Weekly Market Commentary By H.E.R.O. (3 to 7 May 2021)
Extreme rotation into Cyclicals (Materials/Commodities/Energy, Banks, Transport, Homebuilders) during the week led to tech stocks tumbling in its worst sell-off in months, sparked by Treasury Secretary Janet Yellen’s comments on Wednesday that interest rates may have to rise moderately to keep the economy from overheating. The losses in tech sustained even as Yellen attempted to walk back her remarks, carefully avoiding any predictions about interest rates and emphasizing her respect for the central bank’s independence, though there was a slight rebound on Friday after a shocking April employment report that the U.S. economy added just 266K jobs, a huge miss compared to the 1M consensus estimate, casting doubts over the strength of the recovery/reflation Cyclical rotation thesis. Investors who had been betting the Fed would raise rates as early as the end of next year abruptly retreated from those positions on Friday after the disappointing April employment report and now see the earliest the Fed might tighten roughly two years away. With vaccines and policy support in place, consensus is building that the pandemic-ravaged economy will return to normal activity. What’s debatable is the pace of the recovery. The murky picture is pitting investors against each other, whipping up extremely violent rotations among stocks. The back-and-forth between investment styles – Cyclical/Value vs Growth/Defensive - has been playing out all year and the split view on the trajectory of the economy is dividing the market like never before. Yet, market indexes continue to remain “resilient” and rose regardless of reflation, inflation or deflation.
Apple tumbled on Wednesday for its largest drop since October, while Amazon plummet 5.1% during the week with Bezos selling off US$2.4 billion worth of shares after reporting its 1Q results. NYFANG+ index fell 2.9% and cloud software stocks had a complete meltdown with the CLOU/WCLD index and ETFs plunging 6.8% to 8.5%. Cathie Wood’s popular gigantic ARK Innovation ETF collapsed 9.2%. The speculative dash-for-trash appears to be over as unprofitable tech tumbled over 35% from its recent Feb high. The most-shorted stocks suffered their biggest weekly loss since Oct 2020 and recent IPOs saw the biggest weekly drop since March 2020. The market narrative is that when speculative growth in the Cyclicals is abundant, you don’t pay a premium for it; the growth-at-any-price market winners no longer seem so exceptional in an economy where everyone else seem to be able to grow as well. Hedge funds were “extreme” sellers of tech stocks before Yellen’s interest-rate remarks as prime brokers and banks slashed their support for leverage following the Archegos fallout. The Fed also warned of hidden leverage lurking in the financial system and financial stability risks emanating from frothy stocks, pointing to the rise of retail-frenzied meme stocks as one sign that risk-taking could be getting out of hand, and that some asset valuations are “elevated relative to historical norms” and “may be vulnerable to significant declines should risk appetite fall”. SEC Chairman Gary Gensler told the House Financial Services committee that congress should consider regulating crypto exchanges. Meanwhile, the U.S. dollar plunged on the dismal jobs data, to its weakest since February, propelling copper prices to climb to record highs for the first time in more than a decade Friday, fueled by bets on a U.S.-led global economic rebound that would boost demand for metals used in manufacturing and construction, leading commodities to continue their (transitory) charge higher (5th straight week) with the Bloomberg Spot Commodity Index up a stunning 65% YoY, a record spike. Gold had its biggest weekly rebound in 6 months, paring its YTD losses to -3.6%.
China stocks were hit and the China CSI 300 index plummet 2.5% during the week after the Biden administration that it would likely follow Trump's China investment ban policy announced in November. For the past few months, one of the key reasons why investors had bid up some of the Chinese mega caps is the hope that Biden would undo some of the various investment bans rolled out by the Trump administration as part of ongoing trade war between the US and China. Chinese healthcare stocks crashed after Biden's team decided to break away with the Bill Gates-backed status quo and support a WTO initiative to unlock Covid-19 patents to help fight the global pandemic. Beijing announced on Thursday the "indefinite" suspension of all activity under a China-Australia Strategic Economic Dialogue amid strained relations between the two countries, causing the Aussie dollar to fall sharply. Beijing has ordered a halt to work on two high-speed rail projects with total investment of 130 billion yuan ($20 billion) in Shandong and Shaanxi provinces, signaling concern over growing local government debt. More than 40 Hong Kong stocks worth a combined HK$140.9 billion ($18.1 billion) remain suspended from trading after failing to release their 2020 earnings, the highest number of such halts in at least five years.
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.