Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
28 February 2023
“Incoming economic data points to further hawkish implications, increasing risks that the Fed will need to tighten for longer”
The latest boost to US bond yields came from stronger-than-expected retail sales and PMI indicators, following the surprisingly robust payrolls growth and sharp rebound in services sector business confidence in January. The series of strong data points to a resilient consumer-driven US economy, challenging expectations for a 1H23 recession, despite weakness in the manufacturing and housing sectors. Moreover, the latest FOMC minutes noted that “a number of participants observed that financial conditions eased in recent months, which some noted could necessitate a tighter stance of monetary policy.” The PCE Core inflation prints of 0.6% month-on-month, 4.7% year-on-year well exceeds the central bank’s tolerance. Taken together, it is logical to extend the timeframe several months for the onset of any US recession and meaningful disinflation.
Risks of higher policy rates for longer saw an end to credit spread compression 2 weeks ago, as most major credit indices widened for the first time in over a month. The Bloomberg Asia USD Credit spread widened modestly by 10 bp to 266 bp and the 14 bp rise in UST yields pulled total return down by 1.0%. Spreads, currently very near their pre-pandemic level and below the 12-month average of 335 bp, factor in an optimistic scenario as the tailwinds from a more sanguine macro-outlook seem to have been mostly reflected during the compression over the past months. The relative tightness in spreads is to some extent offset by the higher yields, which are generally near the wider end of the past decade. The technical backdrop turned somewhat less supportive given primary issuance ramping up ($28 billion YTD) and slowing EM bond fund inflows on the month.
In China, economic data has been mixed. In January, total social financing was RMB 5.98 bn, exceeding consensus estimates of RMB 5.4 bn. This was driven by the corporate sector, which accounted for 95% of new loans compared to 84% year-on-year, as the recovery of industrial production and acceleration of infrastructure projects stimulates demand for corporate loans. In contrast, exports, car sales and housing transactions remained weak since the start of the year. This aligns with loans to households remaining subdued in January, decreasing RMB 586 bn year-on-year. Meanwhile, there are early signs that the housing market is bottoming with the decline in transaction volumes moderating and new home prices staying flat month-on-month in January after falling for 11 consecutive months. The market is watching for potential further support measures during the National People’s Congress commencing 5th March.
Fixed Income Strategy
Despite circa +50 bp repricing of forward Fed fund rates in the last 2 weeks, incoming economic data points to further hawkish implications, increasing risks that the Fed will need to tighten for longer; some Fed officials have raised the possibility that the FOMC might shift back to 50bp increments for tightening. With bond yields at 95th percentile but investment grade credit spreads at 25th percentile over a decade, yields matter more currently terms of absolute value whereas spreads appear relatively expensive. When lower volatility assets such as short-dated USD bonds and cash offer higher yields than longer-dated bonds, maintain lower duration and credit risks and position in cash or T-bills.
Maintain position in Macau gaming operators. After easing most travel restrictions for inbound travellers from mainland China, Hong Kong and Taiwan, Macau registered January visitor arrivals +101% year-on-year and +259% month-on-month, which was attributable to Lunar New Year holidays but also indicative of pent-up demand. In February, although visitor arrivals are likely to be lower relative to the holiday surge, gross gaming revenue is projected at circa 45% of pre-pandemic levels. S&P forecasts earlier earnings breakeven, which could lead to faster credit metrics improvement and lifting of the negative rating outlooks. In the meantime, some issues offer reasonable yield cushion against market volatility.
Macau Gross Gaming Revenue Recovery Is Getting Started
Source: Bloomberg Finance L.P.
Position in shorter dated South Korea corporates. The underperformance of Korea spreads due to liquidity concerns could abate as the Bank of Korea appears nearly at the end of its tightening cycle. Moreover, South Korea exports to mainland China this year may benefit given Korea’s historical sensitivity to mainland China’s business cycle. Some Korea issuers are among the highest rated credits in the corporates space, with opportunities yielding 5% or more for moderate duration.
Trim high yield positions on a tactical basis. Valuation-wise, spreads are well below long-term average while the overall spread basis between IG and HY has fallen significantly over the past several months. The supply-demand balance is less favourable than until several weeks ago and may not help keep spreads at current levels. A potential increase in rate volatility could trigger additional decompression in this sector.
