Weekly Market Commentary By H.E.R.O. (10 to 14 May 2021)
Inflation fear engulfed the markets in flames during the week, with heavy losses inflicted upon tech (NYFANG+ index -4%, ARK Innovation ETF -4.9%) to emerging markets (MSCI China -3.1%, extending losses from its mid-Feb highs to more than 20% and entering a bear market, Taiwan TWSE -8.4% in biggest crash in its 54-year history, STI -4.5%, MSCI Asia Pac -3.2%), although losses were pared by Friday’s bounce in the U.S. market (U.S. tech indexes were down over 7% during the week) on dip buying, as inflation worries seem to subside and market narrative settling on the inflation run-up being “transitory” and lacking staying power due to reopening quirks such as used car prices rising 10% which accounted for a large slice of gains in the overall inflation index. Markets have been fixated on widespread signs of price pressures as commodities like copper and lumber, as well as computers chips, surge to records. U.S. core CPI, excluding food and energy prices, rose 0.9% from the prior month, the biggest such increase since 1982. Most of that increase, however, can be attributed to a few categories that collectively account for around 13% of consumer spending in normal times: used cars and trucks, hotels and motels, airfares, motor vehicle insurance, car and truck rental, admissions to live events and museums, and food away from home.
Despite hotter-than-expected U.S. inflation data, commodities had their worst week since October, after Beijing vows to crack down on surging commodity prices, although it did not say how it would cope with the rise in commodity prices. However, fear lingers on in the form of stagflation after U.S. consumer sentiment reading for May unexpectedly dropped back to February’s level, despite the progress on vaccinations and reopening the economy since then, and overall retail sales flat in April, a miss from economists’ forecast of a 0.8% gain, following the big shortfall in job growth reported a week earlier. After the US$1.9 trillion American Rescue Plan that gave most Americans US$1,400 in free money, the outlook for the Biden administration’s wish list of over US$4 trillion in further spending is increasingly uncertain as pushback grows over showering unemployed people with money that disincentivized them from finding work. Bloomberg’s John Authers described the market phenomenon in the reflation/rotational trade into Cyclicals as “clowns with rotating planks”. Risk Parity quant strategies crashed this week (as bonds and stocks fell together) and this was the worst week for RP strategies since March 2020, resulting in unusual wild swings in stocks with many high-quality fundamentals names sold off aggressively.
Confidence in Asia has been hit due to a worsening COVID outbreak from Taiwan to Singapore and MSCI Asia Pacific looked to post its worst monthly performance since March 2020 when markets took the biggest hit from the pandemic. Singapore STI fell 4.5% during the week after saying on Friday that it will return to the lockdown conditions it last imposed a year ago to contain a rising number of untraceable infections. China entered a bear market during the week. China stocks have remained largely range bound after the CSI 300 Index entered a correction in March, accompanied by muted volumes, a sign of weak trading conviction. A Hong Kong gauge tracking Chinese technology stocks has lost more than 30% since a February high. Beijing had pledged to curb the “reckless” push of technology firms into finance and crack down on monopolies online. Alibaba tumbled to the lowest in almost a year after reporting its first quarterly loss since 2012. Meituan slumped 13.7% after its CEO posted a poem seen as critical of Beijing. With more than $100bn of dollar debt borrowed by Chinese companies on international markets coming due this year, global investors are on edge. Last year, Chinese companies defaulted on a record $7.3bn of offshore dollar debt and $22.7bn worth of renminbi-denominated bonds. In 2021, they have missed payments on almost $3.3bn in dollar bonds, or as much as was expected in a full year before the pandemic, and defaulted on 99.8 billion yuan ($15.5 billion) of onshore bonds. While 2021 is set to be the fourth straight year the 100 billion yuan level has been topped, it previously hadn’t happened before September. For all of 2015, when China’s stock market crashed, defaults totaled just 8.9 billion yuan.
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.