Principal Monthly Viewpoints (August 2021)
Q: Principal Asset Management (Asia) Investment Management Team
A: Crystal Chan, Principal Asset Management (Asia) Senior Investment Specialist
Q:With HK stocks lagging behind, what is the outlook to the market?
A: As China continues to tighten the regulatory regime, risk-off sentiment has spiked considerably in the Mainland as well as HK market. Volatility in HK stocks has surged from the end of June onwards. As of last week, 30-day volatility of the Hang Seng Index (HSI) exceeded its four-month high, the Index dropped from 28,800 to 24,700 at one point, with a decline as much as 15% within just a month, indicated the worst performer among the world’s major markets.
In fact, HK stocks lagged the broader market in the first seven months this year. The HSI recorded a -4.7% returns while the Hang Seng China Enterprises Index (HSCEI) dipped 14% on aggregate, the difference being attributable to composition of the two indices. In the property sector, real estate companies included in the HSCEI were primarily Mainland developers, some of whom were mired in debt. This sector dropped almost 18% YTD, impacting performance of the Index. Conversely, real estate stocks included in the HSI were chiefly local property stocks, which have risen nearly 7% this year so far.
With the Mainland’s policy outlook remaining uncertain, risk premium of stocks may continue to increase, while markets may remain volatile in the short run or even reached the new lows. However, with markets undergoing substantial corrections, digesting risk factors, and regaining an optimistic outlook on earnings, HK stocks have more room for recovery. If the HSI can return to 25,000, it may be able to recover its downside gap at 26,800, representing an improved outlook.
Despite slower economic growth in the second quarter, China’s main economic indicators, such as industrial production and fixed asset investments, were better than expected. Retail sales performed surprisingly well, indicating that the sector has not been impacted by sporadic cases of COVID-19 and restrictive measures. However, as the base effect and the Mainland property sector weakens further, normalisation of trades continues, and the growth of consumption slows, all these may lead to a greater economic downside risk in the second half. PBOC’s monetary policy is expected to remain neutral with accommodation throughout the year, which means sufficient liquidity, and that bodes well for equities.
Compared with other Asia-Pacific markets, Hong Kong’s economy has benefitted from steady implementation of its vaccination programme, which brought the pandemic under control. Besides, serval financial stimuli have already been in place, the economy should continue to recover, and earnings growth of local stocks may improve further. The P/E ratio of the HSI is currently projected at around 12x, which is more reasonable than other markets in the region or even Europe and US markets. Nonetheless, domestic stocks are still affected by external uncertainties such as inflation and monetary policies, while the lack of transparency in China’s policies will continue to plague markets for some time. We therefore have adjusted our outlook on HK stocks to neutral at the beginning of the quarter.
In times of greater market volatility, investors should make allocations on a sectoral basis, avoiding those directly affected by national policies, such as education, large tech platforms, real estate, and healthcare. On the other hand, sportswear, new energy, advanced manufacturing, and other sectors supported by policies may benefit in the short to medium-term. Among tech stocks, investors can beware of corporate that enjoy relatively stronger market demand and lower policy risk, such as hardware and chip companies.
Compared with the broader market, we currently prefer local stocks. The Consumption Voucher Scheme and steady implementation of the vaccination programme should boost the territory’s consumption, in turn benefitting local consumption stocks. With cross-border travel is set to reopen and supported by abundant liquidity, local property prices may rise further. Moreover, since real estate stocks usually outperform when inflation is on the rise, investors may pay attention to the sector.
Q: What opportunities exist outside of HK stocks?
A: Other stock markets around the world have been relatively resilient, especially mature markets. Despite markets once again plagued by COVID variants in the third quarter, and risk-off sentiment causing bond yields to decline in the third quarter, Europe and US stocks rose around 2% on aggregate in July, extending the strong trend displayed in the first half. Over the first seven months, US stocks rose 17% on aggregate, ahead of other markets, followed by European stocks which advanced 15.6%.
The pandemic remained the market’s largest uncertainty in the past month. Global seven-day average of new cases rebounded from roughly 300,000 cases daily at the end of June to nearly 600,000, with confirmed cases in 87 countries still on the rise. With the virus variant spreading at a faster rate, the seven-day average rebounded to above 60,000 with the US once again became the country with the most confirmed cases.
Nevertheless, with the vaccination rollout gaining momentum, global seven-day average number of deaths fell consistently to this year’s low point. As of last week, over 4 billion doses of vaccine have been administered globally, and roughly 26% of the world’s population has received two doses of vaccine. Based on these steadily rising numbers and the current pace of vaccination rollout, herd immunity may be achieved by the first quarter of next year.
