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Wealth Management Head
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Economist Global Treasury - Research and Strategy
The US Federal Reserve (Fed) surprised markets in June by discussing when to taper its quantitative easing program. The central bank also forecasted that interest rate hikes may begin in 2023, earlier than it had before. Despite its hawkish tweaks, the Fed is only likely to exit its dovish policies gradually - starting with slowing its bond buying from early 2022. The Fed’s caution dan prudence should keep benefiting risk assets for the remainder of 2021, while maintaining their current fed funds rate at 0.00% - 0.25% and still buying USD$120 billion worth of bonds per month to support its economy.
Domestically, the insurgence of the COVID-19 Delta variant has been the most prominent news in the month of June; with many experts stating that an extra vaccine shot should be considered in order to gain extra protection from the new variant. Earlier this month, the government introduced a new measure to decrease domestic mobility called “Pemberlakuan Pembatasan Kegiatan Masyarakat” or “PPKM”, with Emergency status that is to be applied from the 3rd of July until the 20th to subdue the COVID-19 infection rate.
In regard to economic data, the mostly watched was the inflation numbers for the month of June that saw a decrease from 1.45% to 1.33%. June’s PMI Manufacturing also recorded a slight decrease, from 55.3 to 53.5. At its June meeting, the Bank of Indonesia held the 7-Day Reverse Repo Rate at 3.50% as expected. However, ever since that June meeting, daily new cases have jumped almost three-fold. Therefore, the July meeting of Bank Indonesia will be an event closely watched event, as investors will want to know more of what steps will be taken in regard to monetary policy in the coming months.
In the month of June, the JCI moved rather sideways in range of 5,950 – 6,100, closing the month just up 0.64%. The biggest threat currently for the stock market is the probability of a full lockdown, which the government appears to be trying so hard to evade. With the spike in daily new cases last month, investors adopted more of a wait & see stance rather than a panic selling attitude. Looking forward, calm, and opportunistic investors will be looking to bargain hunt stocks on underperforming sectors in June such as the transportation & logistics (-6.72%), properties & real estate (-5.54%), and consumer non-cyclicals (-3.39%).
The planned IPO for GoTo and Bukalapak next month will also be the focus of investors as it would spearhead the technology revolution in Indonesia, helping to shift the Old Economy into the New Economy. We still see there is substantial upside in the stock market, with a year-end projection of 6,400 – 6,800.
The bond market recorded a loss in the month of June. The 10-year government bond yield went up 2.62% to close the month at 6.59%, levels last seen in April. The move was propelled by a variety of factors such as the COVID-19 Delta variant that dampens sentiment, and the depreciation of the Rupiah. However, foreign investors still recorded an inflow of Rp 18.07 trillion in June which means that most of the selling action is dominated by domestic investors. With a relatively higher Real-Yield offering by domestic bonds, we believe that the bond market should still be supported for the remainder of 2021. We still maintain our previous year – end projection for the 10-year government bond yield at the range of 6.15% - 6.50%.
The Rupiah depreciated against the USD for as much as 1.54% last month, moving in tandem with the Dollar Index (DXY) that went up from 89.8 to 92.4 by the end of the month. As inflation and tapering fears in the US have supported the US Dollar, it has in return applied pressure to the Rupiah. Moreover, the current situation surrounding COVID-19 in Indonesia is also a concern for investors, as it would derail the originally planned recovery path of the economy. Hence, volatility for the USDIDR will persist in the coming months. We expect the USDIDR to close out 2021 in the range of 14,300 – 14,500.Juky Mariska, Wealth Management Head, OCBC NISP
Despite hawkish tweaks at its June policy meeting, the Fed is only likely to exit its dovish policies gradually - starting with slowing its bond buying from early 2022. – Eli Lee
Since the pandemic first emerged in early 2020, massive monetary easing by the Fed and other major central banks have helped the world economy start recovering from the shock of the COVID-19 virus.
