Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
20 September 2022
“We argue that the risk-reward is increasingly skewed towards Global Equities”
The upcoming FOMC meeting will take place from 21 to 22 September. Markets have fully priced in a 75-bp rate hike and we expect the FED Funds Rate to trend at 3.25% by end of Q3 this year. Bloomberg’s September 100-bp Hike Odds model has forecasted a probability of 19% which in our opinion is a stretch. This is because we observe US CPI beginning to ease albeit not to market expectations – it typically takes time for monetary policy to take effect on the economy. Markets are thus wary of the risk that the FED may front load rates too much and for too long.
Looking ahead towards the end of 2022, we hold the view that a FED Funds Rate of 4% is highly possible with 2 more FOMC meetings remaining. The majority of the market participants have priced in a subsequent 50 bp and 25 bp rate hike respectively on the assumption that US CPI further subdues lower than expected i.e. Q4 US CPI slowdown by 1% to a median of 7.2%. The next US CPI report will be released on 13 October. We caution for further market drawdowns if inflationary pressures remain elevated and as markets re-price themselves accordingly for a 75 bp rate hike. Against the backdrop of the elevated inflationary environment, we recommend addressing the increased borrowing cost of loans via loan swaps. We also recommend prudent management positioning and having access to dry capital in preparation for next year. We prefer to focus on higher strike, profit taking and long-term positioning with a margin of safety trades in high-growth sectors such as information technology.
Source: Bloomberg, data as of 19 September 2022
Source: Bloomberg, data as of 19 September 2022
Source: Bloomberg, data as of 19 September 2022
Elevated inflation, which picked up pace contrary to market expectations for a decline on the month, broad-based US employment gains and robust wage growth for August, and generally hawkish Fed commentary, are driving a higher near-term trajectory for US yields. Under a soft landing scenario, where growth rebounds next year alongside materially lower (but above target) inflation, it is unlikely the Fed will be easing. An alternative scenario with inflation persistence, albeit at lower levels, is likely to result in an extension of the rate hike cycle rather than cuts. Longer dated yields can also reset higher as markets revise long run rate expectations in the event of a soft landing, especially if policymakers revise upwards their rate projections in an economic environment where inflation over the medium term will be higher than the average over the previous decade. Only in a recession scenario where inflation abates from demand destruction rather than supply factors would yields be expected to decline.
Global output contracted in both the manufacturing and service sectors for the first time since June 2020, as new order inflows declined, international trade volumes fell and signs of excess capacity grew. The JPMorgan Global composite PMI fell to 49.3 in August, from 50.8 the previous month. Although only modest, the downturn reflects an increasingly broad-based deterioration of output and demand conditions both by sector and region. Companies are also taking a more cautious approach to cost control and employment in the face of a worsening economic climate, some withdrawing earnings forecasts. The headwinds damping global goods sector activity are being felt acutely in Asia, where the latest factory output reports for August manufacturing PMIs softened across Asia and point to downside growth risk. The level of concern varies depending on exposures to tech, autos, and other manufacturing. While most of Asia is linked to tech, the manufacturing sectors in Japan and Korea also share a sizable exposure to the still-recovering motor vehicle sector. Korea’s July IP and August customs exports showed a continued recovery in the automobile sector even as weakness in tech products persisted. Given its reliance on electronics, Taiwan has seen the sharpest slowdown in the August manufacturing PMIs.
In China, momentum from the post-lockdown rebound appears to be intact and better than anticipated. While NBS non-manufacturing PMI fell 1.2 pts to 52.6 in August, industrial production (+4.2% y-o-y), retail sales (+5.4% y-o-y) and fixed asset investment (+5.8% y-o-y) grew faster than market expectations. Reports of new COVID clusters and rolling lockdowns are raising concerns even if the government appears reluctant to impose the draconian measures taken in April. In the real estate sector, contracted sales year-on-year are stabilizing in favour of a few top developers, while most private developers continue to face sluggish turnover and deteriorating liquidity. The government measures to address the liquidity situation of developers and mortgage suspensions on delayed home deliveries modestly boosts sentiment in China real estate HY. News of US imposing broader curbs on exports of semiconductor making equipment to China are a potential source of market volatility. Ahead of the October Politburo conference, expectations are low for substantial fiscal stimulus.
