A Brief on Global & Local Markets, Investment Strategy.

Week in Review | 12 – 16 June 2017

US Fed maintains hawkish outlook despite weaker inflation

To no one’s surprise, the US Fed continued to press forward with its normalisation of interest rate last Wednesday – which saw its target range raised for a second time this year to 1.00-1.25%. The Fed’s dot plot chart also remained unchanged from the meeting, and the board will look to hike another round before the end of 2017 and 3 more next year.

The central bank showed no intention of slowing down its rate hike cycle despite the weaker core CPI data released hours before the meeting. Inflation reading unexpectedly fell by 0.1% for the month of May vs. economists’ expectation of a 0.2% increase; marking a third straight miss.

Chairwoman Janet Yellen however reaffirmed the Fed’s hawkish stance amid slightly stronger growth projections and downward revision to its unemployment forecast. Yellen cited that the weak inflation reading was more of a transitory softness, but further highlighted that upcoming data points will be closely monitored to ensure that the central bank’s inflation target of 2.0% remains on course.

Despite all the hawkish rhetoric, many are still unconvinced that the Fed will be able to hike interest rates too rapidly. Currently, a December rate hike is only 37% priced-in and markets are expecting only one rate hike in 2018.

On a separate note, the Fed had also announced that it will begin to chip off its balance sheet should growth continues to be evident. According to reports, the central bank will start off by tapering USD 6 billion of UST and USD 4 billion of mortgage-backed securities (“MBS”) per month – and will look to gradually increase the amount.

While tapering would mean less liquidity in the market, we believe that any big impact is unlikely as the sum intended for tapering only amounts to about 1.0% of the Fed’s current balance sheet holdings.

Asian equity updates & positioning

Last week marks the 13th consecutive week of inflows seen into the EM basket; keeping emerging markets within Asia well buoyed. In the midst of the on-going consolidation, we have shifted our focus away from cyclical stocks and are currently more focused on companies that possesses solid fundamentals and long-term growth elements.

Additionally, we are also looking to add in on dividend yielding names. Inflation which have somewhat eased – and a lesser likelihood for a sharp rate hike – should lead to more demand for income. In light of this, we believe that high dividend stocks will continue to do well in the near-term.

REITs in particular have performed better in the last two months due to bond yields which have trended lower. While REITs stocks have had a slow start to the year, it has somewhat caught up with the general markets and we are seeing more interest in regional REITs – especially those within HK and Singapore which have done fairly well.

On a separate note, South Korea is also a market that we are optimistic on – stock valuations are relatively attractive; trading at single digit P/E as compared to its other ASEAN peers which are trading at about 15x P/E in general. Besides that, robust earnings among the nation’s large chaebols such as Samsung have been a positive force in propelling the Korean economy.

Furthermore, President Moon Jae-in – who was elected following Park Geun-hye’s impeachment last month – has sparked momentum for some corporate reforms. Improving governance with added transparency will likely result in more efficient corporate structures; gradually removing previous uncertainties and renewing investors’ confidence.

In fact, these developments are already beginning to lure foreign funds into the market. South Korea has perpetually been underweighted by global investors at about 3-5% below the MSCI Asia Index weight – but has since reversed to neutral in terms of weightage.

Our portfolio exposure in South Korea currently stands at about 14%, weighted mostly towards tech, financial and travel-related names.

Domestic market

The 1MDB investigation continues to be pursued as the US Department of Justice (“DOJ”) released yet another report on the probe; allegedly linking several Malaysian officials and individuals to scandalous emails, and unauthorised transfers of money.

In the past 3-4 years, the 1MDB issue has resulted in significant outflows from the Malaysian market. Hence, we will be re-evaluating our current position, given that the recent report has shed some new light on the case.

Additionally, the direction of the MYR will likely be dictated by market movements, but no panic selling has been observed thus far. Ultimately, the underlying economy is still fairly strong, and fundamental improvements within the market is still evident. Nonetheless, we intend to be more cautious moving forward, and have momentarily stopped our buying until more clarity can be obtained.

Fixed income updates

The fixed income space continues to be fairly stable at the back of stronger inflows. The 10-year UST yield rallied from 2.2% to a low of 2.1% last week amid a weaker core CPI reading. Albeit being at the lower-end of its range, it is still well within our estimates of 2.1-2.5%. Hence, at this level, we are still biased towards underweighting our portfolio duration.

Additionally, several of our funds which holds USD positions have benefitted from the greenback’s strength following the Fed’s move to tighten its monetary policy last week.

Nonetheless, we intend to tread ahead with more caution, but will also look to selectively participate in HY issuances against the current backdrop.

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