“Fed likely to hike another 25 bp in May”

Macro

US March headline CPI of +0.1% was cooler than consensus estimate of 0.2% and encouraging vs February’s +0.4%. The March FOMC meeting minutes incorporated projections for a mild US recession starting later this year with a recovery over the next 2 years. In addition, March retail sales (-1%) and manufacturing output (-0.5%) were below expectations. However, core CPI remained firm with a month-on-month rise of +0.4% and year-on-year moving back up to +5.6%. In conjunction with the March employment report – which showed still robust payroll growth and a low 3.5% unemployment rate even as other parts of the report signalled some cooling – the data do not make a case for a Fed pause during the May FOMC meeting. Combined with the declining risk of a banking systemic crisis, this has also reduced the severity of a drag from tighter lending conditions. Taken together, in our opinion Fed is likely to hike another 25 bp in May, bringing the funds rate to 5 – 5.25%, followed by an extended pause.

A month after the Credit Suisse Additional Tier 1 write-downs, AT1 securities continue to trade with an elevated premium vs. senior and Tier 2, an indication that the AT1 asset class has likely entered a new, structurally higher premium regime. This is a reasonable reaction from the market demanding significant compensation for the risk that issuers will extend the maturity of their AT1s if the economics of doing so makes sense and largely discounting the reputational impact of not redeeming at the first callable date. Although existing AT1s with upcoming call dates will reset at a significantly higher coupon in the event of non-call, many are priced to call currently. That said, many uncertainties that remain for the asset class will continue to hinder any material reinvigoration of demand and should set the bar to add risk at a much higher level than what is currently being priced. Asian AT1s may be distanced from the epicentre of events but likely to still experience second order impacts from repricing and volatility.

In China, incoming data points to an impressive 1Q23 growth bounce. March total social financing increased 10% year-on-year, vs +9.9% in February and 9.4% in January. March exports surged 14.8% year-on-year with substantial gains to the US and EU, with the 1Q23 trade surplus rising to a record high $205 billion. This suggests the supply chain has recovered and is benefitting from resilient near-term global demand conditions. Meanwhile, inflation remains benign with March CPI +0.7% year-on-year and PPI -2.5%, leaving room for further PBOC policy stimulus in 2Q23 to support growth momentum. The housing market showed further signs of stabilization, as NBS data showed new home prices increased 0.4% month-on-month in March, after rising 0.3% in February, while home prices in the secondary market increased 0.26% month-on-month in March, after rising 0.12% the previous month.

China Inflation Leaves Room For Monetary Policy Stimulus

Source: Bloomberg Finance L.P.

Fixed Income Strategy

Credit spreads have only partially retraced the widening since the March bank failures, while the rates market looks relatively more downbeat. The flip side of sustained high employment levels and core CPI remaining well above stated targets is that the room for rate cuts is fundamentally limited. We expect further room in the near-term for credit spreads to tighten as banking stresses abate and rates to move higher from current levels. From a tactical perspective, we are skewing towards shifting from long end high grade to short end Asian financials where regional banking systems have been resilient and economies are supported by the tailwind from China’s reopening.

Our view is to maintain positions in high quality China developers. March property sales increased +29% year-on-year while divergence continues among the major developers within the sector. SOE backed developers are leading with solid sales growth above the industry average. In contrast, leading private developers’ contracted sales are staying roughly flat or still declining in the 20% range. The tentative recovery in the housing market is benefitting largely the best quality developers, and there is little fundamental justification to shift down the credit spectrum.

Our view is to maintain position in Macau gaming operators. Macau March 2023 gross gaming revenue reached $1.6 bn, +23% month-on-month and +247% year-on-year, exceeding median estimates of +205% year-on-year. The 1Q23 GGR recovery translates to around 65% of pre-pandemic mass-market levels and operators are expected to be EBITDA positive at this rate. Moody’s expects Macau’s mass-segment GGR in 2023 to be around 75% of its 2019 level and fully recover in 2024. At the same time, the rating agency revised its outlook on operators to stable from negative. In the event 1Q23 earnings fail to beat consensus estimates and the sector sells off, we believe that presents an opportunity to increase positions.

Equities Strategies

While we continue to be overweight in defensive sectors for US equities, e.g., consumer staples and healthcare, we also continue to implement shorter-term tactical/swing trades through accumulating or buying quality, high beta US names as investors sector rotate into higher beta names in view of a potential end to rate hikes in the coming months. These may include selected quality technology stocks as well as quality blue-chip financial names that suffered collateral damage from the recent SVB/Credit Suisse saga. We continue to believe that wide-scale contagion in the U.S. and Europe banking system remains distant.

For HK/China, we continue to remain overweight in beneficiaries of the China reopening theme; Chinese airlines, domestic consumption-related, travel-related and F&B-related sectors. We are also skewed towards infrastructure-related names in view of an accommodative policy stance.

Overall, ourinvestment view is to raise or maintain a relatively higher overall Equities exposure for the near term as market will likely continue to price in the possibility of the end of the rate hike cycle leading up to the next Fed meeting.

Research

Moving into April, we are taking a close look at the upcoming Q2 earnings season with a particular focus on the US banking sector. The positive surprise of JP Morgan’s earnings has been a welcome relief to the market given the recent banking turmoil. Strong net-interest-margin income may continue to provide tailwinds to the sector but individual banks’ balance sheet should also be closely scrutinised for any potential weaknesses.

Another major talking point come 2H2023 will be the potential shallow US recession. Recent data has pointed to a slowdown in the labour market, manufacturing and in service activities, further signalling an impending recession should these trends continue in the coming months.

The Conference Board Leading Economic Index (LEI) The LEI is a predictive variable that anticipates (or “leads”) turning points in the business cycle 6-12 months ahead. It comprises of almost all major economic data points including manufacturing; unemployment, building permits, Stock Prices; Credit Index; Interest rate spreads, etc.

Statistically, it is one of the more accurate leading recession indicators for a 6-12month forward looking timeframe. The index threshold is widely regarded as a recession signal when it crosses a value of -4 and below. The latest reading of the LEI as of 28th February 2023 is -7.1. While the rate of month-over-month declines in the LEI have slowed in recently, it still points to the risk of a near term shallow recession in the US economy – unless consumer and business confidence resumes significantly and/or if yield curve are no longer inverted.

Although recessions generally tend to be tougher on risk assets, we are seeing a fundamental change in the economy and businesses today vs pre-2000s. Over the last 10 years, growth has generally outperformed value due to the effects of quantitative easing and overall looser monetary policies. During the most recent recession in 2020, both growth and value fell equally hard before growth greatly outperformed over the next 12 months (until end 2021). Given such a structural shift in the economy, will value continue to remain resilient in a recession or will growth now be of greater focus?

Figure 3 represents the performance of major growth and value ETFs (calculated from their respective recession troughs with a 1-year horizon). It is evident that growth generally outperformed value in the immediate period after a recession.

Historically, Value stocks often outperform growth in “ordinary” recessions because of cheaper valuations and defensive sectors with businesses that tend to hold up well. However, in three of the most recent US recessions (2000-3, 2007-9, 2020), twice, growth stocks have surprisingly outperformed value stocks. Overall, value outperformance tends to be shorter lived (less than 18month on average) vs growth (more than 24 months).

The key difference is that many “growth” companies today have real products, strong revenues, innovation and real earnings on a forward basis, and are likely to continue to gain market share relative to traditional companies. Signs are indeed pointing to a shift back in favor of growth in the mid to long term. With that being said, we still believe that there are still pockets of opportunities within the “value” space, but investors will have to be even more selective in their picks.