Equity

Major “events” in markets have been caused by wrong assumptions over mathematical relationships. The Long Term Capital Management Debacle (LTCMD) in 1998 was primarily the result of the incorrect assumption of perfect markets by a cluster of Nobel Laureates. The naïve and wrong assumptions over correlations proved to be the spectacular undoing of the mortgage markets in 2007-8.

Currently, the US economy is stuttering. Headline growth during the latter half of 2023 was extremely rapid – GDP growth averaged more than twice the economy’s 20-year average - but this strong activity was led by the public sector, either directly through government investment or indirectly via the authorities’ support for household incomes.

In my experience, there is nothing so powerful for asset markets as an “unquantifiable positive story and a tonne of liquidity”. Russell Napier’s Library of Mistakes in Edinburgh looks brilliantly at some of the madness that has taken hold of financial markets over the centuries (well worth a visit if you are ever nearby), and of course Edward Chancellor’s Devil take the Hindmost is the seminal text on the subject of credit-financed investment madness, but I have seen my fair share of mad booms firsthand.

We are heading into a changing world, where the more recent past can no longer be relied on to guide our path forward. But we are not blindfolded. There are tools we can use to provide a greater degree of certainty. Our Future Quality approach is designed to help us identify franchises that are set to endure.

We expect 2024 to be a year of domestic consolidation and long-term reform measures, where markets are driven more by Japan-specific events than by global factors. After decades of deflation, we see Japan as finally breaking out of this cycle in 2024, as it enters a virtuous cycle of price increases and wage hikes.

We believe ASEAN will offer good pockets of growth and quality opportunities, as well as earnings resilience and protection amid some of the prevailing global macro headwinds.

Considering that major tech companies are profitable, cash rich and cannot afford to lose out in the highly competitive AI race, spending on high-end computing and neural networks looks set to continue in 2024. This will likely create a lasting boon to many component suppliers (the so-called picks and shovels of AI) across Asia.

For those willing to brave immediate challenges, we believe China will continue to offer long-term opportunities as the country has been working to become technologically self-sufficient and develop high-end technologies on its own in a more challenging regulatory environment.

We believe that our “New Singapore” narrative focusing on sectors and companies that represent the future of the city-state will remain relevant in 2024. Energy transition has risen to prominence within the New Singapore narrative in addition to data, technology, healthcare, logistics, tourism and food solutions.

Whether for year-end management reasons, or as a result of political considerations, it is a fact that the US Federal Reserve has allowed effective monetary conditions to ease over the last month. The public sector has injected more than $200 billion of liquidity into the financial system. It therefore comes as no surprise that financial markets are booming, yields are tumbling and the dollar is weak, a situation that we expect to continue into year end.

It has been a wild few weeks within debt markets – sharp sell-offs, even sharper rallies, and then a renewed sell off. Movements in equity markets have looked tame by comparison. Bond markets are certainly having to process a lot of conflicting information – inflation, deflation, politics and a mountain of potential issuance next year following what was an amazingly quiet year for debt issuance in 2023.

Over the recent years, there has been a tendency amongst politicians and the media to target the CPI rather than inflation itself, or at least the inflation process. Too often have we heard from policymakers that inflation can be brought down through direct government subsidies or price controls. Subsidies may well have a justifiable social purpose, particularly during times of externalities such as wars but they have no role in controlling inflation. We have even heard that interest rates should not be increased “because they affect mortgage rates and mortgage costs are in the CPI”.

The media is abuzz with stories about the demise of the US Dollar as a reserve currency and the rise of alternatives, such as the proposed new “BRICs” currency. From our perspective, we cannot think of a worse monetary idea than a pan-BRIC currency. It is difficult to conceive a less optimal currency area i.e. one worse than the Euro Area, which has certainly had (and continues to have) its problems.

There was quite simply nothing not to like about the latest US consumer price index data; not only was the headline a good number but so too were most of the internals.

One cannot turn on a financial news programme at present without hearing some talking-head or other discussing the outlook for interest rates, almost as though they are the only thing that matters to markets or the economy. We suspect that the matter to a degree to the latter, and much less to the former than is generally accepted.