The continuation of monetary accommodation around the world this year, stimulating fiscal measures， steady rise of administered doses and the global vaccination rate have enabled the economy to recover from the pandemic. US economic growth during the second quarter was 6.5%, with total scale of the economy returning to pre-COVID levels. Looking ahead into the second half, multiple rounds of fiscal stimuli have triggered a transfer of wealth. The savings ratio of US citizens is significantly higher than pre-pandemic levels, which could unleash the potential spending power for goods and services. Consumption expenditure, accounting for two thirds of economic output, will hopefully continue to drive US economic growth. However, it remains to be seen whether employment and supply restrictions would hinder economic recovery.
In Europe, faster vaccination rollout and multiple countries lifting lockdown measures have enabled the Eurozone economy to recover rapidly, as indicated by the composite PMI hitting a 20-year high in July. Despite the constraints EU faced in boosting the scale of its fiscal measures, the ECB will maintain its proactive monetary stimuli for some time. Under the new forward-looking inflation guidelines, emergency debt purchasing programmes may even be prolonged, which is positive for the economic outlook.
Looking at fundamentals, corporate earnings are still supporting the upward trend of equities. If we consider the actual and predicted earnings of the S&P 500 up to last week, corporate earnings may grow 75% YoY in the second quarter, reaching a new high since the fourth quarter of 2009. Faced with rising earnings forecasts, 88% of companies that have announced their earnings have exceeded expectations. These companies spanning from finance, healthcare, technology to communication sectors and more.
To conclude, despite facing various risks, mature markets from Europe and the US are less prone to policy risks than Asia and emerging markets. With the economy performing well and support coming from accommodative monetary policy and financial conditions, stocks performance should be positive. During the quarter, 10-year yield of US bonds is not likely to rebound substantially. This could benefit tech stocks with abundant cash flow and stable earnings prospects. In particular, US tech stocks may lead the S&P 500 and Nasdaq to record highs.
Q: Will plummeting actual yields trigger stagflation?
A: Relatively weak market sentiment in stocks has caused investors to turn decidedly risk averse, while the spread of COVID variants has resulted in rebound of the confirmed cases. Markets were thus worried that the global economic recovery may be impeded once more, resulting in capital flowing into bonds because of risk aversion and the government bond yields falling. Disregarding the effects of inflation, real yield of 10-year US Treasuries dropped to a historic low of -1.16% at the end of July; real yield of 10-year German Bunds declined even further to -2%, also a historical new low. Tumbling real yields and consistently rising inflation have sparked concerns over stagflation.
Stagflation is an economic phenomenon where low growth and high inflation co-exist. As the vaccination rate continues to rise steadily, a resurgence of COVID cases has triggered market concerns that new lockdown measures will result in higher savings rates and lower consumption expenditure, hampering economic recovery. Meanwhile, due to the low base effect and disruption in supply chains, June CPI in the US was up 5.4% YoY, a new high since August 2008. Stagflation investment themes may benefit bond prices in developed countries, commodities such as gold and certain large tech stocks.
However, we believe it’s too early to be concerned about stagflation. While the global economy may have peaked in the second quarter, the overall trend of recovery should remain unchanged. Despite highly contagious COVID variants undermining their effectiveness, vaccines should be able to substantially lower the ratio of severe cases and deaths, thereby avoiding a new round of extensive lockdowns which would obstruct the recovery process.
Despite inflation remaining high or even going up in the short run, it is expected to decline in the medium-term, i.e., the high inflation environment should only be transitory. In the US, rising second-hand vehicle prices and low base effect of energy prices boosted June CPI. Excluding these factors, inflation in June was basically unchanged from May. We are of the opinion that with supply chains returning to normal and employment markets warming up, the pressure on prices should be gradually relieved.
With the economy recovering and inflation on the rise, investors should monitor the Fed’s pace of tapering. In the recently concluded July FOMC meeting, the timing, frequency, and method of cutting down bond purchases were extensively discussed. We believe Fed Chairman Powell may clearly state his intention of tightening policy at the Jackson Hole Symposium in August, and officially put the plan in motion by the end of this year or early next year, depending on the progress of recovery. Since liquidity is expected to tighten in the future, real yields may rebound from their trough, propelling yields to trend upward again.
(Written on 4th August 2021)
Senior Investment Specialist
Principal Asset Management (Asia)