Weekly Market Commentary By H.E.R.O. (19 to 23 July 2021)

U.S. markets stormed to new highs during the topsy-turvy week with one of the worst-ever market breath, overcoming a sharp sell-off on Monday and the biggest U.S. equity fund outflow in six weeks, while Asia and China stocks languished, with MSCI ACWI All World Index +1.4%, Topix -1.4%, TWSE -1.8%, MSCI China -0.6%, Hang Seng Tech ETF -5.1%, Tencent -5.9%, Keppel DC -1.9%, Phillip S-REITS -1.3%. “Growth” and Cyclical/”Value” stocks seesawed for much of the week as market participants weighed spiking infections of the COVID-19 Delta variant against strong corporate results and signs of economic revival. So far, 88.3% of S&P 500 companies have beat their earnings forecasts—even more than over the past four quarters—while 84.2% have topped analysts’ expectations, compared with an average of 73.7% over the past four quarters. Rising input costs and supply chain disruptions shrinking profit margin dominate the tone of many U.S. earnings calls. Meanwhile, U.S. services PMI plunges unexpectedly to 5-month lows as business outlook slumps. Goldman's Prime Brokerage service observed a surge in hedge fund dip buying as the S&P tumbled as low as 4,220 on Monday. Those same hedge funds, however, then proceeded to dump the rally, resulting in the biggest net selling in single names since Nov 2019. The iShares U.S. Broker-Dealers & Securities Exchanges ETF (IAI) also suffered its worst outflow since 2008 crisis in an ominous sign. Meanwhile, Dr. Robert Malone, a pioneer in the field of mRNA vaccines, shared a viral Twitter thread which lays out the disturbing trend that the most-vaccinated countries in the world are experiencing  a surge in COVID-19 cases, while the least-vaccinated countries are not.

Market participants now look toward next week with the Fed’s two-day monetary policy meeting and a series of high-profile earnings. Traders will be looking for clues regarding the timeframe for tightening its accommodative policies, although Chairman Jerome Powell has repeatedly said the economy still needs the central bank’s full support. Bloomberg reported this week that opportunistic asset allocators were caught wrong-footed with losses recently in chasing after and increasing their allocation towards bonds, REITS and trying to catch a “great buying opportunity“ on China Tech “bargain” on highly misleading price signals, as the U.S. 10-year treasury yield rebounded 10bps during the week to inflict losses on bonds, REITS and yield-based assets.

THIS IS YOUR FINAL WARNING: China stocks are dangerous to hold in a Bloomberg headline news, as China stocks tumbled during the week, and China ADRs posted the longest losing streak in more than two years, over the risks and shockwaves posed by a potentially widening regulatory crackdown in the nation’s technology and edutech industry, with global investors who are big backers from Tiger Global, Sequoia DST, Warburg Pincus to Temasek and GIC reeling. The Nasdaq Golden Dragon China Index plunged 8.5%, the steepest drop since March 2020, after Beijing was said to consider forcing companies that offer school tutoring to turn into non-profits and to ban off-campus tutoring, as well as holiday and weekend tutoring, in an education overhaul. That drove the gauge to its fourth straight weekly decline, its longest slump since May 2019. Darkening skies are gathering for China’s cloud kingpins and the industry as Alibaba’s cloud business, which dominate with a 40% share, saw revenue and income growth fell precipitously during the first quarter. Tencent is set to plunge in the weeks ahead as the regulatory fangs sink in: Beijing orders Tencent Music to relinquish exclusive music licensing deals global record labels within 30 days, and the WeChat mini programs for banking pose ‘significant’ risks of personal data leakage, according to an annual cybersecurity report published by a group reporting to China’s powerful internet watchdog, negatively impacting its valuable Weimob (2013:HK) business. Meanwhile, the potential liquidity and bankruptcy crisis of Evergrande, China's largest and the world's most indebted property developer with more than US$300 billion in total liabilities (the size of Singapore’s GDP), becomes ever grander on growing troubles as the company's shares crashed below the liquidation value of its standalone assets, its lowest ever value, and yield on its dollar-bond spike to above 35%, after a creditor’s successful court demand to freeze some assets in a bank account, and four of Hong Kong's top banks - HSBC, Bank of China’s Hong Kong unit, Standard Chartered and Bank of East Asia - stopped providing mortgages to buyers of China Evergrande Group’s unfinished residential properties in Hong Kong.

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.