Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
10 January 2023
“Adopted a 4-step framework approach in navigating change in the market regime.”
Recent economic data in the US (manufacturing, retail sales, leading index) came in softer than expected. This occurred alongside a second successive downside miss in inflation, and a Fed that appears to push back against easing financial conditions as it slows the pace of hikes. Despite a skew of 2023 dots that implies upside risk to the median 5-5.25% projection, and FOMC members’ indications that the Fed will hold the policy rate at high levels for some time, markets have chosen to ignore this messaging. Not only is the market’s peak rate below Fed projections, but it appears investors are either expecting easing because of a rapid return to “normal” levels of inflation or low probability of a “soft landing” scenario shortly after the peak.
Asia credit spreads have rallied 53bp since their wides in 3Q22. It is assumed that “bonds are back” given the more attractive yields, but valuations are split currently depending on whether investors are looking at spread or yield. Asia investment grade spreads now back to the 40th percentile since 2010 offer less value given the potential for renewed recession fears. On the other hand, all-in yields at 6.6% are at their 94th percentile since 2010. This places more emphasis on the path of rates – a continuation of the rally in rates should be less supportive for spreads in January. For Asia high yield excluding China property, spreads currently at 560 bp in the 60th percentile appear to provide comparatively better risk reward. Global macro factors, specifically the interaction between inflation, rates and growth, will contribute volatility in the Asia credit market near term and a few more data points should provide more clarity on the path forward.
In China, reopening is proceeding on a frontloaded schedule. It is expected that surging Covid case numbers in early 2023 results in some disruptions across a rising number of cities, although full lockdowns are avoided, and full reopening is completed by mid-2023. In this case, economic contraction occurs during 1Q23, then shifts to growth for the remainder of the year. The shift to a pro-growth stance by China policy makers benefits other Asian economies. The reopening bounce in the works should provide the overall region with a significant demand lift, with the recovery in China travel reinforcing the region’s services demand. The risk is that it turns out to be tougher than expected for the government to switch the narrative from describing Covid as a deadly virus with serious consequences to a much more benign one. In this scenario, prolonged economic disruption occurs. In the meantime, the PBOC will likely maintain loose monetary policy before full reopening and will likely deliver additional stimulus to counter surging cases and reduction in economic activity. China housing sales and other property indices may be weak during 1Q23, due to disruptions in the initial stages of reopening.
Fixed Income Strategy
With inflation potentially peaking and terminal rates approaching, and policy makers appearing Assuming the recent trend of supportive US employment data continues, the market’s attention will focus on CPI. If the recent trend of falling month-on-month CPI prints continues, bond markets will assume that the Fed will adopt a less hawkish stance. In the event market prices out rate hikes in 2023, this just puts a greater burden on the Fed to keep rates higher for longer to maintain the stated 2% inflation target. Take profit on duration rallies if this scenario materializes. Risks to this strategy: if the soft-landing path no longer looks tenable should data come in worse than expectations, the duration rally likely resumes as recession risk is repriced.
Position in Macau gaming. Whilst this segment has rallied recently, it still yields high single digits. Most Macau gaming operators have between 10 and 14 months’ liquidity to wait for the border with China to reopen. Continuation of travel relaxation measures by the Macau administration despite recent outbreaks of new cases in both Macau as well as mainland China is encouraging. There are probably disruptions if more outbreaks occur and travel restrictions reimposed, but complete bans seem less likely. This should allow gross gaming revenues in 2023 to recover up to half of pre-COVID figures and operators to turn cash flow positive.
Macau 2023 Gross Gaming Revenue Expected to Recover Up to Half Of Pre-Pandemic Reading
Position in China property developers backed by state-owned enterprises and strong private-owned developers, both of which are better supported in terms of onshore funding access and market share leadership. For issuers with severe liquidity issues, funding support has yet to materialize and erosion of market share on homebuyers’ continuing concern about their ability to deliver presold properties leaves these firms at risks of protracted funding crises. In the distressed space, further clarity on restructuring is needed. Some issuers could choose to prioritize onshore operations over offshore debt repayment and/or seek bond exchanges to extend debt maturities.
With China’s domestic GDP expected to rebound from less than 3% in 2022 to 4% – 5% in 2023, that could support commodities prices – especially base metals but oil and coal too. A potential headwind is global growth slowdown, but commodities prices should still settle at levels that would allow corporates to generate free cash flow to lower debt levels. As there is significant variation in credit quality among energy and commodities producers, position in companies that have lower leverage and higher proportion of fixed price sales contracts.
