Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
1 August 2023
“The higher-than-expected growth in the US economy in 1H opens the possibility of another rate hike in September”
The annual inflation rate in the US slowed to 3% in June 2023, the lowest since March 2021 and slightly below expectations of 3.1%. The core inflation rate has also dropped to 4.8%, the lowest since October 2021, although slower-than-expected and above the Fed’s preferred rate of 2%. This is largely due to housing inflation for both rented and owner-occupied housing, which is the largest component of the US Bureau of Labor Statistics CPI calculation. However, we remain positive that the US economy is entering a disinflation phase as the rental price index has empirically lagged by about 12 months.
Additionally, the US labour market also remained resilient as initial claims fell by 7,000 from the prior week to 221,000 in the week ending 22 July, sharply below market expectations of 235,000.Consequently, both the total average hourly earnings (AHE) and AHE for production & non-supervisory employees, which are corresponding measures of wage inflation, have risen by 4.7% and 4.4% respectively on a year-on-year basis.
Elevated wage inflation and rising cost of production have inevitably caused the S&P 500 profit margins to decline for 6 straight quarters to 10% in 2Q23 although still above the 10-year median level of 9.39%.
Despite the headwinds, the S&P500’s corporate earnings led by the magnificent 7 have remained resilient as observed by a 2Q23 sales and earnings surprise of 1.94% and 6.01% as of 27 July. Analysts continue to be positive on corporate earnings and are forecasting an increase in EPS and sales per share in Q3 and Q4 which should translate to the normalisation of profit margins in the coming months.
In sum, we hold the view that the Fed is in a conundrum as it reaffirms its commitment to a 2% inflation target while maintaining price stability along with low unemployment as per its core mandate. The higher-than-expected growth in the US economy in 1H opens the possibility of another rate hike in September.
Fixed Income Macro
The July FOMC raised the funds rate target range by 0.25ppt to 5.25%-5.50%, as expected. The post-meeting statement’s description of economic growth was upgraded from “modest” to “moderate” and did not signal a slower pace of hikes at future meetings. However, Chair Powell indicated the FOMC will focus on whether forecasts that inflation will remain low prove correct and previously advocated for a “careful pace” of tightening. If the next several CPI prints continue to be soft, that path will be low enough for the FOMC to justify that it makes sense to slow the pace. Therefore, the FOMC likely remains on hold at the September meeting. Regarding the potential for easing, current market pricing features circa 60 bp of rate cuts over the next 12 months. Expect that the bar for the Fed to ease is high, particularly if the growth outlook is near potential, employment remains robust, and financial conditions have eased further.
For credit, recent data provides investor confidence that bringing inflation down to an acceptable level does not involve recession, and this scenario would imply that credit spreads and treasury yields revert to a more typical negative correlation regime. In the scenario of an on-hold FOMC, core yields will likely remain rangebound to slightly higher, while spreads will likely remain flat to marginally tighter. Conversely, any growth concerns would likely allow the rates component of total returns to act as an offset against wider spreads. In both scenarios, the recently restored negative correlation is expected to persist barring an unexpected re-acceleration of inflation.
In China, the July Politburo meeting stance on fiscal and monetary policies was largely unchanged, indicating low probability of any large-scale stimulus this year. The Politburo promised “counter-cyclical” policy that suggests easing restrictions in the property sector and “resolving” local government debt risks. Having acknowledged that housing is posing economic risks, the government is more likely to relax mortgage policy, including lower downpayment requirement and relaxed mortgage definition to ownership-based from mortgage record-based to stimulate demand while removing home purchase restrictions that facilitates rotation of home demand from low-tier cities to high-tier cities. On local government financing vehicles (LGFVs), more concrete steps are required, with credit stresses in the LGFV sector remaining elevated as evident from delayed bond payments by riskier issuers.
China Mortgage Lending Records First Year-on-Year Drop Since 2013
Source: Bloomberg Finance L.P.