As the developed world continues to struggle with inflation and a lack of growth, Asia stands out as the bright spot, with inflation well in check and monetary cycles peaking ahead of the West. Growth in Asia is also expected to outperform the West over the next few years, reversing a decade-long trend of developed world growth outperformance.

Financials, healthcare and energy buck the trend and rise in a down market.

Against a backdrop of a more stable bond market, we prefer relatively higher-yielding Philippine, India and Indonesian government bonds. In addition, there appears to be early signs suggesting that inflationary pressures in these countries have likely peaked, which we see providing further support for these bonds. As for currencies, we expect the Thai baht and Indonesian rupiah to outperform regional peers.

Although recent headline-grabbing events within the banking system have moved the topic of a potential credit crunch centre-stage in the markets’ consciousness, the fact is that a credit crunch within the Global Financial System began a year ago, while that in the US domestic economy began late last year. More recently, Europe looks to have moved down the same path. Admittedly, the global situation did improve during December and early January, when global financial conditions eased for a variety of primarily technical reasons, but this has proved to have been only a false dawn.

Our Gravity Index for China has made only a very modest recovery so far this year.

In a world starved of workers and growth, we believe that Asia’s ability to supply both puts the region on a very firm footing over the longer term. Once we get through this current US-led rate tightening cycle and the flush out of weaker financial institutions in the West, we see a bright future for Asia, which is now trading at extremely attractive valuations.

Bonds have been attracting more attention from investors recently in view of their higher yields and the possibility of capital gains. In addition, as equities have lost their shine for now amid higher interest rates, bonds are expected to continue to benefit from an asset allocation perspective.

Bonds have been attracting more attention from investors recently in view of their higher yields and the possibility of capital gains. In addition, as equities have lost their shine for now amid higher interest rates, bonds are expected to continue to benefit from an asset allocation perspective.

Countries in the region took divergent monetary paths during the month. India and the Philippines raised their respective policy rates, while Indonesia and South Korea maintained their interest rates.

The official GDP growth target of “around 5%” unveiled at China’s annual National People’s Congress was lower than many external forecasts, and fiscal policy looks less accommodative relative to both market expectations and that of 2022. In our view, these conservative targets leave room for outperformance and likely reflect cautiousness over unexpected events and reluctance in overstimulating the economy.

The MSCI AC Asia ex Japan Index slumped 6.8% in US dollar terms, giving up its January gains. China’s reopening and peak interest rates euphoria in January were short-lived as hotter-than-expected economic indicator releases in the US raised the spectre of higher-for-longer interest rates.

Current equity market conditions dictate that you choose your investment attire particularly carefully. In our view, buying profitless technology companies is like going up a Scottish mountain wearing flip-flops. You might get away with it, but the odds are not in your favour. Instead, we prefer the protection afforded by profits (and cash) generated today—not at some unspecified point in the future.

We maintain the view that global inflationary pressures may moderate further. We prefer Singapore, South Korea and Indonesia bonds. As for currencies, we favour the renminbi, the Singapore dollar and the Thai baht.

Asian equities made a strong start to 2023, with the MSCI AC Asia ex Japan Index returning 8.2% in US dollar (USD) terms in January, supported by a rebound in investor sentiment towards China.

Chinese shares outperformed in December as the country continued to move away from its zero-COVID policy while markets in Taiwan and South Korea slumped amid concerns towards the global economy. In ASEAN, Thailand led the region as the country is expected to be one of the biggest beneficiaries of a potential return of Chinese tourists.

We expect global inflation to ease and global growth to weaken in 2023; we also think that the Fed is likely to pause hiking rates by the first quarter of 2023. Against this backdrop, we are broadly constructive on regional bonds as most Asian central banks could be nearing the end of their rate hike cycles.

We are more positive on duration overall, on the assessment that we are likely past peak hawkishness from the Federal Reserve and other developed market central banks. We favour Singapore and South Korean government bonds, given their relatively higher sensitivity to stabilising US Treasury yields.

Asian stocks rebounded strongly in November after Federal Reserve Fed Chair Jerome Powell pointed to slower pace of monetary policy tightening and lifted market sentiment. All Asian markets ended in positive territory, with China in the lead with a month-on-month (MoM) gain of 29.7%.