But central banks are now starting to gradually exit their ultra-loose monetary policies as vaccinations allow lockdowns to be lifted and economies to reopen.
At its June meeting, the Fed surprised financial markets by making hawkish tweaks to its overall dovish stance.
The FOMC published new economic forecasts showing that the median - or average - member of the Fed’s decision-making committee now projects the central bank to start lifting its fed funds rate in 2023 by two 25bps increases - rather than waiting until at least 2024 before considering increasing interest rates.
Equity markets and other risk assets turned more volatile immediately after the Fed’s meeting in June. Long-term 10Y and 30Y yields fell towards 1.45% and 2.00% respectively as investors marked down future growth prospects.
Despite the hawkish tweaks, we think the central bank’s leadership remains more dovish than the new median FOMC forecasts imply.
Following the adverse market reaction to its June meeting changes, Chairman Powell stressed the Fed would remain patient to enable a full US recovery. Interest rates would not be lifted prematurely until the Fed thinks that employment is too high or because it fears the possible onset of inflation.
Our forecast for 10Y yields, however, is still 1.90%. The strong US recovery, buoyant risk assets, Fed tapering and increases in inflation as America reopens are set to push the benchmark Treasury yield closer to 2% over the next 12 months.
Despite the Fed’s tweaks in June and our own interest rate forecast changes, the macroeconomic outlook remains supportive risk assets this year. Treasury yields are set to stay low by historic standards.
The Fed’s moves, however, have increased expectations that the central bank will start to exit its ultra-loose stance sooner rather than later. Its changes are thus likely to increase volatility in risk assets for the rest of 2021 even if the Fed does not begin tapering until early 2022.
As policymakers start to stage their gradual exit from record levels of stimulus, we believe the outlook for returns on risk assets over the next 12 months remains positive but lower, with greater scope for market volatility. – Eli Lee.
In the second half of 2021, many investors are asking whether we will see a continuation of the bull market in risk assets or fall into a bear market. We believe the reality is likely to be far more nuanced. As policymakers start to stage their gradual exit from record levels of stimulus, we believe the outlook for returns on risk assets over the next 12 months remains positive but lower, with greater scope for market volatility.
Despite fears of the economy approaching peak growth, strength on the consumer and capex fronts leaves us still cautiously optimistic on the prospects for US equities.
Although we had mentioned that the picture for Europe continues to improve, with progress in the vaccine roll-out and reopening optimism, we will be closely monitored for any pick-up in Covid-19 cases that may result from the Delta variant.
While investor sentiment has been weighed down by the modest pace of vaccinations ahead of the Summer Olympics starting on 23 July and the extension of a state of emergency to contain Covid-19 through 20 June, we believe an acceleration in the pace of vaccinations in the coming months could help narrow Japan equities’ year-to-date underperformance relative to world equities
Earnings revision for Asia ex-Japan remains on the uptrend, although we note that momentum has moderated. According to Refinitiv consensus forecasts, earnings per share (EPS) growth for FY21 is projected to come in at 37.1% (as of 23 June 2021), versus 35.4% at the end of May this year.
The Energy sector continues to perform and has led the pack year-to-date. Buoyed by higher oil and natural gas prices, optimism has returned but too much of a good thing would be self-defeating if marginal suppliers are encouraged to activate wells again.
Another sector that we have had a positive view on is Financials, and it is the second-best performing sector year -to-date. For the Technology sector, which is all about innovation and disruption, we have been seeing increasing interest in various segments. For instance, Chinese internet related companies are trading at more attractive valuations.
In fixed income, we remain overweight in Emerging Market High Yield bonds, where valuations still look relatively attractive and should offer a buffer against the adverse impact of rising rates compared to other credit segments. – Vasu Menon.
Rates remained rangebound as investors weighed the copious positive economic releases against the potential adverse impact of the Delta Covid variant. A stable interest rate environment proved salutary for Credit, which saw spreads continue to grind tighter. Going forward we expect the positive economic growth story to dominate; coupled with manageable inflation we expect a period of modest upward movement in rates.
