 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.
Derek Loh – Head of Equities
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.
Lawrence Chan – Head of Fixed Income
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”).