Weekly Market Commentary By H.E.R.O. (31 May to 4 Jun 2021)
Markets continued their choppy advance with mixed trading in Asia during the week, with MSCI All World Index +0.8%, S&P 500 +0.6%, NASDAQ +0.2% but Singapore -0.9%, Hang Seng -0.7%, China CSI -0.7%. Weaker-than-expected jobs growth eased concerns about the economy running too hot and causing an early tightening of monetary policy. Nonfarm payrolls increased by 559,000 jobs last month, helped by vaccinations and a reopening economy, and most contributed by restaurants which accounted for a third of the total, following an unexpected slowdown in the labor market in April and below the consensus forecast of 650,000 new jobs in May. Total employment is still 7.6 million below its pre-pandemic level. At this rate of job gain, it will still take 14 months to recover fully. There remains the lingering concern that some of these 7.6 million may not be able to work or come back to look for work again. Markets also shrugged off the Fed’s surprise announcement that it would start selling the US$13.8 billion corporate bonds & bond ETFs it bought during the depths of the pandemic, which some pegged as the first tiny step toward tapering, though there is no tapering of Fed’s main bond-buying program yet. Biden on Wednesday signaled “major changes” to his tax proposal which would not focus on raising the top corporate rate in an attempt to win the support of the Republicans who opposed an earlier proposal to raise the corporate tax rate from 21% to 28%. Instead, Biden recommended a new, minimum corporate tax of 15%, seeking to take aim at dozens of profitable U.S. corporations that pay little to nothing to the federal government annually. However, even with the new tax concession, the White House's US$1 trillion infrastructure-led stimulus plan is around four times as much as Republicans have been willing to spend. Biden had originally set a Memorial Day deadline for reaching a deal before he let that deadline slip back to June 7. Democratic senators emphasize that they plan on moving forward on a sweeping infrastructure package “with or without the support of Republican senators”.
Massive short covering in speculative frenzied retail-driven heavily-shorted meme stocks during the week led to the biggest hedge fund rout since March and a sell-off in many popular growth stocks that were down -5% to -10%. The popular ARK Innovation ETF slumped -2.3%. The week also saw furious forex volatility with a sudden, violent, and sustained bid for the U.S. dollar, which saw its biggest daily gains in nine months since September 2020, before paring back some gains on Friday. Gold was cut by the sharp dollar rise to decline -0.6%. U.S. markets also entered into summer with a dangerous record margin levels (it has never been anywhere near US$800 billion, see chart below), which usually peak just before major market corrections.
Importantly, the frustratingly noisy “Cyclical/Value” vs “Growth” label is starting to recede in importance as 2021 nears its halfway mark, with the market narrative shifting focus to companies with strong fundamentals: The “resurgent growth” factor from the year-on-year comparisons of the reopening trade in Cyclicals is becoming less meaningful, and the “back-to-normal” market narrative has increasingly shifted focus to making comparisons of the 2021 results with the pre-pandemic 2019 numbers, sending a warning to investors who believe we are through the fog of the pandemic. Some institutional fund managers such as First Eagle are also reported to be positioning for the great fiscal and monetary stimulus unwind ahead, with the sober view that the overall outlook for economic growth is quite subdued once you get through the cyclical recovery that’s occurring at the moment.
Meanwhile in Asia, Biden on Thursday blacklisted more Chinese companies from U.S. investment, expanding to 59 companies, up from 44, and clarifying a ban introduced last fall by Trump that was aimed at companies the U.S. said had ties to China’s military complex. Investors have a 60-day grace period and 365 days to divest shares they already own in these companies. China’s pricing watchdog, a bureau within the country’s top market regulator, summoned Meituan, Didi Chuxing and six other sharing economy platforms on Thursday for a stern reminder to toe the regulatory line in a sign of sustained regulatory scrutiny on the country’s tech sector. Meanwhile, the COVID-19 epidemic in Guangdong province continues to worsen, and the busiest commercial streets in Shenzhen– the East Gate Pedestrian Mall 东门老街and the Baima Clothing Wholesale City in Luohu District - has been closed due to infection as China orders its first lockdown since January.
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.