Rates continue to be the main driver of performance in Global Credit. Based on data from Bloomberg Barclays and JP Morgan, US Investment Grade (IG) bonds with the highest duration delivered the weakest year-to-date performance (-1.9%) followed by EM IG (-0.7%).
After rising eighty-five basis points in the 1Q of 2021, the 10-yr US Treasury yield rallied twenty-five basis points in the 2Q amidst concerns that the Fed would turn hawkish given surging growth and inflation. However, we believe that the reflation trade still has legs, supported by ongoing dovish Fed monetary policy. Our house view is for the 10-yr US Treasury yield to finish the year at 1.75%. As such, we advocate a below average portfolio duration.
Given our house view of rising rates into year-end 2021, we are maintaining our overweight stance on HY and underweight recommending on IG based on the following rationale: 1) HY is much more attractive on a relative and historical valuation basis; 2) the duration for IG is much higher than HY (essentially double) and therefore more exposed to rising rates and 3) a lower spread component on IG leaves less of a buffer against the adverse impact of rising rates.
Fundamentals are likely to support further oil price gains in 2H21 although we remain unconvinced that commodities are about to enter a new super cycle. – Vasu Menon
We upgrade our 6 and 12-month Brent forecasts to US$80/barrel, mostly on the strength of pent-up leisure demand. As the world emerges from lockdown, 'buying stuff' makes way for 'doing things'. Pent-up demand for domestic travel in the summer holiday season in Western countries should lift oil demand. Higher oil demand and normalised oil inventories will require OPEC+ to raise output further to stop the market overheating.
Our expectation that gold will find it hard to shrug off Fed taper talk have proven true. We continue to believe that the gold price cycle peaked in 2020 and that markets will fail to surpass of US$2,000/ounce in the base case outlook. Reduced portfolio hedge demand for gold may be reflective of macro recovery that favours industrial commodities to gold.
Gold could yet stage a tactical bounce after the sharp late June decline triggered by a hawkish Fed surprise. But the risk of strong US jobs/inflation data translating into higher US real yields rather than break evens keeps us cautious on gold’s medium-term outlook. We cut our 12-month gold price forecast to US$1675/ounce.
Looking into the second half of this year, vaccination, and reopening will increasingly become the base case for global economies. Even for those that are still fighting renewed spikes in case counts, the experience they now have in dealing with such outbreaks, should imply that the market impact will be more contained.
We view the June FOMC as a key turning point that should set the stage for how currency markets do in the second half. Notably, rate hike expectations, as seen from Eurodollar futures, have showed no signs of retracing to pre-FOMC levels. This suggests that they are now being priced in by the markets.
In Asia, the recovery in the USD has affected Asian currencies via-a-vis the greenback. Nevertheless, the USD-G10 currencies is where the main battleground is, not USD-Asian currencies.
Closing the Q2 of this year, global recovery appears stronger. US employment data shows improvement every month. Additionally, US inflation is still the market focus, where inflation increased 4.2% YoY in April 2021. Meanwhile, Personal Consumption Expenditure (PCE) which is the inflation reference of The Fed, increased 3.6% YoY. However, the Fed sees that the increasing inflation’s nature is only temporary. Therefore, tapering is predicted to not occur anytime soon, keeping the US Treasury yield stable and supporting risk assets.
Moving into domestic market, a few sentiments influence Indonesia’s market. In addition to the anxiety about increasing US inflation, market players also pay careful attention towards COVID-19 situation which shot up in some countries in Asia. On the other hand, Cryptocurrency volatility has also gained attention lately.
Approaching June, economic data release shows improvement within the country. First, Manufacturing PMI data increased from 54.6 in April to 55.3 in May. Moreover, inflation is also reported to increase 1.68% YoY in May, from only 1.42% YoY increase in April.