Given the run higher in the equities market since the end of last year was largely based on hopes that the terminal rate would remain just below 5% and rate cuts by the US Fed would occur at some point in the second half of this year, stocks have given up some of the recent gains. Depending on the key measures of inflation (PCE and employment data) declining to a reasonable level deemed acceptable to the US Fed, the overhang on Global Equities, in particular US and European Equities (due to the lack of positive catalysts and relatively higher valuations), may continue to weigh on overall market sentiment. We are more inclined to add exposure in HK/China and also the US (albeit lower down the order to HK/China) versus the other regions.
Therefore, we recommend to overweight in defensive positions for US equities, e.g., consumer staples and healthcare. Look to underweight in US consumer discretionary as the sector is most sensitive to further interest rate increases while consumer sentiment is not improving.
Take partial profit on Chinese telecommunications companies (as valuations run higher) and keep remaining balance for dividends and defensive play. Remain Overweight in Chinese airlines, domestic consumption-related, travel-related and F&B-related sectors, which shall continue to benefit from the earlier than expected China re-opening in the near- to mid-term.
The Eurozone beat economists’ expectations of a -0.1% GDP contraction and instead grew by 0.1% in Q4 2022. Similarly, the UK reported a 0% growth in Q4 2022 after experiencing a -2% contraction in Q3. Both the Eurozone and the UK demonstrated resilience against the ongoing energy crisis by narrowly avoiding a technical recession in 2022. However, we note that major Eurozone economies including Germany and Italy contracted by 0.2% and 0.1% respectively.
Evidently, the Eurozone’s Manufacturing PMI rose to a five-month high level of 48.8 in January, above expectations of 48.5. This, however, falls slightly below the 50-threshold level of contractionary territory. The Eurozone’s headline inflation has also seen its peak – reaching an all-time high of 10.6% in October last year – and has since moderated for 3 consecutive months. The decline has been attributed to falling energy prices below pre-war levels because of a relatively warmer winter. Energy prices are expected to cool further as LNG imports rise to record levels with the resumption of shipments and flow from Norway by US LNG exporter Freeport. On the other hand, labour markets have strengthened as unemployment rates fall to an all-time low of 6.6% in December 2022. This will likely spur wage growth and add pressure on service wage inflation.
Given that energy prices are still above median levels and core inflation appears sticky, the ECB has remained hawkish and pledged to stay the course in rising interest rates significantly. This has brought eurozone interest rates out of the negative territory for the first time since 2014. Following in the footsteps of the US, the ECB will also begin reducing its 5 trillion-euro balance sheet by 15 billion euros per month. We expect monetary tightening to weigh on business activities and exert a drag on investments.
To navigate the uncertainty, we have identified our bull, base and bear cases for the Eurozone inflation and growth outlook and our respective responses to mitigate risks.
In our base case, we expect the Eurozone to enter a short and shallow recession. In this scenario, we expect core inflation to moderate at above-median levels given of falling energy prices. Domestic demand will weaken in the short term but remain resilient to a new norm of elevated inflation and interest rates. We thus recommend a defensive exposure via a European equity fund, performing covered call options on existing European equities to earn coupons during this recovery phase or allocating into EUR-domiciled investment grade fixed income for investors without leverage.
We enter our bull case in the unlikely scenario where core inflation significantly decreases as energy prices fall below median levels and the labour market continues to remain resilient. We will then expect the Eurozone to avoid a recession against the backdrop of strong domestic consumption in addition to external demand from China’s strong reopening. Given the catalyst for potential upside, we would recommend an overweight into consumer discretionary sector equities. Luxury brands including LVMH and Hermes will likely continue to outperform albeit they have a more global consumer base.
In our bear case, we caution against a potential surprise upside in core inflation as prolonged low unemployment rates fuel further wage growth in service sectors. This is coupled with global inflationary pressures from China’s strong reopening. The escalation of the Ukraine-Russia War may also aggravate energy prices. Considering these factors, the ECB is pressured to continue hiking rates to alleviate the entrenched pricing pressures – tilting the Eurozone into a longer and deeper recession. We thus recommend taking profits (if any) from European equity positions given the downsides and/or short EURSGD as a form of a currency hedge.
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.