Weekly Market Commentary By H.E.R.O. (23 to 26 March 2021)
Markets were choppy and rocked by messy price swings that whipsawed traders during the week, capped by an extraordinary spree of block trades on Friday which erased US$35 billion from the values of bellwether stocks ranging from Chinese technology giants to U.S. media companies, spurred speculation of forced selling by a massive fund being liquidated. ADRs of Tencent Music Entertainment plummet 34% and Baidu fell 19% during the week. The NYFANG+ index, a group of 10 of today's highly-traded tech giants, slumped 4%. Down 11% since the end of December, hedge funds’ alpha is heading for the worst year since at least 2015, exacerbated by their short-dollar bets as losses mount with the strengthening USD. Both speculative loss-making tech stocks and SPACs entered bear market plunge of over 30% from recent high this year, along with China tech, EV and cloud software stocks which continue to decline over the week.
Fear is everywhere in the volatility market - the skew, or the cost for one-year protection on the main U.S. stock benchmark, which measures how much traders are willing to pay for hedging against steep market drops, is at extreme levels over a rather long history. Overall market breadth was low worldwide with far more declining issues than advancing ones, as markets digest the news of super-mutated virus from Tanzania and India, younger Brazilians dying from COVID in an alarming new shift, the epic Suez Canal traffic woes creating supply chain disruptions, disastrous vaccine campaigns in Europe, and Germany’s warning that the third COVID wave could be the worst yet as the pandemic is taking a renewed toll on western and central Europe. Markets were mixed over the reopening/ reflation trades that has sent Cyclicals soaring against tech which threw U.S. indexes most out of sync in two decades since 2001, with the Russell index selling off 2.9% for its worst drop in four weeks as market chatters are increasingly shifting towards the view that the rally and easy money in Cyclicals is almost done and that they are vulnerable to a sharp reversal, and some institutional mutual funds are reported to be paring down their positions in Cyclicals. Markets were bracing for large shifts in quarter-end portfolio rebalancing to position for the next phase of the market. How long will the frenzied rotation into Cyclicals last? The market narrative are that earnings growth of Cyclicals will start to decelerate after the initial short-and-hot burst, and after the first half of the year, that’s the time for high-quality stocks with strong balance sheets and organic earnings growth to shine.
Chinese stocks have been under pressure after a warning from the SEC on Wednesday that it’s taking steps to force accounting firms to let U.S. regulators review the financial audits of overseas companies - the penalty for non-compliance being delisting from exchanges. China has long refused to let the US Public Company Accounting Oversight Board examine audits of firms whose shares trade in America, citing national security concerns. In addition to that, Beijing has proposed forming a joint venture with local technology giants that would oversee the lucrative data they collect. China’s US$1.3 trillion stock-market rout is tormenting financial markets and showing the world what happens when central banks and governments start exiting trillions of dollars in pandemic-era stimulus, given that China is ‘first in, first out’ in the pandemic. Like elsewhere, the rally had been led by retail investors chasing a small number of stocks, many of whom piled in at the top as a frenzy grew. Now the China CSI 300 index is trailing MSCI global benchmark by the most since 2016 this month and the most popular mutual funds are getting crushed. In addition, China’s US$2.3 trillion of hidden debt last year is expected to climb even further this year, according to a government-linked think tank, creating increasing risks to the stability of China’s financial system. Twenty Chinese military aircraft entered Taiwan’s air defence identification zone on Friday, in the largest incursion yet reported by the island’s defence ministry and marking a dramatic escalation of tension across the Taiwan Strait. General sentiments in emerging markets remain weak as a result of the stronger USD and also triggered by rate hikes by central banks in Brazil, Russia and Turkey.
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.