“War in Ukraine – the decision on whether to ban Russian energy exports”

Market Overview:

“The US and European allies are in talks to ban Russian exports of oil and gas, the sanctions targeting Russia’s energy exports will have a direct impact on the energy supply for Europe; affecting inflation and growth.”

Commodities prices to remain volatile, an embargo on Russian energy export – expect oil price to spike higher. Even with the potential deal to lifts sanctions on Iranian oil, it can only partly cushion the blow. Gold prices soar past USD2,000/oz, revisiting 2020’s high.

Figure 1: FOMC Dot Plot (Source: Bloomberg)

Since the start of the Russian-Ukraine war,10Y US Treasuries, commodities Oil and Gold prices have been driven up. Two important scenarios to look out for is the aggressiveness of US rate hikes and the negotiation between Russia and Ukraine. With all the sanctions against Russia, the war may come to an end sooner than expected as funding runs dry.

The decision to ban Russia’s energy exports is key and has a direct impact on global economic growth. Implications: Commodities (Oil and Gold) prices to further surge, escalate stagflation risks. Fed normalization could be cut short and ECB may delay EQ exit.

We maintain the biases of global monetary leaning towards tighter conditions. As we countdown to the Fed first rate hike in March, the increased uncertainty will keep financial markets volatile in the near-term, especially in risk assets including growth stocks. We urge investors to adopt a more conservative approach, maintain higher cash levels and be highly selective in their investments.

Fixed Income Overview:

We anticipate FED Funds rate to be kept 0% – 0.25% and probably 0.50%, with at least three rate hikes each in 2022 and 2023 (FOMC dot plot median at 1.6% by the end of 2023) based on the16th December 2021 meeting. According to Fed Funds Futures, the first rate hike would be Mar 2022.

The CDS index for Asia ex-Japan Investment Grade entities surged to 124.5 as at 07 Mar 2022 from 101 as at 22 Feb 2022.

Asia IG credit spread rebounded to 128 as at 8 Feb 2022 from 126 as at 18 Jan 2022.

Asia HY credit spread dropped to 891 as at 8 Feb 2022 from 1036 as at 18 Jan 2022.

10-yr Treasury dropped to 1.74% as at 07 Mar 2022 from 1.85% as at 22 Feb 2022 (expect to be around 1.5% to 2.5% for the year of 2022)

We expect sentiment in the HY bond market to remain relatively muted to range despite the recent injection of capital of approximate USD 6.5 billion by various Chinese financial institutions to Huarong, aiding it to serve its debts and prevent a debt default.

Figure 2: CDS Asia ex-Japan Index 1-year Chart (Source: Bloomberg)

Highly leveraged HY bonds (B rated) may face refinancing/default risks – several onshore/offshore bonds have defaulted recently including bonds issued by Sunshine 100 China Holdings, Fantasia Holdings, Sinic Holdings, Modern Land China, Evergrande, Kaisa, China Aoyuan. Evergrande also announced on 3 Dec 2021 that it planned to “actively engage” with offshore creditors on a restructuring plan.

We caution investors holding marginal investment graded bonds (BBB-, Baa3) to be wary 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.

We recommend investors to stick to short dated high quality (BB Rated) High Yield bonds (ex-China)with a duration of less than 3 years and be prepared to hold the bonds to maturity. At the same time, it is suggested to reduce / control portfolio exposure in high leverage BB-rating & all B-rating Chinese real estate bonds. Geographically, we are overweight Emerging Markets’ bonds (Investment Grade and High Yield with BB ratings excluding China) and neutral on Developed Markets and Chinese bonds.

Further, we recommend investors to match their exposure of high-beta bonds such as: CoCo Bonds, Perpetuals, and high yield bonds to their respective risk appetites. It is also recommended for investors to hold a more diversified fixed income portfolio and to reduce leverage of portfolios due to various uncertainties across sectors. We advise investors to dive deeper into the issuer’s stand-alone fundamentals to ensure the strength of the company.

We recommend investors to continue to monitor low beta bonds. For reference, purchase yields (3-5 year low beta IG bonds: 2.0% – 3.0%; 3-5 year low beta HY bonds: 4.5% – 6.5%). Overall, with the expectation of rates going higher and more volatility going into year 2022, we 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:

With the biases of global monetary leaning towards tighter conditions in 2022,expect risk of sharp volatility in risky assets at least into the first quarter of 2022.

Despite the belief that interest rate hikes are generally negative for Equities, we believe it will be the speed, frequency and magnitude of the upcoming Fed rate hikes that will, to a large extent, dictate the direction and volatility of global Equities market throughout this year. Fed indicated to begin to hike rates in March and 50bps could be a possibility.

The global Equities market have pulled back significantly as anticipated, in particular, the Nasdaq (growth stocks in the US) in view of the relatively rich valuations vs other Global Equity markets as well as the looming interest rate hike cycle in 1H’22 that will likely have a greater negative impact on growth stocks.

US Inflation is expected to test new highs at levels around 9% and inflation is rising rapidly around the world amid escalation of Russia-Ukraine war with little signs of easing in the near term.

Fortunately, the US FED has been providing sufficient clarity with regards to their intentions in relation to monetary policies thus far, specifically on how they have been managing market’s expectations. Henceforth, we remain constructive on Global Equities for the mid-longer term despite anticipating further possible near-term volatility arising from the initial rate hike in the earlier half of this year alongside the Russian-Ukraine war.

With various headwinds on the horizon, we urge investors to adopt a more conservative approach prior to the initial Interest rate hike anticipated to materialize in the earlier half of this year and stay over weight selective blue chips and maintain higher levels of cash to mitigate the risks of excessive volatility. Nevertheless, we believe investors should be buying the dips during this pullback due to the Ukraine-Russia war.

Year To Date, the Nasdaq, S&P500 and Dow Jones Industrial Average declined 18.6%, 11.6% and 10.5% respectively, CSI300 and Nikkei declined 11.4% and 12.4% and the HSI -10.2% from positive 2 weeks ago.

Figure 3: 1-Year chart comparing S&P 500 Index and Hang Seng Index (Source: Bloomberg)

Geographically, we continued to prefer towards HK/Greater China Equities vs US and Europe Equities heading into 2022, mainly because of the valuation perspective (HSI trading below book value again: current P/B 0.87X). The recommendation would be to stay more defensive initially by holding more cash prior to the initial rate hike by the US FED and await better buying opportunities on the anticipated pullbacks during the same period. Further pullback in US stocks, in particular Nasdaq tech stocks are anticipated.

Overall, we favor Cyclicals over Growth stocks. although the preference gap is closing as tech stocks pullback further from the recent geo-political tensions. Fundamental bottom stock picking is crucial even within favoured sectors. Regulation on Chinese tech continues. Buying opportunities for Equities are emerging globally. Specifically, maintain overweight in Banks (Singapore, China & US), Chinese Autos (in particular EV related themes), Alternative Energy. Begin to increase allocation to (i) US and Chinese Technology sector and (ii) Chinese Consumer stocks. Buy the dip in phases on further decline in the coming week as valuation starts to become more reasonable. Sectors to be avoided for now include Chinese Property (regulation overhang), Oil & Gas (currently rich valuations).

It is important that investors adopt a well-diversified portfolio overall. Stay nimble and defensive by employing more tactical trading while mitigating anticipated volatility with a major overweight in selective blue chips. Maintain higher levels of cash (30% – 50%) todo more tactical short-term trades to capture opportunities arising out of ongoing market volatility, as well as to remain defensive against a volatile market backdrop.