Although New Zealand’s November 2022 rate hike was larger than expected, markets had been pricing in aggressive tightening for quite some time. This may soften the impact of the current challenges. Given that yields on some bonds are now approaching 6%, we feel that stronger income generation opportunities are also providing a silver lining in the fixed income market.

As we look towards 2023, it is easy to be overwhelmed by the broader permutations of possible outcomes. But things don’t appear so dire in Asia. Inflation, which is effectively a value transfer from net consumers to net producers, may continue to benefit India and pockets of ASEAN due to favourable demographics and rising productivity.

As geopolitical risks and globalisation are reassessed in the wake of the COVID-19 pandemic and war in Europe, we believe that Japan stands to benefit as more companies refocus on their home markets.

Some of the factors that have shaped 2022 look less likely to recur in 2023 (for instance, supply chain duress because of COVID containment) but others will likely last longer (most notably a higher cost of capital). We are cautiously optimistic that less aggressive monetary policy will eventually make 2023 a kinder year for equity markets but there may yet be shocks to overcome.

We expect a moderation of growth, a peak in inflation and a more accommodative monetary policy in 2023. We see this as a positive for Singapore, as we believe a more accommodative policy backdrop will help support continued expansion in corporate earnings growth in 2023.

We believe that the rewards will outweigh the risks related to China amid an existence of enough cyclical, thematic and structural trends that could enable the country to outperform in 2023; particular focus will be on the government’s zero-COVID policy and its support for the property sector.

The ASEAN region fared better on the whole in October thanks to gains by the Philippines and Malaysia; Hong Kong and Taiwan stocks were volatile while the China market continued sliding.

The low for this bear market could be a lot closer at hand now than it was, with equity valuations having fallen considerably. We remain focused upon assessing our companies’ ability to deliver earnings expectations and cash generation. These give us confidence in the long-term, even if shorter-term developments remain volatile.

The recent reporting season showed that New Zealand’s “gentailers” (companies that both generate and sell energy) remain committed to developing renewable generation capacity, with five such projects currently under construction. However, a rise in the cost of developing such capacity in the past 12 months is creating a significant challenge for gentailers.

Rising interest rates and inflation woes continued to weigh on regional and global markets. US consumer prices registered above expectations with the August consumer price index (CPI) jumping 8.3% year-on-year (YoY). The tight labour market made further case for a rate hike, culminating in a 75-basis-point (bps) interest rate hike by the US Federal Reserve (Fed).

The regional index of the MSCI AC Asia ex Japan in August was flat at 0.0% in US dollar terms, recovering after falling into negative territory earlier. The North Asian region was weighed down by foreign currency effects, trailing behind its ASEAN counterpart. India benefitted from its rate hike and lower oil prices.

In an encouraging sign for New Zealand equities, the benchmark NZX 50 Index ended August approximately 10% higher compared to the lows it saw in June, when it dropped below the 11,000 level for the first time in two years. However, the market still faces challenges given that at the end of August the index was also down about 10% compared to the start of 2022.

Our belief is that we have moved into a new regime where inflation will be structurally higher despite the anchors of high debt burdens, ageing societies and ongoing technological disruption.

Higher commodity prices impacted returns in Asia, while a slip in prices of crude oil and metals benefitted many Asian nations. We expect the future trajectory of inflation to dictate the path of interest rates, which in turn is seen determining economic growth globally.

This month we focus on two ESG-linked themes that generate a significant amount of investor interest: carbon neutrality and modern slavery.

As in the rest of the world, times are tough for New Zealand’s economy. Even so, given that stagflation occurs when higher inflation is combined with slower economic growth and rising unemployment, New Zealand is contending with the negative growth and inflationary aspects of stagflation without the accompanying unemployment issues.

Fears of a recession and the US CPI hitting a four-decade high of 8.6% year-on-year in May rippled through various economies. Asian markets took heed from the multiple headwinds in the US, with inflation being a common theme across the region. For the month, the MSCI AC Asia ex Japan Index fell by 4.5% in US dollar terms.