Weekly Market Commentary By H.E.R.O. (1 to 5 Nov 2021)
Robust corporate earnings, stronger-than-expected October U.S. employment report, encouraging results from Pfizer’s COVID-19 pill study, and reassurances from the world’s large central banks that interest rates will remain at historic lows for a little while longer have combined to propel markets to record highs, led by economically-sensitive Cyclicals during the week, while China continues its slump on struggles to stamp out its most widespread Delta COVID virus outbreak since Wuhan and escalating contagion fears and bond market meltdown from Kaisa’s default on its off-balance sheet high-yield guaranteed wealth management product that proved that simplistic official doctrines such as the “three red lines” leverage test that Kaisa passed are a parody and that harsh top-down policies only create uglier monsters underground. MSCI ACWI All World index +1.6%, S&P 500 +2%, Stoxx 600 +1.7%, KOSPI -0.1%, Hang Seng -2%, China CSI 300 -1.4%, MSCI China ETF -2.3%, Hang Seng Tech -1.9%, China Internet ETF KWEB (in StashAway’s portfolio) -1.9%. Meanwhile, the Securities and Exchange Commission on Friday approved a framework to determine which US-listed Chinese companies fail to fully allow auditing inspection and, therefore, will be delisted from American capital markets.
The Bank of England’s shock move to keep interest rates on hold on Thursday caused bond yields to dive, as investors swiftly re-evaluated the rate hike cycle that strategists argued had been overextended. The decision followed weeks of speculation that the BOE would become the first major central bank to raise borrowing costs since the start of the pandemic. It also came a day after Fed Chair Jerome Powell announced it will begin winding down its monthly asset purchases later this month in staggered fashion, which equity markets took in their stride, while saying officials can be patient on hikes. Interest-rate futures, which had priced in two quarter-point increases in 2022, shifted the second one into 2023. Most strikingly, yield curves are flattening again — a sign that traders expect the Fed and other central banks to ultimately step in and gradually tighten policy to prevent inflation from overheating. The era of unlimited central bank largesse is drawing to a close, injecting intense volatility in to government bonds and inflicting heavy damage on a clutch of high-profile hedge funds nursing billions of dollars in losses. With the 3Q earnings season ending in two more weeks, markets are entering into a complicated environment, with a pick-up in growth in the fourth quarter as Covid-19 headwinds have abated, but a moderation or slowdown in economic growth outlook in 2022, which suggests that structural growth winners will outperform economically-sensitive Cyclicals in 2022. Meanwhile, iron ore futures extended losses below $100 a ton on shrinking steel output in China and signs economic growth is facing mounting headwinds.
Shares of Chinese online health-care providers have been battered since the government released draft rules last week that deepened concerns about restrictions on growth potential for the sector. Ping An Healthcare and Technology has plummeted more than 30% while Alibaba Health Information Technology has lost nearly 18% since the proposed regulations were published on Oct. 26. The draft rules include a ban on online consultations for initial diagnosis. Medical judgments must be conducted by a registered doctor, and artificial-intelligence software should not be used as a substitute, the rules said. The stock rout extended the months-long slump of internet health-care stocks amid calls by Chinese state media for ensuring the safety of online prescription-drug sales and tougher rules on how companies handle user data.
Market sentiment and excessive optimism over Cyclicals may be punctuated by warnings from scientists that Merck's "revolutionary" COVID drug molnupiravir - which purportedly cut hospitalizations in half during a study that was cut short - could cause cancer or birth defects, according to a report published Thursday by Barron's. Molnupiravir works by incorporating itself into the genetic material of the virus, and then causing a huge number of mutations as the virus replicates, effectively killing it. In some lab tests, the drug has also shown the ability to integrate into the genetic material of mammalian cells, causing mutations as those cells replicate. If that were to happen in the cells of a patient being treated with molnupiravir, it could theoretically lead to cancer or birth defects.
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.