Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
04 January 2022
“The inflection point of interest rate cycle is here!”
“FED Powell signaled the tapering process will end in March 2022 earlier than previously expected of Mid-2022. The dot plot also indicated that there could be potentially three interest rate hikes each in 2022 and 2023. ”
The inflection point of interest rate cycle is here! This pivoting is a game changer as investors were accustomed to a low interest rate environment. To quote, famous value investor Warren Buffett used to say, “interest rates are to asset prices what gravity is to the apple. When there are low interest rates, there is a very low gravitational pull on asset prices. Only when the tide goes out do you discover who has been swimming naked!”
As we head into 2022, with the hawkish FED and inflationary pressures as the backdrop, we do expect volatility to continue at least into the next two quarters. We believe there could be potential normalization of inflationary pressures as well as supply chain issues, however it may stay elevated as Omicron added another layer of uncertainty into that mix. With various headwinds on the horizon, we urge investors to adopt a more conservative approach and be more selective in their investments.
Figure 1: FOMC Dot Plot (Source: Bloomberg)
Figure 2: S&P 500 and Nasdaq indices (Source: Bloomberg)
Fixed Income Overview:
FED Powell signaled they will double the pace of tapering and the process could end in March 2022 earlier than previously expected of Mid-2022.
We anticipate FED Funds rate to be kept 0% – 0.25%, with three rate hikes each in 2022 and 2023 (FOMC dot plot median at 1.6% by the end of 2023) based on the December 16th meeting. The 10-yr US Treasury rebounded to 1.62% as of 04 January 2022 from 1.43% as of 21 December 2021 and is expected to be around 1.25% to 2.25% for the year of 2022.
The credit default swap (CDS) index for Asia ex-Japan Investment Grade entities dropped to 77 as of 04 January 2022 from 84 as of 21 December 2021. Asia IG credit spread dropped to 118 as of 04 January 2022 from 123 as of 21 December 2021. We expect IG bonds credit spreads, except for Chinese issuers, to range bound over the coming months. Asia HY credit spread dropped to 877 as of 04 January 2022 from 890 as of 21 December 2021.
We expect sentiment in the HY bond market to remain relatively muted to range despite the recent injection of capital of approximate USD 6.5 billion by various Chinese financial institutions to Huarong, aiding it to serve its debts and prevent a debt default.
Figure 3: 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 Sunshine 100 China Holdings, Fantasia Holdings, Sinic Holdings, Modern Land China, Evergrande, Kaisa, China Aoyuan. Evergrande also announced on 3 Dec 2021 that it planned to “actively engage” with offshore creditors on a restructuring plan.
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 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, with the expectation of rates going higher and more volatility going into year 2022, we recommend a balanced and more diversified portfolio, with short duration (less than 3 years) IG and high quality (BB rated) HY 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 hawkish FED is here. With the inflection point of interest rate cycle, we continue to reiterate our prudence strategy. Despite the belief of normalization for both inflation and supply chain issues, we believe it could stay elevated as Omicron added another layer of uncertainty into that mix. Hence, we envision the continuation of higher volatility into the year, at least for the first two quarters of 2022.
On the other aspect, we continue to like the constructive and transparent FED, especially on how they have been managing market’s expectation. Henceforth, we continue to be constructive for equities, while being prudent and extra selective at the same time.
As we head into 2022, with various headwinds on the horizon, we urge investors to adopt a more conservative approach and stay in selective blue chips.
Figure 4: 1-Year chart comparing S&P 500 Index and Hang Seng Index (Source: Bloomberg)
Geographically, we maintain our stance being constructive on HK/Greater China vs the US in terms of valuation. Still, investors should hold more cash (at least 1/3) or hedge their portfolio and embrace higher volatility. 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 in conservative stance. We prefer sectors such as cybersecurity, select technology, auto EV, green energy, healthcare, and financials ex-China and ex insurance.
It is important that investors adopt a well-diversified and defensive portfolio, stay in selective blue chips, reduce any over-exposure towards equities. 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 04 January 2022. 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”).