Fed Prepares for the Big Unwind

Flash Points:

  • Fed balance sheet unwinding to be gradually unwounded with initial reduction caps
  • Inflation picks up in August, breaking 5-month streak of sluggish data
  • Market positioning still seen tilting towards dovish stance with only rate hike priced-in until 2018
  • Leadership uncertainty at the Fed prompts policy continuity risk

All Eyes on Fed September Policy Meeting

The US Federal Reserve is scheduled to meet for its upcoming policy meeting on September 19 – 20 to discuss the current economic climate and decide on further monetary policy adjustments.

Although there is no expectation for a change in interest rates during this month’s policy meeting, it still holds particular importance to markets.

Central bank watchers are eagerly anticipating the Fed to finally pull the trigger and begin the unwinding process of its US $4.5 trillion balance sheet – a culmination of its massive bond-buying programme which it accumulated following the 2008 GFC.

The Fed has previously said in a recent communique that it will start the unwinding of its balance sheet “relatively soon”.

Most observers have interpreted this statement to mean that an announcement will be forthcoming at its upcoming September policy-meeting or latest by this year-end. The unwinding exercise is then slated to begin in the month subsequent to the announcement.

Impact to Markets – Don’t Hold Your Breath

Whilst some observers are rightfully anxious over this perceived squeezed liquidity and a possible end of the easy-money era which kept the economy afloat since the 2008 GFC – markets aren’t necessarily holding their breath or bracing for any large corrections.

The unwinding exercise will be gradual in nature, in line with the Fed’s mandate to placate markets and ensure that the economy continues to chug along at a moderate pace of growth.

The initial reduction caps of its balance sheet will be gradually unwounded by US $6 billion per month for US Treasuries (UST) and US $4 billion per month for mortgage-backed securities (MBS). Subsequently, it then follows a step-up schedule to increase the cap by US $6 billion for UST and US $4 billion for MBS by every 3 months respectively.

Eventually, after a year from inception, the Fed is then expected to increase to maximum reductions caps to US $30 billion per month for USTs, and US $20 billion per month for MBS.

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When Is a Stock Too Expensive?

Flash Points:

  • Defining what’s expensive is relative
  • Paying a high multiple is sometimes justified
  • Buy on fundamentals not valuation
  • However, valuations are a useful gauge for timing

Bargain Hunting for Stocks

Picking stocks often becomes an arduous affair, replete with decisions and choices. For some, it’s a daily occurrence, akin to second nature.

With the increasing number of platforms made available today, investors can now access various markets & exchanges – thus being easily left spoilt for choice.

But a recurring question investors commonly ask is when a stock becomes too expensive?

Put more simply, we all know when we are overpaying for items like smartphones, clothing, laptops, etc. – we check against the quality of the material, brand recognition, its unique features and utility value.

But how can investors evaluate the same for stocks and determine when you’re overpaying for one?

What do we mean by ‘expensive’?

If one believes the Efficient Market Hypothesis (EMH) which states that the price of assets will factor-in or discount all available information – then the value of a stock should be reflective of its fair value at that point in time.

It does not mean that one cannot make money from stocks trading at their fair value – as long as the underlying business continues to grow, we believe its share price will chart higher to reflect the improved growth.

In other words, the fair value increases over time as its business grows.

Sceptics may argue against EMH, but markets tend to be fairly efficient and react to these positive or negative catalysts accordingly.

Factors like a loss of key management personnel or major customers, adverse regulation, natural disasters, etc. can affect the firm’s fundamentals and its ability to deliver earnings growth.

We think a stock is deemed ‘expensive’ or overvalued when its valuation is not reacting fast enough to these negative changes.

Or the value ascribed runs ahead of its fundamentals & earnings growth potential.

Alternatively, one could also take a different view from what the market thinks due to different interpretation of facts governing the fair value of the stock.

Thus, defining whether a stock is ‘cheap’ or ‘expensive’ is relative and depends on more than just the valuation itself.

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More Compelling Reasons for Malaysia

Flash Points:

•Improving economic fundamentals and robust exports to underpin growth

• Property and banking sector poised for turnaround

• Ramping-up of infrastructure and new economic drivers to fuel growth

• Prospects of further China Investments and bilateral led initiatives to sustain construction job flows

More Compelling Reasons for Malaysia

Against a benign economic backdrop of moderate growth, gradual interest rate hikes and mild inflation – markets especially in Asia are poised to stage one of their best rally this year.

