Weekly Market Commentary By H.E.R.O. (1 to 5 March 2021)
Havens, emerging markets, credit (LQD, EMB), China tech and global tech stocks are hammered heavily this week, pressured by the stronger USD and rising interest rates to 1.56%, up from 1.2% a few weeks ago and less than 1% at year-end 2020. The U.S. dollar surged to its strongest since Thanksgiving (with its biggest week since October 2020), after the Fed Reserve chief Powell made no mention in the Thursday meeting in taming the recent rise in interest rates and mortgage rates which jumped above 3% for the first time since July 2020. There was no talk of Operation Twist (a simultaneous selling of front-end Treasuries and buying of longer-dated bond), or Yield Curve Control, or even supplementary leverage ratio (SLR) relief—a technical rule dictating how much capital a bank has to hold and impacts the ongoing crunch in the repo markets as a result of the dramatic wave of shorting in the treasuries market and Japan’s rush out of global bonds. Key for the markets will be the performance of the Treasury market: Next week will see auctions of 10- and 30-year maturities, which will be important tests of investor demand, as well as the next FOMC meeting on 17 March for clues about what the panel might say or do about bond yields. Some form of yield curve control will be inevitable down the road, as interest costs one percentage point above the Congressional Budget Office’s baseline estimate would add US$9.7 trillion—more than 10 times the annual U.S. defense budget—to the deficit from 2021 to 2030.
NASDAQ was down 3 weeks in a row and down over 10% from recent highs on Friday, before an intraday technical rebound after Europe markets closed. China Tech (Hang Seng tech index) is down 21% in the recent two weeks. US semiconductor index is down -15% from highs, Tesla -33%, Solar ETF TAN -32%, Global X Cloud Computing ETF (CLOU) -15%. The US$24-billion ARK Innovation ETF with its portfolio of profitless tech and biotech companies is down 25% in the recent two weeks. Emerging markets also suffered their first outflows since October 2020, with investors pulling money from stocks and bonds in an abrupt end to what had been a months-long streak of inflows. Meanwhile, there is continued frenzied rotation into the reflation trades in cyclicals (financials and energy) on the overwhelmingly great expectations that the massive stimulus measures will result in a pre-COVID normal economic scenario very soon, especially after the blind optimism over the BLS report of a seemingly impressive February jobs report on Friday, which showed a whopping 379K total jobs added in February (and 465K private payrolls, or more than double the 195K expected) - but 75% of all jobs added were actually in food service and drinking places, i.e. waiters and bartenders. Credit markets were also rocked by Credit Suisse’s liquidation of the US$10 billion Greensil high-yielding funds that were underwritten and “guaranteed” by giant insurers to protect investors from losses; Greensil had specialized in trade finance and packaging outstanding invoices or receivables into bonds that could be bought and marketed by respectable institutions like Credit Suisse.
China’s top banking regulator, Guo Shuquing, on Tuesday voiced concern about Chinese real-estate prices, calling it a bubble, and said it could threaten the financial sector and broader economy—another indication Beijing could turn its focus to risk controls and slowing credit growth. Ping An-backed China Fortune Land defaulted last Friday on its US$530 million bond whose investors include BlackRock and HSBC, imperilling its dollar-denominated debt totalling US$4.6 billion and the country’s debt-laden real estate sector and the international investors backing it. China Fortune Land’s bonds have been trading at deeply distressed levels for weeks, but analysts said the default was still surprising, which shows that the government is dead serious about letting weaker companies default. China Fortune Land is the biggest international defaulter on record from China. Emerging markets are increasingly shaken by China's credit impulse which is now rapidly shrinking, and most real-time indicators of China are showing a sharp slowdown across the economy which appears to be rolling over in everything from traffic and mass transit, to manufacturing even as prices of many goods (especially food) rose sharply, in what some may call a pre-stagflationary outcome and posing grave risks to the speculative frenzied reflation trade with adverse consequences on all inflation-sensitive assets.
The portfolio stocks remain well-anchored to very strong and powerful fundamentals with clear and visible growth prospects and robust end markets, and are very likely to rebound resiliently from the sentiment-led rotation 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. In the process of writeups in two new larger-cap stocks into the portfolio: (1) US-listed BWX Technologies, U.S.’s #1 nuclear power technology solutions leader with 100% monopoly share as the sole supplier for U.S. naval (submarines, aircraft carriers, ships) for the last 60+ years, and growing nuclear medical & nuclear energy reactor for space business; and (2) Italian-listed SOL Group, Europe’s #1 technical gas (medical and industrial gas) and oxygen homecare therapy leader.
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.