“Continue to favour defensive equity against the backdrop of recessionary risk”
The S&P 500 continued to perform strongly, with the index now up more than 12.6% from its annual low in June. The rise was boosted by new hopes of a soft landing for the economy following slowing US inflation and strong employment data. But the Fed needs to see more evidence that the inflationary threat is over before changing policy, and believes recession risks remain. Against this backdrop, we continue to favour defensive equity exposures.
The fundamental economic outlook has improved, but downside risks remain. Strong employment data and expectations that most inflation indicators will continue to decline have revived hopes for a soft landing. But it is also premature to think that the risk of a recession is now almost non-existent. The Federal Reserve still wants growth to slow so it gets closer to its 2% target, and hitting around 1% leaves the economy vulnerable to all risks.
Concerning sentiment in the Chinese real estate sector is troubling. However, there were signs of stabilization with government promises to ensure the implementation of stalled projects. A coordinated policy response could ensure the containment of the housing crisis and will not impact China’s overall post-COVID recovery. However, the real estate market could remain in turmoil for the coming few months.
Home loan boycott news dampened sentiment in the Asian high yield (HY) market. A default in China’s property sector will continue to put pressure on Asian high yield bond yields in the near term. While we don’t view mortgage developments as a systemic risk, they are weighing on homebuyer and lender sentiment and could slow prospects for a sales recovery.
Signs of a divided market are increasing. Broadly, investors fall into one of two camps; 1) Inflation remains high alongside strong macroeconomic data, Fed hikes aggressively, inflation slows but economy also slows and weakens due to high borrowing costs and eventually leading to recession or 2) Inflation remains high alongside strong macroeconomic data, Fed hikes aggressively, inflation slows but economy also slows and weakens due to high borrowing costs. Fed stops rate hikes, inflation normalizes at acceptable level and economy stabilizes. The key determinant, in our opinion, of which path will eventually materialize, hinges mainly on the pace and magnitude of Fed rate hike decisions. With all due respect, we fear the Fed is likely to overshoot and fall behind the curve once again based on the Fed’s past track record, i.e., the probability of path 1 is currently higher. That said, the jury is still out. We believe the more prudent way is to continue to monitor macro and inflation data from the US and the corresponding Fed actions. We are conscious of the fact that it has been approx. 5-6 months since the Fed first hike rates. We mentioned previously that there is a lag time of 3-6months between fed actions and actual impact to economy and economic data. We are expecting the Sep/Oct inflation data to better reflect the impact of Fed rate hikes. Come that time (in Sep-Oct period), we believe there should be greater clarity with respect to whether inflation is under control as we head into September. In the meantime, we recommend to stay cautious (refrain from major and aggressive portfolio rebalancing within the portfolio) while gradually buy selected sectors and stocks on major market pullbacks.
Geographically, our preference is still inclined towards HK/China mainly from a valuation perspective. Notwithstanding, we acknowledge that a lack of major catalysts, regulatory and macro risks as well as geopolitical tensions serve to undermine our call. As investors with mid-longer term investment horizons, we adhere to fundamentals and valuations and take a longer-term view on our calls. Accordingly, we remain advocates of fundamentally sound secular themes in the likes of the electrification of vehicles, and digitalization of the global economy. Notwithstanding, we also recommend to hold defensive names with material dividend yields and strong cashflows (including Chinese and US Telecoms) should the global economy fail to fend off potential recessionary risks as anticipated by more cautious market participants. Overall, we remain cautiously bullish on China and recommend to gradually allocate on dips on US technology sector.
In general, we recommend investors to:
- Refrain from major portfolio rebalancing actions over the next few weeks unless there are major unforeseen events. We maintain mid-longer-term overweight in Banks (in particular Singapore banks, lesser extent on Chinese banks) on longer term rate hike cycle theme; Chinese Telcos (defensive with material dividend yields), Chinese Autos (in particular EV related themes) and Chinese Healthcare. These sectors are fundamentally attractive over the longer term and investors may consider selectively accumulate on major pullbacks; Unless inflation shows signs of abating in the US, i.e., take cue from upcoming US inflation data, we remain Neutral on US equities overall.
- Overall, continue to employ more tactical short-term trades in order to capture opportunities arising out of ongoing market volatility; do consider to put on partial hedges as well as hold sufficient levels of cash in the portfolio (no less than 15%) to remain defensive and to stay nimble amid continued market volatility.