Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
31 January 2023
“Headline US inflation is slowing down; we remain cautious of core sticky inflation”
Markets remain focused on when central bank rate hikes might exact a bigger impact on growth that, if excessive, could induce a recession. Though the Fed’s next rate hike(s) are likely to be 25 bp increments, the cumulative effect of its tightening is still cooling the economy. While the financial markets signal from credit spreads has been constructive, the signal from the US yield curve is less bullish. The US 10-year yield is down 60 bp since November and the 2s10s curve at -70 bp is the most inverted since 1982. The latter metric sliding into negative territory has tended to precede recession. Even as December US PMI data was slightly stronger than expected, it was in line with other incoming data showing the service and manufacturing sectors are contracting, and cooling employment sub-indices suggest the pace of job creation measured by nonfarm payrolls could decelerate more in coming months. However, prices charged and output prices sub-indices remaining firm, shows sticky price pressures.
Most Asian central banks, which generally had been late to the global hiking cycle, are moving to scale back or even conclude their monetary tightening cycles—despite, in some cases, still elevated inflation. This month Bank Negara Malaysia held rates at 2.75% vs expectations for a 25bp hike, and Bank Indonesia, hiked 25 bp as expected to 5.75% and projects core inflation moderating to 2% – 4% during 1H 2023. After hiking 25 bp to 3.5%, Bank of Korea governor’s comments sent similar dovish messaging. Taiwan is expected to remain on hold this year at 1.75% as the central bank prioritizes economic growth on falling export demand. An exception is Bank of Thailand which hiked 25 bp to 1.5% and projects further tightening to control inflation as the economic recovery gathers pace from a tourism rebound.
In China, exit from zero-COVID is likely to be consumption and services led, consistent with the pattern in other economies on reopening. Expect consumption to be boosted by income growth and accumulation of savings during the pandemic years. Services such as entertainment, transportation, and medical services have room for a large rebound in coming months. Outbound Chinese tourism could be significant, especially benefiting economies geographically close to China (Hong Kong in particular) and with large tourism sectors (e.g. Macau and Thailand). China reopening is likely to push up prices across a range of commodities, but particularly energy as transportation activity rebounds. This may be a modest drag on consumption in energy importers (and/or on fiscal resources, where retail fuel prices are subsidized), which includes most Asian economies.
Fixed Income Strategy
The strong credit market rally in 4Q and in the first weeks of 2023 may limit opportunities currently from a valuation perspective. Investors’ focus will likely shift from upside surprises in inflation to downside surprise in growth. With the Bloomberg Asia USD Credit spread having tightened from 415 bp wides in October 2022 to 280 bp, below its 12-month average of 339 bp, this is a juncture to reduce market risk and increase cash levels in credit portfolios.
Position in Macau gaming. This segment has been one of the strongest performers since November, yet December’s GGR reached just 15% of pre-pandemic readings, and Macau government’s daily visitations tally for the Lunar New Year Period (January 21 – 24) aggregated 61k per day vs 10-15k daily visitations in 2H22 and was almost entirely mass market driven. Should travel restrictions remain low and COVID cases remain manageable, issuers that can pare down debt faster with mass market resumption may be better positioned to perform relative to peers. Even under a zero revenue scenario, most Macau gaming operators have between 9 and 13 months’ liquidity.
Position up in quality for China property developers. While official support has increased for the industry, physical property presales and price action remains challenging, and policy easing is currently more directed towards stronger developers. Credit differentiation continues to matter. For China property high yield, adopt a diversified allocation and minimize concentration of single issuers as idiosyncratic credit events are likely to continue occurring. For many stressed property developers, unless there is substantial recovery in the physical property market, expect lengthy process towards restructuring.
China Housing Demand Remains Subdued
Source: Bloomberg Finance L.P.
China reopening should boost exports from commodity-oriented exporters, for example Indonesia (coal), Colombia, Saudi Arabia, UAE (oil), and Qatar (gas). Gas prices falling circa 80% from 3Q22 highs is attributed to Europe experiencing a mild winter, but China reopening is likely to contribute a resurgence in energy prices in the coming months. 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 recessionary risk still remains, overweight in defensive positions for US equities, e.g. consumer staples and healthcare. With the current data, we viewed that the global recession may not be a hard one but more of a soft-landing. This should allow carefully selected companies in the US market to remain attractive, given the resilience of the US market during an economic downturn (relative to other global markets) and companies that would still be able to retain profits and margins despite a slump in the economy. Underweight in US consumer discretionary due to significant reductions in spending by both businesses and consumers during the actual recession or even the anticipation of a possible recession.
Overweight Chinese telecommunications companies for dividends and defensive plays. Overweight Chinese airlines, travel-related, entertainment-related as well as consumption sectors which shall continue to benefit from the China re-opening theme. Continue to ride this strong wave in selected sectors and names but also look for opportunity to take profit and invest in other markets (e.g. US) in quality companies with strong fundamentals that can withstand an economic slowdown.
Keeping abreast of the latest FED interest rate forecast, we observe that market participants have priced in an average terminal rate of 5.06% by Q2 2023 which is aligned with their recessionary forecasts. They remain optimistic in contrast to FED policymakers and expect the Fed to pivot by Q3 2023 as US inflation tapers off. The Fed, on the other hand, is forecasting a terminal rate above 5% and is considering holding it there beyond 2023. Presently, our base case takes the Fed’s view.
Interest Rate Forecasts: Financial markets remain optimistic in contrast to FED policymakers forecasting terminal rates above 5% by the end of 2023
Source: Bloomberg, data as of 31 January 2023
Against the backdrop of rising interest rates, investment-grade bond credit yields have risen to their highest levels relative to S&P 500 earning yields. On a risk-adjusted basis, fixed income appears more attractive compared to equities in this risk-off environment. However, we advise caution against an overcrowded trade as spreads narrows.
Quantitative tightening has driven credit yields to their highest levels relative to S&P 500 earning yields which makes fixed income attractive
Source: Bloomberg, data as of 28 December 2022
Although headline US inflation is slowing down, we remain cautious of core sticky inflation, particularly in service wage growth, food, and shelter. More recently, we hold the view that global demand will pick up due to China’s reopening which will in turn keep inflation elevated.
The displacement between US job openings to initial jobless claims has also narrowed but remains above historical levels. We expect the gap to narrow further given layoffs within the technology and financial sectors.
US labour markets remain tight as job vacancies and unemployment rates remain above historical levels.
Source: Bloomberg, data as of 28 December 2022
We note that the average hourly earnings growth within the leisure and hospitality sub-sector, which makes up a large component of labour, has continued to outpace the personal consumption expenditure (PCE) index. This is likely the primary driver of service wage inflation.
US inflation remains sticky as wage growth in service sectors continue to rise faster than the PCE inflation rate in addition to food and shelter costs
Source: US Bureau of Labour Statistics, data as of 17 November 2022. KKR, data as of 30 November 2022
Therefore, we remain defensive in our overall portfolio positioning for the first quarter of this year.
William Chow – Deputy Group CEO
Mr. William 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. William 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, he 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.
William 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.
As an ex-portfolio manager for ACA Capital Group, Derek oversaw a multi-billion-dollar global fund for a world-renowned sovereign wealth fund and reputable institutional investors 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
Mr. Tay 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, Ek Pon 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
Mr. 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 at Raffles Family Office, Sky 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.