As at 30 June’17, the MSCI Asia ex-Japan index returned 22.8% becoming one of the best performers in the region so far. For the first time in 5 years, there is also a positive earnings revision for Asia markets, with earnings-per-share (EPS) being revised upwards between 15% – 20% for 2017.

Growth in corporate earnings continue to be underpinned by improving macro-optimism and rebound in the region’s growth with strong exports. Spearheaded by a more outward-looking China, this Asian growth-led renaissance is expected to positively spillover to other markets in the region including Malaysia.

Malaysia Leads Export Race

Locally, the FBMKLCI is charging towards 1,800 points level – lifted by improvements in economic fundamentals with 1Q’17 GDP growing 6.6% y-o-y, despite higher inflation & high household leverage.

Sustained export growth on delayed reaction to the cheap Ringgit is expected to underpin growth. Compared to regional peers in Southeast Asia, Malaysia is leading the export race  with shipments accelerating to a 7-year high of 32.5% in May’17.

Data from Statistics Department also showed that exports to China rose 51.5% y-o-y, its highest increase since on higher demand for electrical and electronic (E&E) goods and petroleum products. The cheaper Ringgit obviously playing a key-role in making exports cheaper, despite strengthening somewhat in the 2Q’17.

Bank Negara Malaysia (BNM) recently maintained its overnight policy rate (OPR) at 3%, whereby it cited receding inflation risks and struck a more sanguine economic outlook at its monetary policy meeting in July – leading most economists to believe BNM will keep the benchmark rate unchanged for the rest of the year, or risk derailing this bourgeoning economic recovery.

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Sea Change in South Korea

Flash Points:

  • Wave of reforms sweep South Korea on back of new administration
  • Government unveils US$ 10 billion fiscal package
  • Measures to enhance corporate governance and transparency of chaebols

Structural Reforms in South Korea

In the wake of President Moon Jae-in’s victory at the South Korea presidential election last month, Moon has positioned himself as a pro-reformist – determined to unite a country torn by bitter divisions after a long-drawn corruption scandal that engulfed a nation.

Former president Park Geun-hye who was impeached and removed from office is now undergoing trial for corruption and for misusing her position to gain personally.

With the scandal now behind the country, South Korea could see a sea change of events which may spell positively for the country in terms of investment opportunities.

Big Test Ahead for Moon Jae-in

Son of North Korean refugees – President Moon campaigned under a pro-reform agenda to clean up corruption and take on the powerful family-run chaebols which traditionally held strong government sway.

The 64-year old, who practiced human rights law before turning to politics, served as chief-of-staff to former president Roh Moo-hyun back in 2004.

A left-leaning Democrat, Moon easily won the election securing 41% of the total votes, beating other conservative and centrist candidates.

Whilst global attention was fixated on mounting tensions between North & South Korea, ultimately it was the economy and concerns of governance that lingered on the minds of South Koreans as they head to the ballot box.

Youth unemployment was a national concern, reaching 11.2% in April which is twice the national unemployment rate.

Rising inequality was another focal point, whereby it was highlighted that the top 20% of income-earners in South Korea made 9.32 times more than those in the bottom 20% as of end-2016.

South Korea’s 1Q’17 GDP reading was revised upwards to 1.1% from 0.9% initially, largely from gains in the construction sector and higher exports.

However, private consumption grew just 0.4 % in the same quarter which was well below overall economic growth.

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Give Yourself a Mid-Year Financial Health Check

Flash Points:-

• Review of budget may reveal wasteful expenditure

• Start planning your taxes early to optimise reliefs & deductions

• Consider tweaking your investment portfolio if allocation of asset-class has deviated from set target

• Insurance coverage should be proportionate to wealth and needs of dependents

Importance of Financial Reflection

It’s hard to believe but we are already midway through 2017. For some, it’s that mid-point where we start reassessing our life goals, careers, and even New Year’s Resolutions to start losing weight and eat healthy.

We start scheduling multiple doctor appointments to complete a myriad of tests, experiment with the latest food fads, start working out in the gym, etc. But, what about our own personal finances and overall financial well-being?

The idea behind a financial health check-up, should not be a concept as alien as paying your own local GP a visit. But sadly, it is something most of us tend to neglect.

Is Your Budget on Track?

There is no better time than to start revisiting your monthly income and expenditure – specifically if they are on track and within what you initially budgeted for the year. If you happen to veer off course, don’t worry – you still have six more months remember?