Moving forward, investors are expecting better economic growth in Q2 of 2021 when compared towards Q1’s data which recorded contraction of -0.74% YoY. As of now, the economic growth still shows a positive trend from -2.19% in Q4 2020. Bank Indonesia projects an economic growth of approximately 4.1-5.1% for this year and 5.0-5.5% for 2022. The economic growth is supported by the improvement of the vaccination program where the target of 1 million dosage per day is predicted to be achieved in mid-June. On top of that, the budget realization of Pemulihan Ekonomi Nasional (PEN), which is expected to accelerate economic recovery, has achieved 24.6% by mid-May 2021.
Throughout May, IHSG recorded a weakening of -0.80%, closed at level 5,947. IHSG is still unable to strengthen above the psychological level of 6,000. Market players appear to wait and see about the COVID-19 situation in the country, especially regarding the effect of long Hari Raya holiday. We see a potential improvement of IHSG, reflected on the improvement of economic activities. The addition of new sectors, health care and technology, on the index is expected to return liquidity on IHSG. IHSG is predicted to be between 5,900-6,300 in the short term.
In contrast with the stock market, bond market has strengthened in the last month. The Yield of 10-year government bond decreased -0.60% to level 6.422% by the end of May. The low reference interest rate has caused Indonesian bond market to be more interesting. This is reflected by the demand of investors at the auction at the end of May, where the incoming bid touched IDR 78 trillion, a significant increase in comparison to previous auctions. The yield of US Treasury has slowed down, causing the inflow of bond market to improve.
Rupiah currency has strengthened against USD as much as 1.14% in May and is closed at level 14,280. Bank Indonesia’s decision to maintain interest rate at level 3.5% also supported the domestic currency. Moving forward, Rupiah still has potential to strengthen due to its value that is still fundamentally undervalued and the support of economic recovery. We are predicting USDIDR will be exchanged at level 14,200-14,400 for rest of Q2 of 2021.Juky Mariska, Wealth Management Head, OCBC NISP
The global recovery from the pandemic remains resilient despite fresh risks to the outlook, but global growth is expected to broadly peak in 2021 as the strength of global stimulus impulse begins to wane as we enter 2022. – Eli Lee
The strong US rebound is pushing consumer prices up. But the Federal Reserve sees summer increases in inflation above its 2% target being only temporary. Europe’s economy is also booming as activity reopens and while Asia is suffering new virus waves. This year’s lockdowns however are not as severe as last year.
We expect the world economy will expand by more than 6.0% this year. The global rebound is being led by economies that have successfully kept the virus under control during 2021 (China and South Korea), quickly vaccinated significant shares of their populations this year (the US and the UK) or begun to ramp up the pace of injections rapidly (the Eurozone).
In contrast, some Asian economies are suffering fresh virus outbreaks. But this year’s lockdowns have been much less severe than last year, and strong global growth is keeping demand firm for Asia’s exports.
Asia’s virus waves are one of the new key risks to the outlook. The other main threat comes from higher US inflation rates over the summer.
The Federal Reserve’s target measure of inflation - changes in personal consumption expenditure (PCE) prices - is now running well above the central bank’s 2% goal.
US core inflation jumped from 1.9% in March to 3.1% in April after PCE prices - excluding food and energy costs - rose more than expected by 0.7% m-o-m as the US economy reopened.
The Fed, however, expects summer increases in inflation above its 2% target will only be temporary. The economy’s reopening is causing consumer prices to jump as demand outstrips supply in the near term. But the US central bank forecasts that inflation will settle down again once supply catches up over the rest of the year.
The Fed’s dovish stance is keeping bond yields at low levels despite US core inflation increasing to around 3% in April. Over the next 12 months, we expect the benchmark 10Y yield will only rise to 1.90% as strong US growth this year enables the Fed to start tapering its quantitative easing from early 2022.
For the rest of 2021, historically low Treasury yields and strong growth in the US, China, UK and increasingly the Eurozone are set to keep supporting risk assets.
