Weekly Market Commentary By H.E.R.O. (4 to 8 Oct 2021)

Stocks took one of the year’s more circuitous routes to an advance this week, led by Energy and Financials, with violent moves as U.S. nonfarm jobs data for September was the slowest this year at 194,000, far below the median projection of 500,000, and oil and natural gas producers surged amid an energy crisis in Europe and China, pushing inflation to multidecade highs in the U.S. and parts of Europe and sending 10-year US Treasuries yield to jump above 1.6%. Swings in the S&P 500 topped 1% for six straight sessions through Thursday, the longest run of volatility in six months. MSCI ACWI All World index +0.7%, NASDAQ +0.1%, while Topix -1.2%, KOSPI/KOSDAQ -2.1%/-3.1%, Cloud Software ETFs CLOU/WCLD -1.1%, Keppel DC REIT -2.5%, Gold -0.2% (Gold -7.5% YTD).

With corporate earnings yet to start, stocks were hostage to the ebb and flow of macro headlines, while raging commodity inflation and persistent supply chain disruptions are threatening corporate earnings. UK gas contracts for November delivery surged to more than £4 on Wednesday, almost 10 times the level at the start of the year. The latest price gains mean gas in the UK and Europe is trading at more than $200 a barrel of oil equivalent — or almost three times the price of crude. In turn, market expectations for UK inflation hit their highest level since 2008, as investors bet that soaring energy bills could be the start of a wave of broader price rises across the economy. Glencore, Gunvor, Trafigura and Vitol are among the commodity merchants facing massive margin calls and losses on their positions in natural gas markets across Europe and US., hammered by a spread (or arbitrage trade) gone wrong. Global food prices jumped to a decade high, and worries are mounting that the situation will worsen as China struggles to handle crops from corn to soy to peanuts and cotton.

The jobs report opens the door wider for combining a November taper of the central bank’s monthly asset purchases with a stronger signal that such a policy action says nothing hawkish about subsequent rate increases. Meanwhile, investors in the US stock market are wagering that the worst of the recent sell-off is over, despite persistent risks that have already knocked US$2.5 trillion off the value of US equities since early September. Measures of demand for options that offer protection if the market were to lurch dramatically lower have receded steadily in recent weeks. This signals that investors are no longer clamouring to hedge themselves from a further slide. The Cboe’s Skew index, which measures investor positioning in the US options market and acts as a gauge of interest for protection against a large slide in stocks, fell to its lowest level in 11 months this week. The previous shift away from gold into bitcoin by institutional investors as a better inflation hedge, seen during most of Q4 2020 and the beginning of 2021, has started re-emerging and accelerating in recent weeks.

Market sentiment and optimism over Cyclicals may be impacted 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.