One of the most crucial aspect of budgeting strategies is periodic monitoring & review – especially to identify why your budget missed its mark. Often, a re-evaluation of your budget may be necessary to cater to new circumstances or changes in one’s lifestyle.

Example, you would definitely need to reconstruct your budget to accommodate a new addition to the family (eg. marriage or birth), a workplace accident, or injury, etc.

The next step is devising a corrective action or control mechanism in your daily spending patterns or saving habits to steer your budget back on course.
It may also be worthwhile to drill into specifics and examine single line-items, to find out where one can cut costs and minimise wasteful expenditure.

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Singapore REITS: More Long-Term Value

Flash Points:-

• Yield spreads for S-REITs most attractive in region at 4.4%

• Less impact seen from rising interest rates

• Higher DPU growth potential for office, business parks and hospitality REITs

Switching Gears, But Don’t Forget the Brakes

Whilst, we are seeing a collective shift globally to a risk-on approach against expectations of higher earnings and a global economic recovery – investors should not neglect to also stack-up on defensive asset-classes, should markets come to an unruly end.

Asian REITs are such possible defensive asset classes, particularly Singapore REITs (S-REITs) – as they continue to perform well and offer one of the most attractive yield spreads (Dividend Yield – 10Yr Bond Yield) at 4.4% in the region.

More distribution per unit (DPU) upside is also seen from further asset rejuvenation projects, redevelopments and a consolidation theme in the industry.

Limited Impact Seen From Rising Interest Rates

In 2016, S-REITs outperformed the broader STI index, rallying by over 11% until Sept’16, as prior expectations for interest rate hikes were dialled back due to key risk events that occurred in 2016 like Brexit, a further correction in crude oil prices, and persistent negative interest rates in Europe and Japan.

However, with improving economic fundamentals, as well as anticipation of further pro-growth policies under the new Trump administration – we saw interest rate expectations starting to pick-up again.
Taking these cues, the Fed raised rates by 25bps in its Dec’16 FOMC meeting – causing equity markets to rally overall post US-elections, as funds ploughed back to riskier assets. Consequently, we saw a correction in prices of REITs.

Generally, REITs do not perform well under an environment of rising interest rates. As US Treasury rates rise, the yield differential (or yield spread) between US Treasury bonds and REITs will narrow. Thus, REITs will appear less attractive, as investors will now seek higher yields to offset the risk taken for REITs compared to treasury bills which are considered risk-free.

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Will Trump Be Impeached?

Shock and Awe at the White House

Four months into office, US President Donald Trump has said and done a lot of things

Some more baffling than others, but never devoid of the shock value that has coloured his presidency, keeping both the media and market observers on edge.

However, his most damaging act had come from his recent decision to fire FBI President James Comey, as well as latest allegations that Trump was also responsible for leaking classified information to Russian officials during a White House briefing.

Although any concrete evidence is absent at this point, many are speculating that Trump’s decision to fire Comey was an attempt to halt FBI investigations into Russia’s possible interference in the US elections.

Trump’s critics have railed against his actions and have called for his impeachment. But just how likely is this to happen and its implications to markets?

Impeachment Explained

To impeach a president is to remove a sitting president from office, stripping away one’s powers and be officially declared unfit to serve

Under the US Constitution, a president can be impeached specifically under two charges, i.e. treason and bribery. The Constitution also contains a broader clause to remove a president for other acts of “high crimes and misdemeanours.”

As most proceedings usually are, the impeachment process is a lengthy and complicated one. Firstly, the process must pass through the House of Representatives, where a simple majority is needed for an article of impeachment to be approved – with each article bearing a charge against the president.

Following which, the proceeding then moves on the Senate with a trial presided by the Chief Justice of the Supreme Court.

Finally and most crucially, it must obtain a two-third majority vote from the Senate to convict the president on any charge.

By all accounts, securing two-thirds of the Senate, i.e. 67 votes is no easy feat and would need the buy-in from both Republicans and Democrats that the president had indeed commit those alleged crimes.

Thus, charging and impeaching a president cannot be entirely a partisan exercise.

Currently, both the House of Representatives and the Senate are majority-controlled by Republicans and given that they probably still need Trump’s working class support base to retain power, it is unlikely that there would be enough votes to impeach Trump in congress.

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China Beckons: One-Belt-One-Road (OBOR) Summit

OBOR to Export Overcapacity and Improve Relations

As China prepares to host its inaugural One-Belt-One-Road (OBOR) summit on 14-15 May in Beijing, global leaders are bracing for a more outward-looking China that is ready to expound upon its influence and increase regional co-operation.