We continue to believe that it is too early to call time on the rally in cyclicals given the gradual reopening of economies and maintain our overweight calls on Energy, Financials, Industrials, Materials and Real Estate. – Eli Lee.
We remain positive on the broad market and maintain an overall overweight position in equities by keeping our overweight in US equities.
We bring Asia ex-Japan one notch down to neutral as we see potential over-optimism over the earnings recovery, especially given the worsening COVID-19 situation in several key economies in Asia. Within Asia ex-Japan equities, we are positive on China, Hong Kong and Singapore, and cautious on India and Thailand.
We remain constructive on cyclicals and would advocate hedging against inflation tail risks.
We remain optimistic, given a combination of factors - global reopening, elevated consumer savings, as well as strong corporate operating leverage – all of which can help to drive sharp recoveries in both economic and earnings growth. It is also prudent to recognise potential risks such as larger-than-expected tax reforms, inflationary risks and tightening of monetary policy. However, we believe that talk of tapering by the Fed is likely to be premature.
The picture for Europe continues to improve, with progress in the vaccine roll-out and re-opening optimism. On the earnings front, the recent results season has been an encouraging one, with companies posting good earnings. At the time of writing, consensus expectations for 2021 earnings growth have been revised upwards to 42%.
Japanese equities were largely range-bound in May, as investor sentiment remained cautious in the wake of Japan’s state of emergency and extended until end-May due to a rapid increase in COVID-10 infections and still slow vaccine rollout pace. Looking ahead, we view earnings growth momentum as key to the equity market performance; consensus forecasts have been shaved to 18% for FYE March 2022.
While risks for Asia ex-Japan such as worsening COVID-19 situation have increased over the past month, some of the supporting factors for the region could stem from expected continued weakness in the USD, as emerging market equities tend to be inversely correlated to the strength of the USD. Strong capital inflows to the Chinese onshore market may also provide a sentiment and liquidity boost to the region.
We maintain our relative preference for the onshore A-share market as it is more sensitive to policy support, and it has less exposure to sectors that are under regulatory tightening. We remain constructive on the Chinese market and recommend investors to focus on the four key investment themes that could ride on the 14th Five-Year Plan (FYP). Domestic consumption is one of the key initiatives in the 14th FYP. In general, we prefer consumer discretionary to staples.
We expect bond yields to continue rising at a modest pace, but interest rates should remain low by historical standards and this, along with attractive valuations, should continue to favour Emerging Market High Yield bonds. – Vasu Menon.
Overall, we remain overweight in Emerging Market (EM) High Yield (HY) bonds, where valuations still look attractive. We are neutral of Developed Market (DM) HY bonds and remain underweight in both DM and EM IG bonds, which face headwinds from a steeper yield curve.
The vigorous new issue market shows few signs of abating. In April we saw a record for new issuance. In May, the US HY market again surpassed its previous record set in 2020, with supply reaching just under USD 47bn, making May 2021 one of 10 busiest months ever. While US IG is behind last year’s record issuance, it is still on pace for the second highest issuance this century. In EM, year-to-date corporate issuance of USD 246bn is running ahead of last year’s record pace.
While rates have moved sideways over the past month, our house view is still for rising rates over the coming seven months of the year. Hence, we consider it prudent to continue to maintain a below-market duration on bond portfolios. However, if we have a repeat of what happened earlier in the year, where rising intermediate and long-dated bond yields caused prices to fall to attractive levels - we would see this as an opportunity to selectively buy US dollar denominated bonds.
We are maintaining our overweight stance on EM HY and underweight recommendation on EM IG based on the following rationale: 1) HY is much more attractive on a relative and historical valuation basis; 2) The duration for IG is much higher than HY and therefore more exposed to rising rates and 3) A lower spread component on IG leaves less of a buffer against the potential adverse impact of rising interest rates.
