A Brief on Global & Local Markets, Investment Strategy.
Week in Review | 8 – 12 October 2018
Brexit deal falters over Irish border
The Brexit saga continues to unsettle markets across Europe, as recent negotiations between the UK and EU on Sunday were left without a conclusive deal; thus stifling hopes for the “divorce” agreement to be finalised by the critical EU summit slated this Wednesday.
Following the impasse, UK’s chief negotiator Dominic Raab and his EU counterpart Michel Barnier both emphasised that real progress have been made in a number of key areas, but have also highlighted a number of unresolved topics – including the Irish border issue; which have been a bane to both parties for many months now. Post-Brexit, Northern Ireland will stay as part of the UK, while the Republic of Ireland will remain as an EU member state.
The outcome is hard to predict at this point. Although a soft Brexit – where the UK and EU maintains close trade relation – is still on the cards, however there is growing unease that both parties may not arrive to a deal before the UK leaves the EU in March 2019. A “no deal” Brexit would bring heavy downside implications to both economies.
The GBP has stayed relatively sanguine in recent weeks, although it did soften against the USD at opening this week.
Asia tumbles on rate fears & geopolitical risks
Global equity markets including Asia extended its rout last week primarily driven by a sharp spike in US Treasury yields; in which yields the 10-year benchmark rose by 20bps. It was one of the largest broad-based market pullback in the last 15 years caused by a spike in yields. This coupled with lingering US-China dispute – that was exacerbated by allegations of the use of spy-chips by China, espionage, election meddling, and the arrest of a Chinese intelligence officer – compounded fears for markets resulting in a risk-off mode. The Hong Kong Hang Seng index slipped by 2.9%, whilst the broader MSCI Asia ex Japan index fell 3.0%.
Rising geopolitical tensions
Bloomberg Businessweek reported that investigators have found Chinese microchips implanted into servers sold by US-based Supermicro, a leading supplier of server motherboards. These chips were allegedly inserted at factories operated by Supermicro’s subcontractors in China and reportedly ended up in almost 30 US companies – including giants like Apple and Amazon – which purportedly sent data signals back to China.
Added to the mix are escalating frictions between US and Saudi Arabia over the alleged disappearance of journalist Jamal Khashoggi who was never seen again since entering the Saudi consulate in Istanbul. Turkish investigators believe he was murdered and body removed from the building. Khashoggi, a US resident and Washington Post columnist has written critically of Saudi Arabia’s policies and its Crown Prince Mohammed bin Salman who is widely believed to be leading a series of purges in the kingdom of political and business leaders.
US President Donald Trump has threatened “severe punishment” against Saudi Arabia if the allegations were found to be true, with the Kingdom issuing its own threat to respond with “greater action” if there were any attempts to do so.
Crude oil prices may find support from this rift between the US and Saudi Arabia through possible oil cuts or sanctions. Crude oil has been on a rising trend this year and has rallied by over 18.0% YTD. Firmer oil prices may exert fiscal stress on the rest of EMs especially net oil importers like India and Turkey; which may add to further pain for their respective currencies.
Earnings, valuations & positioning
3Q2018 earnings season has begun in the US with banking and financial names reporting better than expected results thus far. Earnings growth for the full year is projected to reach mid 20.0% range boosted partly by tax cuts.
On the flipside, we are still seeing earnings downgrades within EMs amidst a broad economic slowdown in the region. Earnings growth forecast has been revised downward from the 14.0-15.0% range to 12.0% for Asia ex Japan; though there could be room for further downgrades this year particularly if ongoing trade tension spirals for the worse.
The drawdown in the past one week has brought valuations down for markets with Asia ex Japan trading 10.9x forward P/E which is close to one standard deviation below its mean. Valuations in ASEAN are trading with a forward P/E multiple of 13.5x. With still room for further downgrades of forward earnings estimates, this could raise the P/E ratio upwards, making valuations appear less attractive then.
On portfolio positioning, we remain cautions given an incrementally volatile market environment especially as developments are still evolving. Capital protection of our portfolios will take precedence in this risk-off environment. We’ve trimmed our exposure in Tencent over regulatory concerns surrounding its gaming approvals and continue to avoid the tech hardware space which sold-down across the board last week over fresh allegations of spy chip insertions by Chinese manufacturers.
Updates on Malaysia
On the domestic front, the local market fell in tandem with regional markets, with the benchmark KLCI closing 2.6% lower. Market watchers seeking for direction on future growth policies by the New Pakatan Harapan (“PH”) government at its investor conference aptly themed “Malaysia: A New Dawn”, were instead greeted by forewarning of higher & new taxes in speeches laid out by the Prime Minister Tun Dr. Mahathir and Finance Minister YB Lim Guan Eng.
Coming Budget 2019 as a “budget of sacrifice”, the finance minister added that new tax measures will be announced during its tabling in Parliament on 2 November 2018. According to estimates, an increase in the corporate and individual tax rate by 2.0% would generate RM8-10 billion of additional tax revenue collections. This could knock-off earnings growth for corporates by 2.0-3.0% in 2019.
Speculation has mounted if the ministry would introduce a capital gain tax or inheritance tax in its budget, though sources have told The Star that any new tax measures would instead focus on the digital economy and reviewing tax incentives.
The Finance Ministry is seeking to cover a shortfall in its coffers from scrapping GST and to pare down its debts through spending cuts in various infrastructure projects. It was also added that asset sales and further divesting of stakes in GLCs may be necessary to raise funds to pay off borrowings.
Markets were spooked by the stake divestment news flow especially given the perception of the apparent lack of GLC support to shore up the local market especially in more volatile conditions. Malaysia holds a distinct characteristic of being a more stable and low-beta market especially due to the participation of GLCs that count for approximately 60.0% of traded volumes. Valuation premiums across various sectors should retreat if GLC participation were to be broken down.
Cash levels across our domestic portfolios range within 30.0-35.0%. While the recent sell-down has brought down valuations to more attractive levels, we see no fundamental need to increase our exposure at this juncture given the level of volatility in markets and the lack of growth catalyst.
Fixed income updates & positioning
The sharp spike in Treasury yields last week sparked a widespread risk-off tone across global financial markets – and the Asian fixed income space was no different.
Notably within the Chinese corporate segment, Shimao Property Holdings Ltd. returned from the Golden Week break with a two-tranche bond offering. Demand for the issuance was however lacklustre, which prompted the real estate company to drop one of its tranches soon after. Moreover, the cautious sentiment was also reflected in the secondary market; where credit spreads have seemingly widened in part due to aggressive short-selling activities by hedge fund managers.
Despite evident market strains, China’s Ministry of Finance proceeded to market its three-tranche new dollar bond – totalling US$3 billion – on Thursday. Many perceived the offering as an attempted vote of confidence in creditworthiness by the Chinese government in light of the softer sentiment seen. The bonds were offered at higher premiums, where yield for its 10-year tranche was set at 45 bps over the Treasury benchmark. Orders for the said issuances were reportedly over US$15 billion.
In the coming weeks, we expect to see more new issuances rolled-out from the Chinese space – namely across banks, corporates, as well as their local government financing vehicles. Nevertheless, we are refraining from redeploying too heavily at this point, and will look to gradually enter the market upon dips; particularly for short-dated papers and HY names. Currently, our Asian portfolios still sit on 8.0-10.0% cash, while duration is kept short at approximately 3 to 4 years.
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