Weekly Market Commentary By H.E.R.O. (22 to 26 Feb 2021)
“Dude, Get Back to Your Desk!” – this is the week that roiled bond markets in a bloodbath with bond traders around the world instructed to keep vigil at their screens after the speed and ferocity of the selloff caught nearly everyone off guard as the yield on 10-year Treasuries - arguably the most important interest rate in the world as it influences prices in virtually every other corner of financial markets - spiked up suddenly on Thursday to 161 bps before retracing back to 1.46%, just about the same as the dividend yield on the S&P 500 Index.
A multi-asset approach was hit by the “sell everything” market rout, led by tech (NASDAQ -4.9%) and the China bubble (CSI 300 index plunged -7.7%), with an overwhelming majority of tech stocks down 5% to 20%, as the surge in real yields weighed on the havens and defensives in gold/bond/REITS/consumer staples which were significantly down. In particular, bonds suffer their second worst bear market in 40 years and gold had its worst month in 5 years: Since Aug 2020, annualized price return from 10-year US govt bonds = -29%, Australia -19% (they do YCC – yield curve control!), UK -16%, Canada -10%. The world’s biggest bond market screams for help but few came to its rescue as the Treasury Department’s US$62 billion seven-year note sale was a complete disaster with the bid-to-cover ratio, an indicator of demand, at just 2.04, the lowest in the auction’s history, alarming enough to spark something resembling a mini flash crash in what’s supposed to be the deepest and most liquid market anywhere. Corporate bonds continued to rack up the biggest losses since the pandemic began as companies scramble to sell debt before yields go up even more. In addition, investors in the $7 trillion mortgage-backed bond market are increasingly becoming forced sellers of Treasuries as they adjust for the reality that fewer Americans will refinance their old mortgages as interest rates increase. Quantitative risk parity strategies and risk balanced funds suffered the worst drawdown and plunged the most since the depths of the Covid rout in March as stocks and bonds move downwards together. Value/Cyclicals outperformed growth in February by the most since March 2001, though commodities broadly tumbled on Friday to pare their speculative rotational gains as the U.S. dollar strengthened. Meanwhile, the week also saw the stunning redemption shutdown of a popular US$1.8 billion “magical money machine” mutual fund with a quant strategy that claimed they could produce attractive high-yielding returns on alternative assets at lower risk than mainstream portfolios, a callout to opportunistic asset allocators and investors who have continued to naively pile into structured notes products that promised guaranteed high-yields with near-zero downside risk. The “humbling” week in bond markets led to fears of paradigm shift on the role of bonds in asset allocation and investors question whether a lasting and destabilising rise in yields is at hand. February also saw a massive shift in the market's perception of The Fed's rate-hike trajectory, now pricing in more than 4 rate-hikes between 2022 and 2024.
Meanwhile in Asia, Hong Kong market tumbled 5.5% during the week after a “shock” transaction tax hike to pay for the government handouts, the first stamp-duty increase on stock trades since 1993. Markets are also waking up to this event as a harbinger of the ills on the negative impact of the Biden administration’s massive fiscal stimulus package. The news was as shocking to the Hong Kong exchange as it was to everyone else, and HKEX interim CEO said that he wasn’t consulted by the government on its decision to hike the stamp duty, with HKEX plunging 16.5% during the week. The increased stamp duty will raise trading costs by 6% to 15%, pressing down trading volumes and crimping the exchange’s earnings per share by at least 3% to 7%. Markets have yet to price in the possibility of a tax on financial transactions in the U.S. markets, a proposal that has recently been rekindled by some Democrats in the U.S. after the recent trading frenzy in GameStop shares.
As euphoric traders piled into the trendy Cyclicals, Value Traps, speculative penny stocks, and loss-making electric vehicle and green energy stocks, 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.