Despite its recent strength, gold faces challenges given the risk of Fed taper talk. It still has a place in investor portfolios, but allocations are likely to be smaller than before. – Vasu Menon.
We expect the oil upswing to stay intact in the second of half of this year with the outlook turning neutral in 2022. Pent-up demand for domestic travel in the summer holiday season in Western countries should lift oil demand. We could also see investors using oil as an inflation hedge. We stay upbeat over the next 6 months but the outlook for oil turns neutral in 2022. Oil market will then probably have to contend with rising supply from OPEC, US shale and possibly Iran.
Gold seems to have benefitted from bitcoin’s recent sell-off. Investors appear reluctant to buy the crypto dip. This is set to test bitcoin’s ‘store of value’ proposition as digital gold. The sharp rise in bitcoin's volatility could reduce its attractiveness versus traditional gold in institutional portfolios. Gold may overshoot and linger slightly above USD1,900/oz in the near-term.
The broad US Dollar (USD) remains at the cross-roads, with the DXY Index close to year-to-date lows, and major currency pairs stuck within recently established ranges. Fed tapering/rate hike expectations will still be the main determinant of USD directionality in June. Any material shift on this front is likely to have a big impact on the greenback’s direction.
As such, US data releases in the run-up to the June FOMC policy meeting will be closely watched by currency markets. The other thing that markets will be paying close attention to, is whether Fed will mention tapering after its June FOMC or whether participants will discuss about it at the meeting.
The increase of daily COVID-19 cases in some countries have gained market attention in the last few weeks, especially in India. India has reported daily case of 300,000 cases with almost 3,500 deaths a day, which is the highest record since the beginning of the pandemic. A few developed countries like the US and Europe, where the advancement of vaccination has led to loosened health protocols, showed an increase in daily cases again. Therefore, some local authorities have set a stricter quarantine.
The recovery process of global economy is still in progress with the help of economic stimulus and lowered interest rate. Manufacture and services activities have expanded. The labour data in the US has weakened slightly with unemployment rate increasing 6.1%. However, this event is received positively by market players with hope that flexible stimulus will continue being enforced to maintain the economic recovery.
This condition was also seen in Indonesia where the growth of domestic economy for Q1 -2021 is still in the recession zone with recorded contraction of -0.96% annually. In Q1, the government had continued to limit activities to curb the spread of virus. As of May 2021, the government has recorded over 21.7 Million vaccine doses given. In other words, 3.1% of population has received complete vaccination.
The government has continued to push economic recovery, including with cash assistance and fiscal incentives. In line with the government, Bank Indonesia has continued more flexible regulations, keeping the interest rate low and ensuring the liquidity of financial markets.
JCI noted slight increase of 0.17% in April. The stagnant movement is reflected on the daily sales which is down to IDR 9 Trillion, whereby previously it had been at IDR 10 trillion at the beginning of the year. A few analysts suggest that lower equity market transaction is influenced partly by the movement of investors from retail to crypto. Additionally, some are waiting for the IPO of Unicorns. Some BUMNs are also projected to take the floor in the stock exchange in 2021. This is predicted to increase equity market capitalization. Entering May, investors will continue paying attention towards the daily case of COVID-19 and the acceleration of national vaccination. Therefore, for short term, JCI is predicted to move sideways at IDR 5,900 to IDR 6,100.
Throughout April, the vibrant bond market is reflected on the movement of return of the 10-year government bond which experience a fall of -4.46%. This fall is influenced by the -3.9% lowering of US Treasury yield. The easing of anxiety regarding the tightening of US Monetary regulation is one of the factors pushing the increase of domestic bond price. Moving forward, domestic bond market is still seen to be promising, with considerably high Real Yield, predicted to return foreign fund to SUN. The yield of 10-year government bond is predicted to be at 6.25% - 6.50% for medium term.
Rupiah moved stably throughout April although the movement was only between IDR 14,000 – IDR 14,500. Entering May, Rupiah has continued to strengthen up to IDR 14,200.
