Weekly Market Commentary By H.E.R.O. (13 to 17 Dec 2021)

Markets slumped with heightened volatility in a wild week led by a tumble in tech stocks, with a rally on Wednesday reversing on Thursday, following a hawkish Powell pivot announcement on Wednesday to turn off the tap by doubling the taper pace at which it’s scaling back purchases of Treasuries and mortgage-backed securities to US$30 billion a month, putting it on track to conclude the program in early 2022, rather than mid-year as initially planned. The Fed also signaled more aggressive rate hike projections to carry out three quarter-point hikes by the end of 2022. The new forecasts also showed policy makers see another three rate increases in 2023 and two more in 2024. Traders anticipated hawkish turn, expected even worse, and unwound the bearish options which contributed to the late-day rally on Wednesday. Traders also made speculative bets that the economy “can handle” the Fed hikes to combat inflationary pressures without choking off economic growth. Still, big reversals played out over the week as investors tried to get a grip on whether Fed Chair Jerome Powell will be able to engineer a soft landing by taming inflation without choking off growth. While investors initially took solace in Powell’s robust endorsement of the economy, characterizing demand and income as strong, a sense of uneasiness sank in later with a drop in long-dated Treasury yields and a flattening yield curve reviving worries over its continued strength.

On Thursday, the BoE shocked traders by becoming the first major central bank to raise rates, from 0.1% to 0.25%, since the pandemic, as it said inflation was likely to hit 6% in April - three times its target level. The BoE said it had to act now, even as the Omicron coronavirus variant sweeps Britain, with daily coronavirus infections at their highest since the earliest days of the pandemic, and EU warns pandemic could last 2-3 more years. Omicron might yet exacerbate inflationary pressures if it adds to supply chain problems but spending holds up. If things play out badly and demand drops sharply, the US and UK central banks may be forced to change tune, if not to reverse this week’s decisions. Norway's central bank, which had hiked in September on the back of an economic rebound, went ahead with a further rise as expected and said more were likely to follow. Compared to ECB and BOJ, only the BoE is likely to take more than a baby step in trimming the monumental support provided to its economy through the pandemic. That could set the stage for a choppy 2022, with the Fed determined to end its asset purchases as fast as possible and kick off interest rate rises soon after, and others more hesitant to shift so decisively in that direction.

Wilder swings in the markets are more frequent. In the Nasdaq 100, the absolute size of close-to-close moves has been roughly 1.5% a day this month, up or down. That’s three times as great as any December since the Christmas rout of 2018 and almost twice the average move of the last year. Notably, market breath continues to collapse and the rise in main indices have been “completely misleading”, with 10 U.S. megacap stocks such as Tesla accounting for over 65% of the gains for the year, and the Nasdaq YTD gains would shrink to below +5% if the top 5 contributors were excluded, while more than a thousand stocks such as PayPal making 52-week lows on a daily basis, over 80% of the more than 3,000 stocks on the Nasdaq exchange are off at least 10%, and speculative retail meme stocks GameStop, AMC also slumped to multi-month lows. The hugely-popular ARK Innovation ETF has dropped -21.9% year-to-date (+5.2% since 28 Aug 2020) as investors ditched the stay-at-home names that thrived during the lockdowns.

Meanwhile, CEOs and corporate insiders are dumping stock at a far faster rate than seen in recent years, while ramping up selling as their own companies engage in record stock buybacks. In November, insiders unloaded a collective US$15.59 billion - an all-time record. Defaults and impairments are also coming at a faster clip in the US$4 trillion municipal-bond market in a potential warning sign for high-yield investors. Meanwhile, a big inventory cycle may soon unfold as early holiday gift-buying by U.S. consumers reverses and supplies of goods start to leap. Excess inventory-building exists beyond retailers. The BIS warns that building precautionary stockpiles of components by some manufacturers might be exacerbating shortages. This creates a false picture of underlying demand. Parallels were made to the early 1970s when inflation was raging due to huge excess demand created by massive federal outlays for the Vietnam War and Great Society programs, similar to the massive post-pandemic stimulus demand. Double- and triple-ordered inventories were delivered and production cuts to liquidate them fueled the 1973-1975 recession, the deepest since the 1930s.

Overall, the upward shift and acceleration in rate hikes over the next three years is very evident. This was a meaningful escalation. But the longer-run projection for the “terminal rate” is unchanged. The Fed’s governors still believe that rates will never need to go higher than 2.5%, where fed funds peaked in 2019 during the abortive attempt to return rates to normal after the financial crisis. There is still no belief at the Fed that inflationary conditions are “normalizing,” or that we are returning to the kind of pre-2008 world where central bank vigilance against rising prices will once more need to be a fact of life. Instead, there's a hope that inflation can be brought under control with relative ease. The market appears to endorse this, and also to believe that there will be no need for the extra rate hikes in 2023 and 2024 predicted in the dot plot. Another counterpoint to the pessimism was the number released by the Fed that U.S. household net worth has surged US$34.1 trillion since the start of the pandemic to a record US$144.7 trillion. That’s a whopping 31% increase over the six quarters ended September 30. The all-time high for any calendar year before 2020 was US$12.5 trillion in 2019. Thanks to unprecedented fiscal and monetary stimulus from the government and Fed, Americans have built up US$2.7 trillion in excess savings since the start of the pandemic, according to Bloomberg Economics, about triple the normal level.

Asian stocks tested 13-month lows on Friday, as fears about the Omicron variant of the coronavirus, inflation concerns and hawkish pivots by the world's major central banks knocked investor confidence. China stocks sank during the week, with MSCI China -5.8%, Hang Seng -3.4%, Hang Seng Tech -5.7%, China Internet ETF KWEB (in StashAway’s portfolio) -8.4%, after the Biden administration added 34 Chinese targets to its banned-entity list, weighing on sentiment, led by China’s biggest chipmaker and several of its largest biotech & pharmaceutical firms that include Wuxi Biologics, on fears that Washington will slap investment and export sanctions against more companies after Commerce and Treasury added sanctions for drone giant DJI and Chinese biotech firms. Investors in Chinese companies could get hit with another round of restrictions if the U.S. bans biotechs in China from buying American exports—another sign that financial decoupling of the two countries is under way. Besides deteriorating Sino-US relations, China's avalanche of macro data turned out to be a disastrous miss across the board on Tuesday. A spate of defaults -- most notably by Evergrande and Kaisa -- have undermined confidence in China’s economy. Across China, tens of millions of square feet of unfinished apartment buildings -- the legacy of a real estate boom gone awry in 2021 -- are derailing countless dreams of owning a home. The Hong Kong-based US$4 billion BFAM Asian Opportunities Fund was reported to have lost more than 10% in the first 11 months of the year, its first annual loss in its nine-year history, caught out by the sell-off in China real estate credit. The debt-laden developer China Fortune Land Development said it has been unable to get hold of a money manager that it gave US$313 million for investment in hopes of receiving an annual high-yield return of 7%-10% through 2022. Tencent, SoftBank-backed online property agency Beike (KE Holdings) was compared with disgraced Chinese start-up Luckin Coffee by Muddy Waters, which said on Thursday that KE had inflated new home sales by more than 126% and commission revenue by between 77 and 96%. The short seller also said the transaction volume and the number of stores and agents reported to investors had “massive discrepancies”. “Similar to Luckin Coffee, this is a real business with significant amounts of fraud,” the short-seller said in its report. KE’s 1.8 billion yuan (US$282.6 million) acquisition of Zhonghuan Real Estate Agency had served as a way to funnel money to management through a proxy connected to them, according to Muddy Waters.

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.