Weekly Market Commentary By H.E.R.O. (17 to 21 May 2021)
The crash of cryptocurrencies during the week, partly attributed to China reiterating that their use in transactions is forbidden, spilled over into the overall U.S. and global markets to weaken sentiments, with S&P 500 down -0.4%, NASDAQ +0.3%, MSCI World Index +0.1%, Stoxx +0.4%, DAX +0.1%, FTSE -0.4%, China CSI 300 +0.5% and Shanghai Composite index -0.1%. Notably, Nasdaq 100 was down 4 straight weeks going into the week and narrowly avoided a 5th straight weekly loss with a very slight gain - which would have been the worst streak since 2012. Overnight reverse repo usage has soared during the week above the COVID crisis highs and the fifth highest on record, with banks sending the Fed a clear SOS signal that their balance sheet cannot warehouse any more Fed reserves at current spread levels, spurring some talks that the Fed may begin to taper its $120 billion-a-month quantitative easing by year-end. The Portfolio of Dividend-Yielding Global H.E.R.O. Innovators rallied +4.3% during the week, led by the Nordic and European portfolio stocks on news of continued positive corporate progress, from CPaaS innovator Generic’s very strong 1Q2021 results from significantly larger customers than what it has managed before, leading to higher messaging volume, to Tencent taking a strategic 3.8% stake in Finland’s state-of-the-art independent AAA game studio Remedy Entertainment, commenting that “Tencent has been monitoring Remedy's development for a long time and is convinced of what Remedy's team has achieved”.
The sharp declines in the market’s dark speculative frothy edges and cryptocurrencies has buoyed the fundamentals-driven structural growth quality companies and also helped gold to continue its advance to pare its YTD decline to -1.2% (and -6.4% in SGD since 28 Aug 2020), as investors head back into assets with durable staying power, instead of frenetically chasing around positioning rotational tactical plays. Inflation fears subsided with commodities crumbling for the second straight week, and copper registered its biggest weekly loss since Sept 2020. The short-end term structure for copper has plunged to negative (3-month forward prices below spot) for the first time in a year, suggesting buyers are finally taking a break. The market narrative has also increasingly shifted towards a view in which inflationary pressures would have a negative impact, instead of positive, for Cyclicals, as they have low margins, low pricing power and inflationary cost pressures will kill their earnings. Premier Li Keqiang spoke out this week against high commodity prices, and warned that Beijing will take concrete steps to curb “unreasonably high” prices.
China's credit impulse ominously turned negative in data released during the week: From peak to negative, it only took 7 months this time, compared with 9-10 months in the past, unleashing global deflationary shockwave that is likely to cool off the transitory inflationary fever. Notably, Chinese companies' debt servicing costs are climbing, with US$2.14 trillion of bonds maturing by 2023, 60% more than the value of bonds that came due from 2018 to 2020, and China bonds are under selling and redemption pressure because investors increasingly believe the Chinese government will no longer bail out state-owned enterprises. China’s stock market regulator CSRC commented during the week that it has started an investigation into alleged pump-and-dump price manipulation in the stock market, vowing to crack down on illegal activities to protect the nation’s 180 million mainly retail investors. The probes followed from controversies about rampant stock price manipulation that have been trending on mainland social media in recent weeks. Ye Fei, a hedge fund manager in China, wrote on his Weibo microblog that he had been owed 500,000 yuan in commission promised by sofa exporter ZOY Home Furnishing for helping to prop up the stock’s prices. The asset management units of several Chinese state-owned brokerages including Shenwan Hongyuan Group and Minsheng Securities were also involved, playing the warehousing role of locking up the stocks in their portfolio to facilitate the ramping of prices.
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.