The trade balance surplus and the high foreign exchange reserves of Indonesia at USD 138.78 Billion, which has been the highest level in history, in addition to the weakening of US Dollar Index post the easing of US Inflation anxiety have made the investors more certain regarding Rupiah. In short term, Rupiah is predicted to move with spread between IDR 14,000 – IDR 14,400.Juky Mariska, Wealth Management Head, OCBC NISP
We see peak global growth in 2021, still strong growth in 2022 and low government bond yields continuing to favour risk assets. – Eli Lee
Economies successfully containing the pandemic are rebounding faster than expected while those suffering fresh virus waves are seeing delayed recoveries.
The global recovery from the pandemic is set to peak over the next few months at a higher-than-expected rate as countries that have successfully contained the virus lift restrictions and re-open their economies.
We are now projecting the global economy to rebound by 6.2% in 2021 compared to our earlier estimate of 5.8% growth.
Looking ahead to 2022, we expect the global economy will continue to experience fast growth next year - albeit at a slower pace than the peak growth of 2021. Our GDP forecast table shows we project the world economy to expand by 4.8% next year.
Peak global growth this year and still strong growth next year will keep continue to propel equities, commodities, emerging markets and other risk assets.
The recovery is being led by the world’s two largest economies - the US and China - with important economies including the UK also rebounding more quickly than anticipated now.
The Biden administration’s fast roll-out of vaccinations, its USD 1.9 Trillion fiscal stimulus approved by Congress in March and its proposed USD 2.3 Trillion multi-year infrastructure investment programme to begin later in 2021 are all helping the US economy rebound faster this year.
We have revised up our forecasts for UK growth to 6.0% for 2021.
In the near term we turn cautious on India’s prospects. With new virus cases now exceeding 350,000 a day, the risks are clearly tilted to the downside for growth with the economy likely to experience a second slump over the summer.
We expect US Treasury yields will increase further over the next 12 months as the US economy recovers from the pandemic and core inflation - excluding food and energy costs - temporarily rises above the Federal Reserve’s 2% target. We only expect 10Y yields to increase to 1.90%. The US central bank’s dovish stance is set to keep Treasury yields anchored at low levels to the clear benefit of risk assets.
We believe that cyclical stocks still have room to perform ahead as the real economy gradually re-opens. – Eli Lee.
To express this view, we maintain our overweight calls on Energy, Financials, Industrials, Materials and Real Estate.
We maintain our overweight positions in the US and Asia ex-Japan, though we reduce India to underweight on Covid-19 related concerns. In Europe, we maintain our relative preference for UK equities, as data is coming in consistently strong, reflecting the vaccination rollout and better global growth as well.
The 1Q 2021 earnings season is well underway, with a good proportion of S&P500 companies that have reported results beating on both the top and bottom line. We have seen an upward revision of consensus 2021 EPS estimates and we would not be surprised if there were further such revisions.
Proposed tax changes are a source of investor concern. At this juncture, we do not expect that higher tax rates will necessarily result in a sharp sell-off across the broad US equity market, even though their implementation could act as a modest short-term headwind for some companies.
Covid-19 fatalities are stabilising in Europe and the overall pace of vaccinations is improving. In the UK, data is coming in consistently strong, reflecting the vaccination rollout and better global growth as well.
Japanese equities underperformed in April, hit by weaker sentiment as the number of cases involving Covid-19 virus mutations increased while vaccine rollout remains slow with less than 2% of the population estimated to have been vaccinated. Looking ahead, earnings growth momentum is key to equity market performance.
The MSCI Asia ex-Japan Index saw a rebound in April, driven by the North Asian markets, which tend to be more sensitive to interest rate movements, and thus benefited from the recent easing in the 10-year US Treasury yield.
The Covid-19 situation in parts of Asia saw a deterioration, with countries such as India, South Korea and Thailand recording higher daily infection cases over the past month. We see downside risks to its economic recovery and have downgraded the country to Underweight.