The forum will see leaders and heads-of-states from 28 different countries, as well as more than 1,200 industry experts and business leaders from across the region attending. First mooted by Chinese President Xi Jinping in 2013, the initiative has a collective aim to spearhead trade & economic integration across Asia, Europe and Africa – creating a revamped version of a Modern Silk Road.

Approved funding for OBOR projects from the Asian Infrastructure Investment Bank (AIIB) and the Silk Road Fund (SRF) totaled RMB 11.8 billion (USD$ 1.71b) and RMB 23.5 billion (USD$ 3.4b) respectively since 2015. As of Feb’17, China has built 56 Economic Co-operation Zones (ECZ) in 20 OBOR nations with a cumulative investment of USD 18.5 billion and generate on average 4,500 jobs per ECZ.

Xi’s OBOR initiative will enable China to export some of its overcapacity while advancing relations with participating countries.

Warming US-China Relations

We are also witnessing a new era of close personal relations between the two largest economies, i.e. US and China. Following Chinese President, Xi Jinping’s visit with US President Donald J. Trump, the latter has discarded his anti-China rhetoric and focused instead on family ties – charming Xi and the Chinese public’s opinion when his grandchildren Arabella and Joseph performed a traditional Chinese song and recited poetry for Xi during his visit to Trump’s Mar-a-Lago Resort in Florida.

Post-visit, both parties claimed to have reached a common understanding and vowed to work towards establishing good, working relationships. Both leaders repeatedly advocated the use of close communication and co-ordination to resolve major international and regional issues.

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The Diversification Effect

No two people are the same. To some extent, this phrase applies to those in the investment world. However, while each investor would have respective tendencies, preferences and even approaches; at the very core, the fundamental idea of investing remains the same – to consistently grow and preserve wealth. Then again, this is easier said than done.

It is often said that death and taxes are the only two guarantees in life. In the investment world however, another two guarantees are observed: (1) change is constant; and (2) every cycle has its ups and downs.

While one can be working hard to identify opportunities, sometimes downturns and market corrections may hit without so much as a hint. Against such backdrop, it makes eminent sense to work around a diversified portfolio as opposed to timing the market in attempts to handpick the “fastest horse”.

No matter how safe or strong the conviction may seem to be, there is a simple logic behind not placing all your eggs into one basket. For instance, different assets may have varying reactions to changing market conditions. It is not uncommon for winners from a particular year to become underperformers in the next, and vice versa. Thus by diversifying your investments, you are more likely to soften the impact on the downside, and may even open doors to unexpected gains from cyclicals.

Some of the common approaches to diversification that comes to mind may include investing across asset classes, sectors, and geographies. In this article however, we intend to focus on one aspect that is often overlooked – currency diversification. Now this does not refer to trading in the FX market per se, but rather building a portfolio with a well-balanced currency exposure; such as by investing in domestic and foreign assets.

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The Gloomy Ringgit

Summary

  • The Ringgit lost approximately 2% week-on-week against the US Dollar.
  • Therisk-off sentiment expanded globally, hurting Emerging Market(“EM”) currencies.
  • Outflows from bond markets exacerbated the weakness in the local currency.

Commentary

The Ringgit lost approximately 2% week-on-week against a strong US Dollar following Donald Trump’s surprise win in the US Presidential Elections.

This was not just a Malaysian phenomenon, as a risk-off sentiment shockwave was sent globally, hurting Emerging Market (“EM”) currencies as markets attempted to assess the impact of the next US president’s pro-growth fiscal policies coupled with his intention for stricter trade deals.

The US Treasury (“UST”) yield curve began steepening at a rapid pace as investors’ expectations were stoked by expansionary fiscal policy taking over from what has been a loose monetary policy for the longest time. The 10-year UST yield rose to 2.15%; a move of more than 40bps in the two days following the results of the elections. Within the same time frame, we have seen Malaysian bond yields rise by almost 30bps across the curve, practically mirroring the movement in USTs. After having seen strong foreign participation into the local bond market over the year, we noted foreign selling interest this time around.

We think that these movements are dictated by the unwinding of the carry trade, of which there is heavy and profitable positioning through the year. Though still unquantifiable at the time of writing, the outflows from the bond market has exacerbated the weakness in the Ringgit as investors reduced their positions in both the bond market and our local currency.

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