Principal Monthly Viewpoints (September 2021)
Q: Principal Asset Management (Asia) Investment Management Team
A: Crystal Chan, Principal Asset Management (Asia) Senior Investment Specialist
Q:How will the FED tapering impact the market?
A: At the latest Jackson Hole Symposium, Fed Chair Powell was tight-lipped about the tapering schedule, choosing to reiterate the talking points from last month’s FOMC meeting instead, such as inflation being driven by transitory factors, and labour markets being weaker than what the headline unemployment rates indicate, despite having made considerable progress. He also mentioned that while the Delta variant is yet to pose a serious risk, it will still threaten economic advancement. He added that although the Fed may cut bond purchases this year, it will not be necessarily followed by rate hikes.
Investors saw Powell’s discussion of tightening policy prematurely as a dovish signal. He pointed out that policies introduced at a wrong time may hinder recruitment and other economic activities. From our standpoint, whether tapering begins in December or January, or whether bond purchases are reduced to USD 10 or 15 billion per month isn’t as crucial as the economy’s ability to withstand the impacts of shifting policy when the Fed communicates its intentions to the market.
The non-agricultural employment data in August coincides with our stance. 235,000 non-agricultural jobs were added in the US during the month, far lower than 730,000 predicted by markets, a record low in seven months. The recent surge in Delta variant cases and the impact of extreme weather conditions had put economic growth under greater pressure in the short run. With the US government planning to administer a third dose of Covid-19 vaccine to the public from September 20 onwards, and new Delta variant cases dipping from peak, labour markets may return to the trajectory of recovery. Whether the country can control this new wave of Covid-19 will affect the Fed’s exit strategy.
The taper tantrum in 2013 happened because the then-Fed Chair Bernanke advocated tighter policy in times of relative economic weakness, causing markets to panic. Eight years later, while Covid-19 variants have led to a rebound in the number of confirmed cases in the US, possibly impeding retail sales and overall growth in the third quarter, the economy is still predicted to record considerable growth in the second half of the year due to the base effect. As for inflation, since the impact of factors related to economic reopening is gradually receding, overall price levels may fall further in the fourth quarter but will remain high before returning to around 2% later next year.
Generally speaking, the US economic background is stronger than it was in 2013, and markets have arrived at the consensus that tapering will commence by the end of this year or early next year. Therefore, as long as economic data maintain momentum over the next few months, and the Fed communicates its intentions clearly to markets, even if tapering begins before the end of the year, the economy and asset prices should experience limited impact.
Q:Is there room for US and European stocks to further advance after this year’s stellar performance?
A: With the third quarter almost over, developed markets have been relatively resilient despite the Delta variant leading to risk aversion and falling bond yields. At the end of August, US and European stocks extended the rally of the first half of the year, gaining 5% and 3.5%, respectively. Both markets led other major markets, rising by over 20% and 17% respectively in the first eight months.
Notwithstanding the prospects of tighter monetary policy in the US, the Fed remains cautious about rate hikes, and it is not expected to enter a rate hike cycle until 2023. Compared with some Asian and emerging markets, US monetary policy and financial conditions remain accommodative, which should support stock market performance.
Even current market valuations are higher than the five and ten-year averages, the positive earnings outlook may still prop up stock prices. Taking the S&P 500 as an example, earnings growth for the whole year could still exceed 40%, even if corporate earnings growth in the second half is slower than the first half. These factors bode well for US stocks.
Europe is another market we remain constructive on. Despite the continent’s slower vaccination rollout, the current coverage rate of over 60% has already surpassed that of US. While countries within the region continue to face the threat of virus variants, the number of new cases is relatively under control and countries with high vaccination rates are even planning to lift all restrictions. As the economy gradually opens up, consumption should drive Europe’s economy in the latter half of the year.
Rising inflation in the Eurozone has prompted the ECB to consider cutting back on bond purchases, but highly accommodative financial conditions should boost stock markets. In Germany, federal elections are set to take place this September and the Green Party may form a coalition government, giving rise to expectations of fiscal expansion domestically and within EU.
Europe has received large capital inflows this year, especially in the ESG sector. European stocks account for only a relatively small share of global market value but represent more than 30% of ESG assets worldwide. With improved corporate earnings, low inflation no longer affecting the economy and an influx of capital, these factors will put European stocks ahead of the pack in the short-to-mid-term.
Q: What is the strategy for China and HK stocks with the Mainland economy facing downward pressure?
A: Data from the third quarter continued to reflect a downturn in the Chinese economy, owing to the base effect subsiding, extreme weather and the new wave of confirmed cases caused by the Delta variant. Official manufacturing and non-manufacturing PMI in August fell to a one-and-a-half-year low, with the latter slumping to 47.5, indicating a contraction and Covid-19’s impact on market demand being more severe than expected.
A more in-depth look at the data shows that the service industry has been hit the hardest, as the sector’s PMI was knocked down from 52.5 in July to 45.2 in August, the first contraction since the coronavirus outbreak last February. Transport, catering, leisure and other pandemic-related fields were impacted the most. In fact, the economic data announced in July generally fell short of expectations, as industrial, consumption and investment indices all pointed to much slower economic growth compared with June.
On the whole, uncertainties arising from the pandemic, coupled with the possibility of significantly lower exports, consumption and real estate activity than the first half should put China’s economy under greater downward pressure. For the rest of the year, markets can expect enhanced policy support, aimed at keeping economic growth within a reasonable range. In terms of monetary policy, PBOC may take a more accommodative stance, reducing the required reserve ratio by 50bps once more by the end of the year, to ensure adequate liquidity. On the other hand, more stimulative fiscal policies should be on the horizon, such as expediting the issuance of local government special bonds, and introducing policies targeted at supporting SMEs.
As downward pressure on the economy intensifies, markets are anticipating a more relaxed regulatory environment for various industries. However, since the policies already in place are beneficial in the long run, we think they are unlikely to be relaxed. Recent regulatory policies in the Mainland show that if a sector is deemed harmful to public interest, or critical to policy goals, such as population growth and increasing disposable income per capita, the Central Government may put the concerns of society ahead of capital markets. Broadly speaking, we think Beijing will strive to achieve stability in the four main areas of banking, anti-monopoly regulation, data security and social equality. Since the sectors and stocks affected by such policies are mostly listed in Hong Kong or the US, China Concepts Stock listed in Hong Kong will continue to be affected by regulatory pressure in the short run.
To conclude, faced with economic slowdown in the second half, despite the introduction of more supportive fiscal and monetary policies in the Mainland, regulatory pressure on industries may trump market sentiment. HK stocks may be affected if southbound capital continues to experience outflows. Conversely, recent trading volume of A-shares has been high, there has been an increase in new investor accounts, margin trading and short selling has hit a three-year high, which reflects investor confidence in the China market. The current market valuation of A-shares is at the average level of the past ten years. Corporate earnings in the SSE Composite Index may grow close to 40% this year, far better than the single-digit growth of its HK counterpart. Conducive fundamentals, liquidity and market sentiment paint a relatively brighter future of the Chinese stocks.
(Written on 8th September 2021)
Senior Investment Specialist
Principal Asset Management (Asia)