Principal Monthly Viewpoints (February 2021)
Q: Principal Asset Management (Asia) Investment Management Team
A: Crystal Chan, Principal Asset Management (Asia) Senior Investment Specialist
Q:What should investors be watching closely as stock market volatility increases?
A: Global stock markets continued to rise after entering 2021 with significant capital flows into emerging Asian markets. However, market volatility trended up at the same time. In the last week of January, the Chinese and Hong Kong stock markets fell over concerns of a policy tightening in the mainland. Meanwhile, US stocks also fluctuated tremendously under a short squeeze triggered by retail investors. The VIX Index, which measures market volatility, soared by 30% to the peak recorded last year. Global equities erased all year-to-date gains in the face of the market adjustment. Investors should focus more on the fundamentals when market volatility increases and we believe that the supporting tailwinds of the upward trend remains intact.
From an economic data analysis perspective, the pace of the economic recovery seems to have slowed in early 2021 while the recovery trend continued. According to the PMI figures tracked by Principal, global PMI fell from a 34-month high to 54.7 in January and the outlook for the global manufacturing industry remained positive. Although the expansion rate slowed, global industrial output expanded for a second consecutive month; the Economic Surprise Index also remained in positive territory for the ninth consecutive month. For 2021, we believe that the global economy will rebound from last year’s contraction and record considerable growth of over 5.5% in 2021. Expectations of a broad vaccine rollout in the first half of the year will be the main growth driver.
As of the end of January, almost 100 million COVID-19 vaccine doses were administered globally, but progress is still lagging expectations, especially in the United States and Europe. If measured by the percentage of the vaccinated population, Israel’s vaccination rate was 52%, higher than the UK’s 14% and the US’ 9%. The vaccination rates of major European countries and China were only in the low single digit range. However, we believe that the average number of vaccine doses administered daily, or the vaccination rate, will increase steadily as more vaccines become available, production, storage and transportation procedures become smoother, and governments adopt measures to speed up the vaccination programmes.
In addition to the vaccine rollout, accommodative fiscal and monetary policies remain as an important support for economic growth. In terms of fiscal policy, the United States was in the spotlight as the new year started. Before officially taking office, Biden announced a USD 1.9 trillion economic stimulus plan, which is equivalent to total additional expenditures of USD 2.8 trillion when added to the previously passed USD 900 billion package. Against the backdrop that the unemployment situation in the United States is still severe, the plan has made significant progress recently. The U.S. Senate and House of Representatives voted to approve the budget plan respectively, representing that the Democratic Party can pass the large-scale economic stimulus bill in Senate by a simple majority of more than half without the support of the Republican Party. If the relevant recommendations can be passed in Congress, as the pandemic is gradually brought under control with the widespread vaccination rollout, the annual growth rate of the US economy may reach 6% or more.
Inflation may rise slowly but monetary policy will remain accommodative in the foreseeable future. Negative real interest rates, forward-looking guidance and balance sheets will guide the future direction of monetary policy, especially in developed markets. By the end of 2021, the balance sheet of the G4 (the Fed, European Central Bank, Bank of Japan and Bank of England) may further increase by USD 4.5 trillion to USD 28.2 trillion (66% of projected GDP). Although the increase is less than the USD 8.5 trillion expansion in 2020, it is very impressive given that growth is on recovery. Even though monetary policy expansion may slow down, global financial conditions will stay in a very accommodative range. Historically, the performance of global stock markets is highly correlated with the Global Financial Conditions Index and risky assets generally outperform during periods with loose financial conditions.
Q: The Hong Kong stock market retreated after a sharp rise last month. Has the relevant allocation changed?
A: We are more optimistic about the prospect of Hong Kong stocks than we were in the fourth quarter of last year. However, the allocation towards local stocks within our mixed assets portfolio has not changed much and remains neutral. The stock market turned positive early last month partly due to the accelerated inflows of southbound capital and the expectation that the People's Bank of China would provide accommodative liquidity support. However, the recent measures of the central bank, including reducing the scale of the reverse repurchase and medium-term lending facility, may indicate that the liquidity stance of the PBOC is changing. In fact, due to the expected improvement of the mainland economy, domestic fiscal and monetary policies will tend to normalize. The central government may tighten the pace of credit growth. The fiscal deficit ratio may fall slightly.
