“The equities market is clearly caught between a rock and a hard place”

Macro

The ongoing hawkish tilt by DM central banks (outside Japan) intensified this month as outsized rate hikes were accompanied by guidance for further tightening ahead. Despite slowing GDP growth this year, labour markets continue to tighten with employment gains running well above pre-pandemic norms. And despite anchoring medium-term expectations through the inflation surge as reflected by the inflation indexed bond market, inflationary pressures continue to broaden with core inflation remaining above 6% year-on-year. Against this backdrop, it was not unexpected that Fed projections showed downgrades to GDP growth and higher unemployment while also raising its median policy rate dot to suggest policy rates reaching 4.5% early next year. Until the economy either enters a clear recession or shows sustained signs of progress on inflation, the pressure for tighter monetary conditions is unlikely to abate and periods of relief are unlikely to be sustained. Those still look like the right conditions to wait for, and it is still the case that neither has yet materialized.

The decline in oil since mid-June has taken prices back to levels last seen in early February, before the Russia-Ukraine conflict escalated. Much of the rise in prices was attributed to risk of potential disruptions to global oil supply from the conflict, but as oil supplies have been re-routed to other markets instead, this risk premium has to a great extent unwound. During 4Q22, further downside to oil prices appears limited by a number of factors: 1) after oil balances having been in surplus over 3Q, they are set to shift to a deficit in 4Q; 2) the northern hemisphere winter should experience an increase in oil use for electricity and/or heating to substitute for expensive gas; 3) with the EU embargo on Russian crude from Dec 5th and on oil products from Feb 5th, Russian oil supply may have to fall as not all of the supplies can be re-routed to other markets; and 4) few if any countries outside of the G7 alliance are joining the price cap coalition.

In China, the State Council announced additional fiscal support for manufacturing industries and SMEs, including a CNY 200 bn re-lending quota, which followed a late-August RMB 1 tn (0.8% of GDP) fiscal stimulus package for infrastructure projects. Goods exports missed consensus expectations and declined 4.9% month-on-month in August, likely signaling the headwinds facing the global economy. The property market remains sluggish with August sales down 23% year-on-year. Property completion data in August posted outsized increase of 62% month-on-month on the back of the government’s efforts to prioritize construction and delivery of pre-sold properties after reports of mortgage boycotts mid-year. Policy support remains mainly at the project level and unlikely to solve liquidity problems at the holding company level or flow to offshore bondholders, therefore the risk of further credit events among private developers remains elevated. Outlook for the Macau casino sector improves on scheduled resumption of mainland China tours groups and e-visas from November, with expectations that gross gaming revenues can increase to 20% of pre-pandemic levels from 10% currently.

Fixed Income Strategy

• Since credit may not fully reflect the rise in real yields, the upside appears limited and conditions for a decisive peak in spreads have not been met. With a fresh tightening impulse underway, any further hawkish shocks may see the market shift to growth concerns. Emphasize the importance of prioritizing capital preservation and overweight high quality fixed income in portfolios. Taking modest amounts of credit risk, it is possible for investors to earn close to 5% with minimal duration exposure.
• Position for travel rebound in Hong Kong and Macau. Strong demand and passenger yields on the back of quarantine easing in Hong Kong are expected to boost airline earnings. The return of tour groups to Macau casinos supports operators with mass market gaming focus and non-gaming facilities.
• Position in China real estate SOEs, as market share gravitates towards those that identify as having least project delivery risks. Among POEs, position in operators that generate earnings from stable rental income and management fees from investment properties and are trading at spreads attractive relative to global peers.
• Position in selected European banks vs Asian and US banks with similar capitalization ratios, on the back of attractive relative valuations. Reduce exposure to S$-denominated Singapore bank AT1s on rich valuations.

Equities Strategies:

The Equities market is clearly caught between a rock and hard place where valuations are starting to look attractive if not already attractive depending on which geographic region we are discussing while there are little near term catalysts to justify a rally in global equities for now. Until the economy either enters a clear recession or shows sustained signs of progress on inflation, the pressure for tighter monetary conditions is unlikely to abate and periods of relief are unlikely to be sustained. Those still look like the right conditions to wait for, and it is still the case that neither has yet materialized.

Although a more proactive policy shift can be anticipated in Q4 and Q1’23 after Party meetings in Q4 and Q1’23 in China, expectations for any major economic boost or stimulus post Party meetings in mid-October will likely disappoint as this event is basically to confirm Xi’s leadership rather than a platform for major policy announcements. China is in a difficult position and given the current macro situation domestically, any notable easing of strict Covid containment measures are more probable early next year rather than this.

Despite disappointing and stickier inflation and hawkish Fed actions, we argue that the risk-reward is increasingly skewed towards Global Equities, in particular, Greater China Equities despite the lack of market traction in Equities globally. Although energy, a key component of inflation has come off its highs seen earlier this year, it should remain elevated as the Northern Hemisphere enters the winter season. We encourage investors to gradually accumulate selected sectors on major significant market declines with a preference for Greater China Equities on valuation grounds. However, we like to highlight that any new Equity exposures (including existing exposures if required) should be considered alongside hedges (partial if not full).

Given the numerous uncertainties we currently face, our preferred prudent approach constitutes asset allocation based on several key theme, namely 1) 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 inflation continues to run away.

• 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 Macau Gaming, Sportswear, Auto as well as Airlines.

Consider to heavily hedge 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, 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.