Overweight in defensive positions for US equities, e.g., in consumer staples and healthcare. Although there are encouraging signs of falling inflation in the United States, we believe that there are still some ways to fully combat inflation and/or that interest rates will remain high for a longer period of time. Underweight in the cyclical US tech industry as declines in both consumer discretionary and business spending are becoming more apparent in the slowdown in earnings.
Overweight Chinese telcos for high dividends and defensive plays, as well as Hong Kong financials, retail and Chinese airlines and travel-related sectors as well as domestic consumption related sectors, which shall benefit from the China reopening theme.
Broadly and in positioning the Equities portfolios for 2023, our preferred approach constitutes asset allocation based on several key themes, namely 1) further potential China easing of Covid restrictions and 2) Disinflation, to capture potential upside should inflation eases while remaining Overweight in defensive, high dividend yielding sectors should recessionary risks escalates as we head into 2023.
- 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
- 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
- Position in selected Banks, in particular, Singaporean Banks higher credit quality and NIM expansion amid improving macro-outlook and SEA growth prospects
- For mid-longer-term exposures, position in sectors levered to the China reopening theme, including but not limited to Sportswear, Auto as well as Airlines
- We also like more defensive selected names in the US in sectors such as Healthcare and Consumer Staples/Durables as the probability and fears of recession escalates
Consider hedging your Equity exposures if you haven’t already done so, in particular, new exposures, i.e., for every dollar of Equity exposure you put on, hedge with downside protection instruments such as inversely correlated ETFs (E.g., 7300 HK, 7500 HK, PSQ, SQQQ, etc.). 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
As we head into the new year, we have adopted a 4-step framework approach in navigating change in the market regime. We hold the view that the uncertainties surrounding the markets will be anchored by 3 key driving forces namely recessionary risks, interest rates and inflationary pressures. Investors are split on their views as several critical questions remain unanswered – will the US core inflation prove to be sticky, what is the expected terminal rate, how long and severe will the impending recession be, and/or what is the likelihood of a Fed pivot this year? Our overall investment strategy thus aims to ride on the confluence of unfolding factors. However, we remain cautious in the event of any unforeseen macroeconomic indicators which may tilt our approach at any given time. We, therefore, highlight the need to remain agile in making timely tactical allocation adjustments in the coming months. Key calendar dates to note would be the release of first-quarter corporate earnings in March and subsequent US CPI results.
Economists are divided on the likelihood of a US recession or soft-landing – Bloomberg consensus suggests a shallow and short-lived recession (Fig. 1). This contrasts with Europe where a recession is almost a certainty. Notably, Goldman Sachs has taken a contrarian view and arguesthat the US will avoid a recession in their investment outlook. With that being said, we believe that the market has not fully priced itself a recession despite the steepest inversion of the yield curve since the 1980s (Fig. 2). During the Volcker Shock period, the yield curve inverted by 241 bps which led to a 10-month long recession. Presently, the yield curve inversion is at 77 bps which suggests a 2-quarter-long recession as markets are optimistic about the slowing inflation.
The S&P 500 Index has fallen close to 21% YTD(as of 28 December 2022) and has yet to bottom out as sell-side analysts may downgrade corporate earning margins in the coming months. Additionally, P/E ratios are still relatively high at 16-17x and although it has historically traded down to 14-15x on average during bear market troughs (Fig. 3). We thus prefer Fixed Coupon Notes, Accumulators, or short-term tactical trading strategies on US equities in the next 3 months. Market pessimism has also led investors to take shelter in defensive sectors that are traditionally well-positioned to withstand the impacts of a slowing economy and high inflation. As a result, defensive sector valuations have risen relative to cyclical which are trading below their median on a price-to-earnings basis (Fig. 4). While we believe that the window for defensive sector trades is still open, we caution against the risks of overcrowding.
In the mutual fund space, we recommend the Legg Mason ClearBridge Infrastructure Value Fund. The fund had a positive return last year despite the challenging macro environment. Due to the price inelasticity of demand for infrastructure, the sector can historically protect its profit margins during periods of elevated inflation. The fund can hence serve as a great source of diversification across market cycles if there is a lack of allocation towards infrastructure within an existing portfolio. However, we caution against the risk of governments enforcing price caps on energy sectors which may diminish the sector’s earnings.
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.