In addition, market should not ignore the tensions between China and the United States. The short-term government policy of the new Biden administration will probably focus on domestic issues and the public health crisis. However, in the medium and long-term, the president may inevitably take a relatively tough stance against China. It is unlikely that China-US relations will improve significantly under political pressure. Should China-US relations deteriorate, the Hong Kong stock market will face adjustment pressure. At the same time, the valuation of Hong Kong stocks is still relatively reasonable when compared with other major global stock markets. The index, however, is not cheap compared to its own historical level. When measured by the peak of 30,000 points, the forecast P/E was over 13x, reaching the highest level in more than 10 years.
However, from a market development perspective, the weighting of new economy stocks in the Hong Kong market has gradually increased, which is favourable for the overall earnings prospects of Hong Kong stocks. The increase in the number of dual-listed shares is also beneficial to the Chinese and Hong Kong stock markets. Among them, the “homecoming” of US-listed Chinese ADRs has become a focus for the market, boosting investor sentiment for the Hong Kong and A-share markets. The return of H-shares to the A-share market will help enhance market valuations.
In addition to mainland capital, foreign capital is also attracted by H-shares with lower valuations. Hong Kong stock investment is one of the better ways to hold RMB assets. In the second half of last year, the mainland A-shares market gradually recovered amid the improvement in economic data. On the contrary, the Hong Kong stock market was weakened in view of the tensions in China-US relations, which led to the gradual widening of the valuation gap between the two stock markets. According to the Hang Seng Stock Connect China AH Premium Index, A-shares are still about 35% more expensive than H-shares. Although the current level is lower than the highest level of 49% at the end of last year, it is still higher than the 10-year average.
Sector wise, we believe that the performance of new economy stocks and old economy stocks have a chance to go hand in hand. Certain industry characteristics of the technology sector, such as relatively stable cash flows and profit margins, will continue to be supported in the current lower for longer rates and uncertain economic environment. In terms of value sector, investors can pay attention to stocks that are likely to benefit from an economic recovery and government policies, such as financial stocks and new energy stocks.
Financial stocks are likely to benefit from the development of the yield curve. Improved earnings prospects may be a catalyst to re-rate the sector and attract capital to relevant sectors for mid- and long-term allocations. As for new energy stocks, the renewable energy will become a global trend and China is no exception. In order to meet its 2030 Carbon Emission Target, the Chinese government is likely to introduce more specific measures to support the development of clean energy in the coming year, which is favourable to photovoltaic and wind power stocks.
Q: What are the risk factors ahead?
A: The U.S. Treasury bond yield rose sharply in January in anticipation of an economic recovery. The 10-year Treasury yield topped 1% for the first time since March last year. The sudden increase in government bond yields may have a negative impact on asset prices. The U.S. Treasury bond yield is regarded as a risk-free interest rate. The increase in U.S. bond yields, especially the 10-year Treasury bond yield, is likely to increase the financing costs of global governments, companies and the public, which may stress the financial market and commodity prices. For instance, in early February 2018, boosted by satisfactory economic data, the 10-year US Treasury yield rose from 2.4% to above 2.9% in just two months, triggering a simultaneous decline in major global stock and bond markets. The S&P 500 Index retreated nearly 10% in the worst drawdown.
As the economy recovers, long-term bond yields may indeed rise amid expectations of economic growth. However, we currently believe that although the economy gradually recovers and inflation is likely to slowly rise, investors should not be concerned for now. Since global central banks do not have the room to withdraw their accommodative policies in the near-term, yields should not increase rapidly. According to the Fed’s employment and inflation forecasts, full employment and an inflation target of 2% will not be achieved before 2023. It is unlikely to exit from its bond-buying plan until the latter part of 2022 and rate hikes should happen later than that which means that the interest rate will remain unchanged for at least the next two to three years.
In the near future, COVID-19 remains the biggest economic recovery headwind. With the New Year effect, the global seven-day average number of daily new cases climbed to a record high of 806,000 in January before falling back to approximately 528,000 at the end of the month. This wave of the pandemic once again disrupted the first quarter’s economic activities in many major regions while some areas in the United Kingdom, Europe and the United States reimposed quarantine measures. A survey showed that less than 70% of the United States and Europe’s populations are willing to get vaccinated in the first year over concerns of potential side effects. The public’s acceptance of the vaccine will directly affect whether the pandemic can be truly controlled in the short-term, and whether the negative economic impact brought about by the lockdown measures will continue.
(Written on 8th Feb 2021)
Senior Investment Specialist
Principal Asset Management (Asia)