Weekly Market Commentary By H.E.R.O. (15 to 19 March 2021)
Tech, Commodities/Energy, Financials, Bonds and China/EM all suffered during the week. After Fed’s chair Powell appeared to pull off the impossible balancing act in calming the markets with his ultra-dovish remarks on Wednesday, it all reversed sharply with the 10-year treasury yield spiking up to the new highs of above 1.75%, while the 30-year broke 2.5%, a level that hasn’t been seen since August 2019. Tech stocks plunged subsequently on Thursday by over 3%, led by cloud software stocks (WCLD ETF down -3.6% during the week). An index tracking the performance of long-dated Treasuries had fallen more than 20% from peak to trough. Commodities stocks crashed as well, with oil suffering its worst weekly loss since October, as signs of flagging demand in key markets abruptly halted a speculative rally. Global oil demand won’t return to pre-pandemic levels until 2023, and growth will be subdued thereafter amid new working habits and a shift away from fossil fuels, the International Energy Agency said this week. Inflation is expected to exceed the Fed’s preferred level of 2% to 2.4% in the short-term, although it is expected to drop back in subsequent years. The commodities rout due to weak demand has subtly changed the market narrative at the end of the week increasingly towards the view that the market fears about inflation are overstated, stumbling the haughty how-dare-you-NOT-be-BULLISH-about-the-economy reflation trade, and resulting in weekly losses in the speculative frenzied trade in cyclicals even as yields rose.
Treasury yields remained volatile after Fed killed off the COVID capital relief for banks in an announcement on Friday, which is set to expire at the end of the month. The relief allowed banks to exclude Treasuries and central-bank deposits when measuring the size of their balance sheets relative to the amount of capital they hold for a yardstick known as the Supplementary Leverage Ratio (SLR). The relief meant they could rapidly increase their holdings of Treasuries and reserves without needing more capital as the Fed pumped money into floundering financial markets. There had likely been some selling of Treasuries by some banks in recent weeks as they prepared for the end of the exemption. Bank shares crashed on Friday on worries that ending the exemption will discourage them from making loans, but recovered some grounds to pare the losses. Meanwhile, the speculative frenzied rotation into the economically-sensitive Cyclicals and questionable companies with weak balance sheets are beating those with sturdier accounts by over 20 percentage points so far this quarter, the biggest gap since at least 2006.
In emerging markets, the Bank of Russia increased interest rates for the first time since 2018 and said further hikes are likely after inflation accelerated faster than expected. The move follows big hikes in Brazil and Turkey this week, highlighting how inflation and rising Treasury yields are becoming a problem across emerging markets. In China, record defaults hit weak Chinese firms during the week as Beijing pulls back liquidity, impacting the over-leveraged risky property firms, local government financing vehicles and energy producers. China’s regulators are also cracking down on “unscrupulous housing speculators” buying property with consumer loans. Beijing is also accelerating its crackdown on alternate sources of finance, from small fintechs to Jack Ma’s Ant Group, led by vice-premier Liu He, Xi Jinping’s most trusted economic advisers and the Chinese Communist party’s most powerful financial official. China’s slew of retail investors that piled into mutual funds in the past year are now offloading prized heirlooms as they cope with losses they have suffered under the country’s US$1+ trillion stock market rout. More than 200,000 users have flocked to Chinese online resale platform Xianyu in the past week, seeking to offset losses from their mutual fund investments by putting precious possessions for sale. Losses in the China markets continued during the week with the China CSI 300 index -2.7%, and are expected to correct further, exacerbated by the consequences of a tough U.S.-China relationship following the hostile contentious meeting in Alaska, the first high level meeting of the new Biden administration with Beijing, as both parties traded angry words at each other.
The portfolio stocks remain well-anchored to very strong and powerful fundamentals with clear and visible growth prospects and positive corporate development progress and robust end markets, and are very likely to rebound resiliently from the speculative sentiment-led rotation and frenzied positioning once the 1Q2020 earnings reports start from mid-April onwards, and the current correction is a great opportunity to accumulate existing stocks and potential new companies.
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 who have remained resiliently positive throughout the most extreme ever market rotational change since November 2020, setting the roadmap this year and beyond in a post-pandemic future. 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.