“Aggressive central bank rate rises is abating”

Market Overview:

“Investors will be looking for indications that pressure for even more aggressive central bank rate rises is abating. The hawkish shift by the Federal Reserve has been a drag on equity markets, contributing to a rise in yields this year and thus giving investors less incentive to own riskier stocks. For the anticipated rise in policy rates to moderate, investors will need assurances that inflation is on a consistent downward trend. April’s US consumer price inflation index reading, though above expectations, provided an early indication that such a trend is in sight. We expect moderating demand for goods, which spiked during the pandemic, along with higher bases of price comparison, to lead to lower inflation rates over the remainder of this year. However, markets will likely need more data to feel confident in this outlook.”

Our central scenario is that a recession can be avoided and that corporate earnings will continue to grow in 2022 and 2023. But investors will need to watch consumer confidence, retail sales, and both manufacturing and services sentiment data closely to become convinced of this more positive outlook.

Fixed Income Overview:

5-year treasury notes yield are at the highest level since Sep 2008 in expectation of persistent US inflation prompting fed to tighten policy more aggressively. YTD it has advance 184 basis points. Currently, gap between 30-2Y treasury rates grew to the widest since mid-March.

Figure 1: 5-year treasury notes yield (Source: Bloomberg)

Some thematic plays are considering ultra-short duration bond funds – rates heading higher, avoiding LT maturities, shorten duration of bond holdings to weather the price decline by holding the bonds to maturity to recoup par value. Alternative is to look for big safe perps with near call dates.

We remain cautious to marginal investment graded bonds (BBB-, Baa3) in the possibility of downgrades. For investors with an investment grade bond portfolio mandate, we recommend bonds with BBB+ ratings or higher, and portfolio duration of 2.5 – 3 years.

Overall, with the expectation of rates going higher and more volatility going into year 2022, we continue to recommend a balanced and more diversified portfolio, with short duration (less than 3 years) IG and high quality (BB rated) HY bonds. Although the absolute returns in the fixed income market may be low, it is still advised to maintain a portion of the portfolio in fixed income given the heightened volatility of the markets.

Equities Overview:

After the recent sell-off, the S&P 500 stands around 18% below its January peak. Riskier parts of the market have suffered even more; unprofitable tech, emerging markets, and US small-caps are now close to or below pre-pandemic levels. While we continue to see positives for the market, investor sentiment isn’t likely to turn until we get greater clarity on the 3Rs—rates, recession, and risk. Until then, we favour parts of the market that should outperform in an environment of rising policy rates, slowing growth, and geopolitical uncertainty.

The S&P 500 is on track for a sixth weekly decline as the prospect of central bank tightening, China lockdowns, and the war in Ukraine all added to recession fears. That has left the index down around 18% from the peak hit in January and just 2 percentage points away from the 20% fall that would mark the start of a bear market.

Riskier parts of the market have been suffering even more. The ARK ETF, which tracks unprofitable technology firms, is now 39% below pre-pandemic levels and 70% down from its peak. Even some core indexes are now close to, or even below, pre-pandemic levels. That applies to broad emerging markets, broad developed markets ex-US, and US small- and mid-caps.

The focus in regard to supply chain is what is the data showing on current China 0 policy panning out and it’s to 0. The rise of new cases in Shanghai is slowing down and expected to hit 0 new cases by end May. Thus, the focus would be on Beijing.

Figure 2: Shanghai and Beijing New Cases Data (Source: Bloomberg)

Trading Strategies:
1. Continue to deploy cash on selected names; Buy on significant declines and in staggered tranches as valuations across most major global equities indices are currently trading close to fair value or below fair value.

2. Preference for HK/China equities vs other equity markets from a valuations perspective; Neutral on US Equities (with the recent significant decline, the Nasdaq is currently trading at fair value although risks of further decline exists on the back of larger than expected interest rate hikes in the coming months). That said, investors may selectively begin looking at US tech stocks for undervalued quality names that are oversold

3. Specifically, maintain overweight in Banks (Singapore & US banks) on rate hike cycle theme; Chinese Telcos (defensive with dividend), Autos (in particular EV related themes) remain an attractive multi-year theme and they are beaten down amid current macro-overhang and headwinds, Chinese Infrastructure related themes from more fiscal stimulus and support

4. Continue to employ more tactical short-term trades in order to capture opportunities arising out of ongoing market volatility; overall to reduce or remove leverage in portfolio