Weekly Market Commentary By H.E.R.O. (14 to 18 Jun 2021)

U.S. markets suffer its worst week in nearly four months after Fed policymakers on Wednesday projected that interest rates would rise twice from record-low levels by the end of 2023, from their earlier forecast of 2024, a signal that the US central bank would act to tame inflation, an unexpected hawkish pivot as traders had previously anticipated the Fed keeping monetary policy ultra-loose. S&P 500 slid -1.9%, Russell 2000 index recorded its heaviest weekly loss since late January, plunging -4.2%, and MSCI All World Index plummeted -2.1%, while China CSI 300 index -2.3% and MSCI China -1.4%. That view came into sharper focus following St Louis Fed president James Bullard said on Friday that the first rate rise could come next year and that he is a "little concerned about housing market froth". Inflation expectations have been dramatically marked down this week as investors digested the latest Fed decision and the shift by Fed policymakers has shaken the speculative reflation/reopening/Cyclicals trade, with financials, energy, commodities and industrials declining sharply, while Big Tech rose with its best week of inflows since September. Tech stocks were also driven up partly by the “quadruple witching” Friday which saw US$818 billion single stock options expiration with trading of shares to replace expiring positions. Copper headed for its worst week since the start of the pandemic on the Fed’s hawkish turn and Beijing’s decision to release some of its strategic reserves of metals to help rein in prices, which dealt dual blows to the outlook for demand.

The yield on the benchmark 10-year US Treasury bond fell to 145 bps, and there was a violent flattening of the 5-year to 30-year Treasury yield curve, which narrowed by the most since 2011 on a weekly basis, and the yield on the two-year note was hovering the highest level in a year, as investors have come to view leaps in US inflation as temporary. The dollar jumped 1.9% in its best week since April 2020 as yields on short-term Treasuries rose, pricing in future expected rate rises, cutting sharply into gold which slumped -6% in its largest weekly fall since March 2020 and the euro had its biggest tumble since April 2020. Market consensus now is that the Fed’s hawkish pivot is a major buzzkill for gold bulls that could see some momentum selling over the short-term. Short-term Treasury yields will continue to rise and that should provide some underlying support for the dollar, which will keep commodities vulnerable. Traders are also bracing for next Friday’s annual Russell index rebalancing with pandemic imprint and trillions of dollars in investments could be influenced by the event. The U.S. retail-sales report for May indicates that the stimulus-fueled bounce earlier this year is dissipating. Retail sales fell 1.3% month over month, disappointing expectations of a more muted 0.8% M/M decline. Market sentiments continue to be weighed by growing fear that the Delta variant will become dominant COVID strain worldwide as WHO says it’s now in 74 countries, which prompted Boris Johnson to delay the UK’s planned reopening for another four weeks.

Meanwhile in Asia, China stepped up its crackdown on shadow banking, taking aim at more than $1 trillion of opaque investments sold by banks as low risk and high yield, even while funds were channeled to riskier borrowers such as developers. Banks and wealth mangers can no longer use money invested in so-called cash management products to buy long-term debt or bonds rated below AA+. An estimated 2.5 trillion yuan (US$390.5 billion) of the products are currently invested in assets that will soon become non-compliant, and need to be swapped for lower-yielding, high quality investments by the end of next year. Banks are also doing away with products that offer guaranteed returns to tamp down on a key source of leverage and risk at the nation’s lenders. As WMPs shift to NAV-based models, the likelihood of investors seeing more frequent and bigger losses is increasing. Shares of China’s property developers, which count cash management products as a funding source, slumped on the news. There are growing fears that China’s most indebted property developer Evergrande, which owed US$104.1 billion at the end of last year, could collapse like HNA Group, after Liaoning government spoke to the developer about introducing state capital into a regional bank to dilute Evergrande’s controlling stake to prevent the abuse of Evergrande from leveraging its bank affiliate to get loans. China hog futures plunge to record lows on pork glut during the week. Wholesale pork prices in China have dropped almost 50% this year and the plunging prices are triggering farmers to race to slaughter their herds before prices head lower - adding to oversupply fears. Biden issued a new executive order on June 9 to safeguard Americans’ sensitive data, which would could result in Chinese apps to face subpoenas or bans. Mainlanders’ purchases of Hong Kong stocks have slumped by more than 90% this month, compared with the volumes in the past two months, as daily inflows averaged HK$194 million (US$25 million) in June, compared with HK$2.5 billion in April and HK$2.6 billion per day in May.

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.