Fixed Income Strategy
• In a scenario of inflation stickiness and upside risks to yields, longer tenor bonds offer insufficient term premium. As relatively lower coupon bonds mature and are replaced with bonds structured with coupons that reflect current rates, the debt servicing capacity of some issuers could wither. Maintain overweight in high grade issues between 3-year to 5-year tenor which should be able to generate modest positive total return going into year end.
• Continue to prefer non-discretionary consumer issuers that can continue to deliver earnings and ability to pass on higher prices to consumers without eroding demand which is important in the current inflationary environment.
• Position in selected Korean utilities that offer relative value vs China and Singapore peers for similar credit quality.
• Position in China real estate SOEs, as market share gravitates towards those that identify as having least project delivery risks. Among POEs, position in developers which have sufficient liquidity excluding cash balances at project level, with preference for bonds of remaining maturity under 12 months, given that property sales and prices are yet to show a sustained upturn.
• Position in selected European banks vs Asian and US banks with similar capitalization ratios, on the back of attractive relative valuations. Reduce exposure to S$-denominated Singapore bank AT1s on rich valuations.
Despite disappointing and stickier inflation and hawkish Fed actions, we argue that the risk-reward is increasingly skewed towards Global Equities, in particular, Greater China Equities despite the lack of market traction in Equities globally. With a key component of inflation, energy, coming off its highs seen earlier this year coupled with continued aggressive Fed actions, we anticipate inflation to show signs of easing before the end of this year. We encourage investors to gradually accumulate selected sectors on major significant market declines with a preference for Greater China Equities on valuation grounds.
Given the numerous uncertainties we currently face, our preferred prudent approach constitutes asset allocation based on several key theme, namely 1) potential China Re-Opening and 2) Disinflation, to capture potential upside should inflation eases while remaining Overweight in defensive, high dividend yielding sectors should inflation continues to run away.
1. Our most favored sector is Telecommunications Operators, in particular Chinese Telco operators that offer high dividend yields at attractive valuations alongside smaller price and hence P&L volatility
2. We continue to prefer certain Consumer Discretionary sector that serve as natural hedges to inflation like certain high end luxury consumer brands that can continue to deliver earnings and ability to pass on higher prices to consumers with minimal impact to demand
3. Position in selected Banks, in particular, Singaporean Banks higher credit quality and NIM expansion amid improving macro-outlook and SEA growth prospects
4. For mid-longer-term exposures, position in sectors levered to the China reopening theme, including but not limited to Macau Gaming, Sportswear, Auto as well as Airlines.
Continue to employ shorter-term tactical trading across both core and peripheral positions to capture market dislocations and volatility. Cash Levels: Keep at least 15% cash on hand to remain defensive.
Semiconductor Sector Breakdown
This week, we look at the semiconductor sub-sector as a potential portfolio core holding. The industry is projected to be worth a trillion dollars by 2030. Capital expenditure within the industry has increased by a double-digit CAGR of 10.5% between 2000 to 2022 to create more efficient chips to meet the growing demand from electric vehicle and data storage sub-sectors. Topline revenue of leading semiconductor firms has seen an average growth of 26.85% in addition to increasing profit margins. This highlights the industry’s strong pricing power against the backdrop of an elevated inflationary environment.
Source: Statista (2022)
Source: Bloomberg (May 2022)
Nevertheless, we recognise the headwinds of declining consumer spending on electronics (i.e. PC and Smartphones) given rising interest rates in the short term. Evidently, if we were to measure the correlation between US CPI and iShares Semiconductor ETF price performance, we will be able to observe an increase in inverse correlation since the start of the year. Therefore, despite the strategic importance of the sub-sector in the long term, we recommend exercising prudence when allocating capital in this sector. Overall, we take comfort in the sub-sector’s 35% YTD decline and see opportunities in quality thematic funds and individual equities.
Source: Bloomberg (2022)
Source: Bloomberg (2022)
The Covid-19 pandemic and geopolitical tensions have exposed vulnerabilities in global semiconductor supply chains. Countries are forced to respond with policies to safeguard the strategic importance of the sector. Given the fragility of supply chains, we look to better understand the semiconductor ecosystem which can be broken down into (1) R&D & Design, (2) Manufacturing, (3) Assembling, Testing & Packaging (ATP) and (4) Distribution.
