Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
17 October 2023
“Pressure erupts in the middle-east while recent data continues affirming the strength of the US economy”
Today, we aim to provide a comprehensive market outlook commentary and scenario analysis to assess the potential outcomes of this geopolitical event.
On 7 October, Palestinian militant groups led by Hamas initiated an attack against Israel, prompting retaliatory actions by Israel, including threats of a ground invasion in Gaza. Our base case scenario suggests that the conflict will remain contained between Israel and Hamas similar to past occurrences. The initial spike in global oil prices, subsequently retraced, was a result of speculation about potential disruptions in Middle Eastern energy production if neighbouring nations were to take sides in the conflict. In our bear case scenario, an expansion of the conflict across the region, affecting major oil producers like Saudi Arabia, Iraq, and Iran, could severely impact oil production and elevate global inflation, adversely affecting risk assets. Safe haven assets such as US Treasuries, the US dollar, and gold might benefit in this scenario. In our bull case, the least likely outcome, a two-state solution involving an independent Palestine and Israel would require extensive discussions, which have historically failed.
Although Israel and Gaza are not significant oil producers, market concerns of broader regional instability led to an initial spike in oil prices. Key players to watch include the USA, Iran, and Saudi Arabia. The US, being an ally of Israel, has moved military assets to the eastern Mediterranean and signalled possible sanctions in response to the conflict. President Biden’s planned visit to Israel adds to the diplomatic efforts. Hezbollah, a militant group based in Lebanon and an ally of Hamas, reportedly backed by Iran, has launched small-scale attacks on Israel. Saudi Arabia, despite recent diplomatic talks with Israel facilitated by the US, suspended normalisation discussions due to the conflict.
While some similarities exist, such as elevated inflation figures, the current environment differs significantly from the 1973-1975 Oil Embargo Recession. In the 1970s, the US was heavily reliant on oil imports (> 40%), leading to the severe impact of the OPEC oil embargo. However, the present-day scenario involves lower oil dependency, increased domestic production, and a transition towards renewable energy. Thus, while an oil supply shock could still affect the US economy, its impact is expected to be less pronounced.
The chart above illustrates the returns of various safe haven assets during previous Middle East conflicts. As anticipated, inflation-adjusted oil prices exhibit the most significant volatility. The US dollar, 10-year yields, and gold also experience short-term upward movements, but these effects tend to be transient as economies adapt to the situation.
Looking ahead, our assessment indicates that the Israel-Hamas conflict will likely dissipate over the medium to long term. However, we anticipate higher core inflation data in the coming months, particularly if oil prices remain elevated, potentially leading to a more hawkish stance by the Federal Reserve. Increased market volatility may present investment opportunities as well.
As with any geopolitical event, it is essential to stay vigilant, monitor developments closely, and adapt your investment strategies accordingly. Market conditions are dynamic, and our analysis is subject to change as new information becomes available.
Fixed Income Macro
Recent data continues affirming the strength of the US economy. The composite PMI and ISM services both indicate growth momentum is intact. The September payroll number was much stronger than consensus estimates, with 338,000 jobs added month and net upward revisions of 119,000 to earlier figures. Other reports showed a jump in job openings in August from an already-high July reading and low levels of jobless claims filings in very recent weeks. While September core CPI at 4.1% year-on-year shows inflation moderating following a 4.3% print for August, core services prices at 0.6% month-on-month, the largest monthly gain since February, likely will cause discomfort for a Fed that wants to ensure inflation is on track toward its target on a sustained basis. Another driver of the surge in yields is the wider US fiscal deficit, which the Congressional Budget Office projects at 6% of GDP this year and similar shortfalls persisting throughout the decade. While financing risks in the Treasury market are low currently, the fiscal path means larger bond issuances over coming quarters at least.
US Is Forecast to Run Persistently Large Fiscal Deficits
Source: Bloomberg Finance L.P.
Global credit spreads widened over the past two weeks, roughly +10 bp and 45 bp in the IG and HY markets respectively. Beneath the surface, US banks have been a notable underperformer, as the magnitude of the move higher in rates has reignited concerns of a potential resurgence of stress in the sector. Asia credit relatively outperformed during the period, with the Asia USD Credit spread remaining broadly unchanged at 246 bp. This is despite continuing outflows from EM hard currency bond funds at $1.9 billion October month-to-date and $3.2 billion in September. The outperformance can perhaps be attributed to the supportive technical backdrop in the primary market given that Asia credit supply year-to-date of $87 billion is 32% lower than the same period last year.