Fixed Income Strategies
Over the next few months, disinflation could become more evident on the back of lower import prices, unclogging of global supply chains and decelerating housing rents. Such relief may be temporary due to a continued tight labour market and companies’ increased willingness to raise prices. It can be challenging to achieve demand reduction without a recession to get price pressures out of the system. Otherwise, inflation is unlikely to fall below 3% on a sustained basis. As a result, there is a risk that the Fed will eventually have to adopt a more hawkish stance, especially if the US economy does not slip into recession later this year. Additionally, with the Bank of Japan adjusting its yield curve control cap to 1% from 0.5% seen as removing an anchor for global bonds, the scope for core yields to decline rapidly is limited. We look to trim rates duration of our bond portfolios.
For credit spreads, August has typically been a negative return month as investors anticipate heavy bond issuance in September. The Bloomberg Asia USD Credit spread is 255 bp currently vs 287 bp at the start of June. Given that spreads have rallied 32 bp over the past two months, there is scope for some widening on valuation alone. One mitigating factor is carry, as attractive all-in yield levels and subsiding interest rate volatility may be supportive for a steady grind in credit spreads. Given the compression in investment grade spreads and the narrowing spread gap between investment grade and high yield, the widest lower rated investment grade segment is an area that still offers some relative value. With many bonds trading at discount, positive convexity in the current environment can be a larger contributor to total returns. We are in favour of shorter dated BBB- segment for better pull-to-par potential.
Relative value in banks vs non-financials remains. Roughly 40 bp of the post-SVB relative widening in spreads vs. non-financials has yet to retrace, leaving room for further relative outperformance of the bank sector. This positive view is underpinned firstly by the sector’s strong fundamentals, given the high proportion of European national champion banks and US money center banks; secondly, by the more supportive supply technicals relative to 2022, where the share of issuance year-to-date has declined to 31% vs 41% in 2022. Underneath the surface, the premium in banks is driven primarily by European banks which trade at a discount vs both broader financials and corporates. We are inclined to increase allocation to both European and US bank senior bonds.
European Bank Sector Offers Excess Spread Premium
Source: Bloomberg Finance L.P.
We continue to maintain our view that the probability of any rate cut this year is low as key macro data such as a slowdown in inflation, strong labour market and consumption are still holding up. Although we continue to favour large-cap and quality growth stocks in the US, it is important to be selective against a backdrop of overbought AI related plays. We recommend to take profit on outperforming stocks, in particular the AI-related beneficiaries and position to buy the dip at more reasonable valuations should a pullback materialise, as well as in defensive and laggard sectors such as consumer staples and healthcare, which offers more attractive risk/reward should the US economy enters into a soft landing in 2H’23.
For HK/China, we continue to remain overweight in beneficiaries of the China reopening theme despite the slower-than-anticipated “reopening” thus far on further potential stimulus from Chinese government in 2H’23 and attractive valuations. We favour Chinese airlines, domestic consumption-related, travel-related and F&B-related sectors. We are also skewed towards infrastructure-related names in view of an accommodative policy stance. These sectors are still trading at attractive valuations and deserve our attention be it from a longer-term fundamental perspective or that of a short-term swing trade. We also continue to be advocates of defensive sectors such as Telecoms and Utilities that provide reasonable dividend yields and valuation upside. That said, the recent announcement of a slew of stimulus though positive for investor sentiment, lacks details to sustain a strong rally that we witness over the last few days. It serves to be prudent to take partial profit on outperforming counters while continue to monitor the market for positive data points that will support a further rally. These data points include but not limited to 1) further stimulus or improvements in the core issue holding back the Chinese economy, ie. the real estate sector and 2) stability or improvement to outlook in industry fundamentals and financials in the upcoming quarterly earnings season and 3) provision of specific details on existing and new stimulus by the Chinese government.
Last but not least, we recommend overall portfolios to remain nimble through tactical swing trades and consider the use of some structured products with downside protection as valuations gets richer.
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 – 16 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 managed 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
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.