R&D & Design
At the initial stages of the value-chain, IP and EDA companies are asset-light and provide intellectual property to integrated circuit layouts for chip design and software to print circuit boards respectively i.e. Cadence and Synopsys.
Manufacturing & ATP
The bulk of the investment options lies in the manufacturing stage. Companies adopt either a Fabless Foundry or Integrated Design Model (IDM) business model. Fabless foundry companies outsource the fabrication of chips, testing and packaging to other companies while focusing on the designing and sales of chips i.e. Advanced Micro Devices and Nvidia. On the other hand, IDM companies have vertically integrated the value chain by designing, fabricating, and selling chips in-house. i.e. Intel and Samsung. In our opinion, we believe that a fabless foundry business model would translate better to an investment strategy as AMD and NVDA outsource their low-margin high-cost work to other companies. This in turn increases their high-profit margins and enables them to focus on R&D growth. Other important players include materials and equipment suppliers. Siltronic is a material supplier that provides silicon wafers which are used in integrated circuits – a composite of several electronic components. ASML is an equipment provider of lithography technology which is used to make 7nm and smaller advanced microchips.
Lastly, semiconductors are then distributed to end users such as Tesla, Apple and Samsung who require semiconductors for their products.
In our list of recommended semiconductor investment ideas, we have shortlisted the VanEck Semiconductor ETF (SMH US Equity) and iShares Semiconductor ETF (SOXX US Equity). SOXX has a larger geographical allocation towards the US with a more diversified holding (30+ equities) including blue-chip names such as Intel, compared to SMH. However, we prefer SMH to SOXX given its earlier fund inception, slightly better risk-adjusted returns, and greater potential upside of its large-cap growth holdings. Moving on to individual equities, we remain cautious and recommend exercising prudence in price entry given lower tech valuations and in turn suppressed CAPEX in the near future. Our overall strategy is to position semiconductor holdings for the long-term while making a margin of safety trades amid headwinds in the short term.
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 the stated date on page 1 (top left corner). 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.
William Chow – Deputy Group CEO
Mr. Chow brings over two decades of asset management experience and currently oversees Raffles Family Office’s (RFO’s) Advanced Wealth Solutions division while also serving on its Board of Management and Investment Committee.
He joined RFO from China Life Franklin Asset Management (CLFAM), where as Deputy CEO from 2018 to 2021 he oversaw $35 billion in client investments. Mr. Chow also chaired the firm’s Risk Management Committee and was a key member of its Board of Management, Investment Committee and Alternative Investment Committee.
Prior to CLFAM, Mr Chow spent 7 years at Value Partners Group, the first hedge fund to be listed on the Hong Kong Stock Exchange, where he was a Group Managing Director.
He started his career at UBS as an equities trader and went on to take up portfolio management roles at BlackRock and State Street Global Advisors from 2000 to 2010.
Mr. Chow holds a Master’s degree in Science in Operational Research from the London School of Economics and Political Science, and a Bachelor’s degree in Engineering (Hons) in Civil Engineering from University College London in the UK.
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.
Ek Pon Tay – Head of Fixed Income
Ek Pon is responsible for fixed income investment management at Raffles Family Office. He has over 20 years of fixed income experience across Singapore and Japan.
Prior to joining Raffles Family Office, he was a portfolio manager at BNP Paribas Asset Management since 2018, responsible for Asia fixed income mandates. From 2016 to 2018, Ek Pon led the team investing in Asian credit at Income Insurance. From 2011 to 2016, he worked at BlackRock, managing benchmarked and absolute return fixed income funds. Earlier in his career, he held several positions as a credit trader in banks for 9 years.
Ek Pon graduated from the University of Melbourne with a Bachelor of Commerce and Bachelor of Arts.
Sky Kwah – Director, Investment Advisory
Sky Kwah has over a decade of work experience in the investment industry with his last stint at DBS Private Bank. He has achieved and receive multiple awards over the years being among the top investment advisors within the bank. He often deploys a top-down investment approach, well versed in multiple markets and offering bespoke advice in multiple assets and derivatives.
Prior to his role, he worked at Phillip Capital as an Equities Team leader handling two teams offering advisory, spearheading portfolio reviews and developing trading/investment ideas.
He has been interviewed on Channel News Asia, 938Live radio, The Straits Times and LianheZaobao as a market commentator and was a regular speaker at investment forums and tertiary institutions.