In China, recent Golden Week holiday consumer and tourism expenditure of RMB 753 billion is on par with 2019 levels for the same period albeit undershooting government forecasts of RMB 782 billion. This suggests the services recovery is tentative amidst the incremental policy easing actions that have been announced since mid-August (demand-side easing measures in the housing market, the PBOC’s rate cut and RRR cut, accelerated issuance of special local government bonds). A key risk to the economy remains the property sector. The easing measures to date are yet to show evidence of significantly boosted new property sales. Given the close link between property and consumption, more policy measures are probably needed to stabilize the property market and to facilitate further increases in consumer expenditure. Such further measures could include product-specific consumption support, further relaxation of administrative controls in the housing market, or potentially even support for surviving property developers.
Fixed Income Strategies
US Treasury yields have increased 6-20 bp October month-to-date despite recent Fed comments that financial conditions tightening through higher bond yields may substitute for further policy rate increases. This is occurring against a backdrop of economic resilience and reacceleration of core inflation, reinforcing the need to maintain the policy rate to be sufficiently restrictive which the market is probably underpricing. On the widening US fiscal deficit, markets will seek more premium for the expected higher debt issuance which probably keeps longer dated yields elevated. Shorter dated yields may be topping out on potential catalysts such as a stretch of soft economic data, rising pressures in other growth-sensitive assets, or even financial stability concerns. Overall, the front end of the curve offers relatively most attractive levels.
The spread differential between US banks and the rest of the IG universe is approaching the March wides. As in the case of SVB, there are concerns around bond portfolios being sold to raise liquidity and duration-related losses being realized as a result, impacting profitability and capital levels. Banks’ capital and liquidity ratios are also under pressure from the current regulatory agenda to increase capital requirements. Beyond the ensuing headwinds for profitability, the outlook for banks’ balance sheet credit quality is challenging for their borrowers who must navigate a combination of higher funding costs and slower earnings growth. For European banks, while EUR yields have also risen circa 50 bp since end 2Q, they appear better placed as the average size of securities portfolios as a percentage of deposits is around 2/3rd of US peers. We are inclined to reduce positioning in US banks relative to European banks with smaller securities portfolios and higher capital ratios.
Macau visitation numbers for the autumn Golden Week period suggest that the gaming sector remains on an improving credit trend. Average daily visitor arrivals during the period increased 3.7x year-on-year to nearly 84% of the corresponding level in 2019. The average hotel occupancy rate reached 87.9% while the average room rate was up 61.7% vs the same holiday period in 2022. The latest numbers should be in line with investor expectations, given most operators have already turned positive free cash flow without any major capital expenditures. Meanwhile, sector spreads have widened circa 40 bp since end-August. Taken together, the recent widening in credit spreads is driven less by fundamentals and more by technicals, as fund outflows compel some managers to reduce positions. The improved valuations present attractive entry points currently.
As previously reiterated, we recommend to gradually accumulate on any material market dips at more reasonable valuations in selected technology counters as well as in defensive and laggard sectors such as consumer staples and healthcare in the US, which offers more attractive risk/reward should the US economy enters into a soft landing in 2024 and in view of the strong YTD run-up in the US technology sector in general. In addition, the energy and defensive sectors could also serve as attractive hedging options if the conflict in the Middle East escalates.
For HK/China, we are and still remain cautious of the inadequacies of the policies and smaller scale stimulus implemented thus far to revive the economy. Nevertheless, we note that the real estate sector is showing initial signs of stabilization as the conscientious efforts of the Chinese government lift hopes that they stand ready to provide the necessary relief/support should the economy continue to deteriorate. We believe the Chinese government will likely continue to monitor the outcomes of these implemented measures for some time before any major step-up in stimulus, if any, is considered. Hence, we are of the opinion that any further significant stimulus, if materialize, will likely come later rather than sooner. Against these backdrops, we recommend investors to consider gradually adding some selected Equities exposure in HK/China in a staggered approach on significant market pullbacks while patiently awaiting 1) signs of recovery in the Chinese economy as a result of the current slew of smaller scale stimulus implemented or 2) further major stimulus, in particular those targeted at the real estate sector, that could revive slowing growth and market sentiment. Furthermore, we recommend a significant portion of these selected HK/China Equities exposure to be gained through Index ETFs rather than individual securities in order to mitigate market and P&L volatility and in the worst case, if further major stimulus fails to materialize.
Our preferred sectors are Technology, EV-related and Travel-related industries. We are also inclined towards infrastructure-related names in view of a potential accommodative policy stance. These sectors are trading at attractive valuations, 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 with decent valuation upside. While we continue to monitor key data points, in particular those that could lift the real economy, market sentiment and hence a rebound in Equities, we reiterate that portfolios should stay nimble and diversified. Overall Equities exposure should remain moderate to low as year-end looms with increasing geo-political tensions and as most of the concerns that plagued global Equities throughout the year still linger.
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.