“Tapering is here!”

Market Overview:

“Tapering is here! FED has officially announced the start of the tapering process this November 2021 and indicative of ending in mid-2022. Both the magnitude and pace will be what the market will be focusing on in the near term.”

While there is indication that no rate hikes will be on the horizon until the completion of the tapering process, FED has also reiterated that they are closely monitoring inflation data and they will not hesitate to act if necessary.

The Federal Open Market Committee said it would scale back by $15 billion a month starting in November. The market took this positively without much tantrum, seen with the U.S indices testing new highs most recently.

Having said that, treasuries fell, taking 10-year yields up more than 4 bps to almost 1.5% area. The yield on 30-year TIPS fell as much as 7.1 bps to minus 0.508%, a record low, reiterating the inflationary concern from street consensus.

The FED also cautioned that rising prices of risky assets “remain vulnerable to significant declines” if the economy takes a turn for the worst. The king of value investing Warren Buffett is also signaling caution with the soaring stock market. Berkshire Hathaway was a net seller of equities for the fourth straight quarter, a trend not seen in data going back to 2008.

Figure 1: S&P500 index (Source: Bloomberg)

That said, we are now heading into the year end, with seasonality factors such as thinner liquidity, and various headwinds on the horizon such as supply chain bottlenecks, energy crunch, and inflationary pressures, we urge investors to adopt a more conservative approach towards the year end and raise more cash.

Across the Pacific, China is continuing to face uncertainties across its real estate market as more and more companies face defaults over its debt repayments and refinancing risk.

That being said, the situation remains very dynamic and fluid, investors should remain cautious and expect even more volatility towards the end of the year. We continue to recommend a more defensive and ultra-selective portfolio allocation, stock picking in certain sectors will be of utmost importance. Investors may also consider taking advantage of any volatility through the use of tactical trading strategies.

Fixed Income Overview:

U.S tapering will start this month and end by middle of 2022. We anticipate FED Funds rate to be kept 0% – 0.25%, with three to four rate hikes (FOMC dots median at 1% by the end of 2023) by the end of 2023 based on the September 22nd meeting. The 10-yr US Treasury dropped to 1.48% as of 09 November 2021 from 1.64% as of 26 October 2021 and is expected to be around 1.0% to 2.0% for the year of 2021.

The credit default swap (CDS)index for Asia ex-Japan Investment Grade entities rebounded to91 as of 09 November 2021 from84 as of 26 October 2021. Asia IG credit spread rebounded to 139as of 09November 2021 from 126 as of26October 2021.We expect IG bonds credit spreads, except for Chinese issuers, to range bound over the coming months. Asia HY credit spread rebounded to 1207 as of 09 November 2021 from 1043 as of 26 October 2021.We expect sentiment in the HY bond market to remain relatively weak as there continues to be adverse news emerging out of the Chinese market. And this could spill over to the Chinese IG space as well.

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 Sichuan Languang Development, Sunshine 100 China Holdings, Fantasia Holdings, Sinic Holdings, Modern Land China. As the government support weaken, four Chinese AMCs (Huarong, Cinda, Orient & Great Wall) may be downgraded by respective credit rating agencies and their credit spreads may widen.

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 again see value and 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, reduce/control their exposure to highly leveraged BB-rated bonds (Greenland, RiseSun) and all B-rated 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, the purchase yields for 3–5-year low beta IG bonds are at 1-2%, and 3-5-year low beta HY bonds are at 3-5%. Overall, we recommend a balanced and more diversified portfolio of high quality (BB rated) high yield bonds and short duration IG 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:

The on-going earnings season and FED’s accommodative positioning in our opinion, despite starting the tapering process, had continued to push the S&P 500 index to all time high. With rich valuations and seasonality factors, we believe the risk is to the downside.

As we head into the year end, with seasonality factors such as thinner liquidity, and various headwinds on the horizon such as supply chain bottlenecks, energy crunch, and inflationary pressures, we urge investors to adopt a more conservative approach towards the year end and raise more cash.

Furthermore, inflationary pressures affecting both wages and raw materials may continue to remain elevated, and this will likely erode the bottom line of many companies, adding further margin pressures.

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

Despite regulatory headwinds continuing to hover over the Greater Chinese markets, we think that the worse is likely to be priced in, and now we see value starting to emerge in select sectors.

Geographically, we recommend being overweight HK/Greater China vs the US. Still, investors should hold more cash as a buffer and be prepared for a mid-long term investment horizon. We urge investors to stay constructive and selective in terms of stock selection and weigh their risk-and-reward. Volatility will persist, and investors should lean towards a more conservative portfolio.

Our investment strategy stays largely intact. We are overweight “Growth” vs “Value” and prefer sectors such as cybersecurity, consumer discretionary, select technology and healthcare.

It is important that investors adopt a well-diversified and defensive portfolio, reduce any over-exposure towards equities and raise some cash. In short, investors should employ a more back-to-basics stock selection approach and continue to adhere to company fundamentals and strict risk management principles (stop-loss mechanisms and/or appropriate portfolio hedging) to mitigate risks from market swings and uncertainties.