Weekly Market Commentary By H.E.R.O. (27 to 31 Dec 2021)

Global markets ended 2021 on a downbeat note punctuated in whipsawed choppy trading on thin volumes with double-digit gains for the third year in a row, as easy monetary policy and a flood of fiscal stimulus helped propel an economic recovery from the pandemic. The MSCI ACWI World Index rallied 16.6%, and the S&P 500 Index ended the last trading day of 2021 with a drop of 0.3% that still left the index 27% higher for the year, powered by Big Tech’s US$2.5 trillion gains in value. Options trading also surpassed stock activity for the full year for the first time ever, according to Cboe Global Markets data, swarming in the same popular overcrowded single name stocks. Notably, speculative growth stocks corrected significantly during the final week: China Internet ETF KWEB (in StashAway’s portfolio) -6.1%, Cloud Software ETFs SKYY/CLOU/WCLD -1.4%/-3.4%/-2.4%, ARKK Innovation ETF -4.5% (YTD -24% and +2.4% since 28 Aug 2020). Beneath the overall market advance lies stomach-churning turbulences and deadly traps: Many pandemic darlings turned into heavy losers during 2021, green stocks become flops that lagged even airlines, more than a thousand stocks such as PayPal made 52-week lows on a daily basis, over 80% of the more than 3,000 stocks on the Nasdaq exchange are off at least 10%, speculative retail meme stocks GameStop, AMC also slumped to multi-month lows, the Nasdaq Golden Dragon China Index plunged -42.7%, more than 1,000 U.S. companies went public in 2021 with returns that are worst in a decade, and many reputable and popular funds ended the year weighed down by hefty drawdowns of -20% to -40%.

Covid cases have continued to surge around the world amid concerns over how far the new Omicron strain could disrupt supply chains, the cost of goods and company performance, as well as its potential for mutations into more infectious and deadlier variants. Dizzying stock market swings in the wake of the emergence of the Omicron variant underscored how confidence can be shaken by unexpected pandemic twists. Tightening monetary policy and central bank’s removing crisis-era support for financial markets present another prospective headwind for the year ahead. US Federal Reserve officials expect to raise interest rates three times in 2022, as the central bank moves to damp inflationary pressures. The Fed also outlined plans in December to double the pace at which it withdraws its pandemic-era $120bn-a-month bond-buying programme. Global bond markets registered their worst year since 1999 and bond investors are nursing losses as many central banks move toward tighter monetary settings to fight inflation. The yield curve has already flattened to a very slim 80 basis points, suggesting that we are moving ever-closer to a recession.

2022 will also bring the midterm U.S. elections in November. Current polls would suggest that the Democrats are headed for a big defeat in Congress, with Republicans gaining control of the House. This has profound implications for fiscal policy. Huge Republican gains in the 1994 and 2010 midterm elections resulted in six years of relative austerity under presidents Bill Clinton and Barack Obama. The result was a budget surplus at the end of Clinton’s second term. Fiscal spending was especially lean from 2010 to 2016, as the budget deficit shrank from around 10% of GDP to about 2% of GDP. Republicans are by no means fiscally conservative, but they are reliably so when they are in the opposition. A Republican majority in Congress would probably result in the budget deficit dwindling from $3 trillion or more to less than $1 trillion. The result would be far less consumer spending and a few percentage points less in GDP growth. And since inflation has been driven mostly by loose fiscal policy, austerity has the potential to slow or stop inflation.

Yet amid a cacophony of macroeconomic stressors, the robust earnings picture is pretty much intact. For the fourth-quarter earnings season that’s about to start in coming weeks, S&P 500 companies are expected to report a 19% jump in profits. Analysts may have again underestimated the earnings potential - S&P 500 firms have crushed estimates by at least 10% for six quarters in a row.

China’s “common prosperity” policies created a greater divide between stock winners and losers at home. Relentless regulatory crackdowns erased more than US$1 trillion in the value of Chinese internet companies and resulted in the Nasdaq Golden Dragon China Index to plunge -42.7% in 2021, China Internet ETF KWEB (in StashAway’s portfolio) -52.5%, Hang Seng Tech -33.1%, MSCI China -22.5%. China’s push to reach carbon neutrality by 2060 spurred some big gains in the electric vehicles and solar space. The saturation and chaotic electric vehicle market in China has resulted in China's Ministry of Finance, along with several other ministries, to announce that subsidies for new energy vehicles (NEV) in China will be slashed 30% heading into 2022. The subsidies are expected to be phased out by 2023. China’s freeze on new video game licences is extending into 2022, dashing hopes that the process might resume by year-end, which has led many small gaming-related firms to close their operations.

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.