Weekly Market Commentary By H.E.R.O. (7 to 11 Jun 2021)
Markets were mixed during the week, with U.S. edging up (S&P 500 +0.4%) to new highs, while MSCI All World Index is down -0.3% (Hang Seng -0.7%, China CSI -1.1%, MSCI China -1.5%). This week saw U.S. Treasuries 10Y Yields drop 10bps - the biggest weekly drop in a year since last June and the 4th weekly drop in a row, even after data showed inflation accelerated in May at the fastest pace in 13 years since 2008, a contrast to how a much higher-than-expected inflation number last month caused a selloff in stocks, as markets digested that the currently-hot inflation numbers are transitory and fully priced in. The market was overrun with speculation that the reflation trade is now largely finished as "inflation has peaked", an argument which was further bolstered by Friday's drop in the 1Yr and 5-10Yr inflation expectations. In addition, currently-hot inflation had led to a collapse in Americans' buying intentions (6 months from today), as measured by the Conference Board, which had cratered in the biggest one-month drop ever across the 3 major spending categories: homes, automobiles and major household appliances. Still-stagnant Wages and an incredibly disappointing Labor market lend further credibility to the Fed’s “slow-play” stance and the decline in yield forces a positioning-cleanse of the insanely crowded “Short U.S. Treasuries” positioning. The unwillingness of West Virginia Democrat Senator Joe Manchin, part of a bipartisan group, to go for a Democrats-only infrastructure package without any Republicans voting, is also tempering fiscal spending and tax expectations. Big Tech jumped despite a bill introduced by a bipartisan group of House members on Friday which proposed legislation that could force the breakup of tech giants, while banks slumped 2.4% in the week as the frenzied rotation into reopening/ reflation Cyclicals paused. As stimulus-fuelled economic growth and inflation peak in the second half of the year, the market narrative is starting to focus on a slower growth outlook for 2022, and some institutional funds such as T Rowe Price are reported to be selling banks and commodities stocks. Meanwhile, prominent hedge funds were reported to have extended their losses from their short positions in the speculative retail-driven meme stocks, from Melvin Capital (down 44.7% YTD) to Light Street Capital (down 20.1% YTD).
All eyes are on the Fed’s monetary policy meeting on 15-16 June, with discussion focusing on when to begin unwinding its US$120 billion per month purchases of government bonds, though most analysts don't expect a decision before the Fed's annual Jackson Hole conference in August. The Fed's balance sheet had reached US$8 trillion this week for the first time ever - basically a double since the start of the pandemic panic-response. As Fed taper looms, global central banks eye their own exits from stimulus. In April, Canada's central bank became the first among G7 nations to withdraw its pandemic era stimulus and signalled rates could begin to rise in 2022. The Norwegian central bank has already announced plans to raise rates in the third or fourth quarter of 2021, likely making it the first among its G10 peers to increase the cost of borrowing since the pandemic began. New Zealand and South Korea have similarly dropped loud hints that policy tightening is on the agenda as conditions improve.
China has passed a new Data Security Law on Thursday (to take effect on Sept 1) that strengthens oversight of data collection within its borders, broadening authorities' reach to include electric vehicles and factories in a move with repercussions for global enterprises and gives Xi the power to shut down or fine tech companies as part of his drive to wrest control of vast reams of data held by giants like Alibaba and Tencent. What started out as a government crackdown on anticompetitive practices among Chinese internet giants has grown into a broader effort targeting hundreds of apps. China’s cyber regulator accused 105 apps, including short-video and job-recruitment apps, of illegally collecting and using personal data, ordering the companies to fix their problems within three weeks or risk legal action. The directives came days after another 117 apps were told to fix user-data problems. China’s economic planning agency vowed price controls in corn, wheat and pork prices and to keep prices of goods linked to livelihood stable, following the highest PPI since the Lehman collapse. Meanwhile, Shanghai Electric's US$1.4 billion in uncollected bills spook market as the shares of the top Chinese producer of energy equipment with a corporate history tracing to the Qing dynasty in 1902 plunged 16% since the potential losses were disclosed before trading on May 31. The difficulties hitting a core state-owned enterprise controlled by the city of Shanghai shed light on credit risk in China, where the country's uneven recovery from the coronavirus pandemic, tightened credit conditions and other factors are seeing companies fall behind on more bills and debts.
As euphoric traders piled into the trendy Cyclicals, Value Traps, we believe that there is a high probability of downside risk in chasing and catching them at exactly the wrong time after their sharp run-up from being blinded by the fiscal stimulus hopes and vaccine euphoria — the light at the end of the tunnel — and things can turn very nasty suddenly, as markets tend to underestimate how long that tunnel is, and how dangerous that tunnel is. This situation is very vulnerable for cyclicals to degenerate or revert back into its true ugly colors as cheap-gets-cheaper Value Traps once the vaccine euphoria fades or something negative happen on the mass vaccination roll-out or the vaccine does not prevent people from carrying and spreading the virus to others or new mutated virus strains erupt to render the vaccines ineffective. Once the vaccines actually start being administered at scale and the pandemic recedes, a lot of investors are going to wake up to the fact that the global economy is still dogged by a host of thorny problems that both predate and have been exacerbated by the virus. The current unsustainable market euphoria over Cyclicals, Value Traps, Zombies (companies who cannot cover their interest expense with cash from operations) and Vampires (junk-rated corporations with negative EBITDA) has created opportunities for long-term investors in the inexorable rise of a selected group of fundamentals-based structural growth innovators. These winners solve high-value real-world problems to generate visible and vigorous quality earnings growth before and during the pandemic, as well as are poised to enjoy continued healthy demand and staying power in a post-pandemic future when the world recovers painfully and slowly to transition from the Pandemic Health Crisis to the next crisis – the PTSD Post-Pandemic Growth Crisis. Our portfolio companies have shown resilience and scalability during this tumultuous environment and the management continue to make key strategy decision to expand their market leadership in their respective fields. The quiet HE.R.O. innovators have invested wisely in innovations that sharpen their exponential competitive edge for long-term value creation, strengthened their market position in the value chain that supercharged their cashflow dynamics, developed new channels, new markets and new customer base for revenue growth while improving their profitability at a time when most businesses are struggling, and nurtured their human capital and corporate culture to foster innovation and ESG sustainability. While the short-term day-to-day price movement can be volatile, what continues to be crystal clear is that the quiet structural growth H.E.R.O. innovators remain the most visible and vibrant pathway in a foggy, volatile, whipsawing, uncertain market to deliver sustained outperformance with their healthy fundamentals results.