We remain constructive on the Chinese market given the solid economic recovery and ample room to react on stimulus. Valuations have corrected to a more comfortable level with MSCI China, CSI300 and Hang Seng Index trading at about 16.7x, 14.2x and 12.8x 2021E P/E.
While we continue to favour value/cyclical sectors such as Materials, Energy, Industrials, Real Estate and Financials, we do see pockets of opportunities in other areas as well, one of them is Aviation sector. Longer-term investors would also focus on companies with higher environmental, social and governance (ESG) standing.
We still favour Emerging Market High Yield Bonds as the global search for yield looks set to continue.
– Vasu Menon.
After a quarter of rising rates and steepening yield curves, the Fixed Income market pivoted in April as U.S. Treasury yields subsided and curves flattened. However, with strong global growth buoyed by economic openings and underpinned by Central Bank support, we expect rates to continue their upward trend (albeit more modestly than in the 1Q) going forward. In this environment we continue favour Emerging Market (EM) High Yield (HY) bonds.
In the 1Q 2021 the “reflationary” trade had a full head of steam. Anticipated fiscal stimulus with Democratic Presidency and full Congressional control, better-than-expected vaccine roll-out in the US and the ongoing monetary backstop, resulted in a ratcheting up of growth expectations.
However, the narrative has changed abruptly in 2Q 2021, driven by a resurgence in Covid cases in countries like India, contagion from Huarong in China and disappointing vaccine rollouts in many European Countries. Consequently, the 10-year US Treasury yield has fallen to 1.62%, US Treasury yield curves have flattened, and inflation expectations have flatlined.
The vigorous new issue market shows few signs of abating. After a record for 1Q issuance, the US HY market already surpassed the April record set in 2014. While US Investment Grade (IG) is behind last year’s record issuance, it is still on pace for the 2nd highest issuance this century. In Emerging Markets, year-to-date corporate issuance of USD 200 billion is running ahead of last year’s record pace.
While rates have moved sideways over the past month our view is still for rising rates over the coming months of the year. Hence, we consider it prudent to continue to maintain a below-market overall duration on portfolios.
The Huarong debacle took centre-stage in April causing turbulence in China’s corporate bond markets. What started as a delayed result announcement eventually took many turns including a rumoured debt restructuring plan coupled with mixed signals on government support for the entity. The event shook the belief that government support is forthcoming even for a large financial company which is perceived to be systemically important by the market.
This is based on the following rationale: 1) HY is much more attractive on a relative and historical valuation basis; 2) The duration for IG is much higher than HY and therefore more exposed to rising rates and 3) A lower spread component on IG leaves less of a buffer against the potential adverse impact of rising interest rates.
Re-opening tailwinds and the renewed reach for inflation hedges could benefit oil prices going forward. – Vasu Menon.
Oil demand is recovering well in the US, Europe and China, with pent-up leisure demand for motor fuels likely to more than offset losses from international aviation and India caused by the spread of Covid-19. Renewed reach for inflation hedges could see oil playing catch-up to the recent rally in industrial metals. OPEC remains confident that recent headwinds will not derail the recovery in oil demand.
Stalling US yields, the weaker US Dollar and rising inflation expectations have lifted gold price back higher. Rising Asia gold imports have also provided support for gold price. China has given commercial banks permission to import a large amount of gold to meet domestic demand according to Reuters. Indian gold imports rose to a record monthly high of 153 tonnes in March amid strong wedding demand. But fresh lockdown in several states in India in response to rising Covid-19 infections could temporarily stifle gold imports in 2Q21.
US economic data have been firm throughout April and have mostly outperformed data in other major economies. The April Fed policy meeting (FOMC) statement alluded to the strengthening economy. Nevertheless, Fed chief Jerome Powell’s pushed back on tapering, arguing that the Fed is “going to act on actual data, not on a forecast”, and it needs to “see more data”. Our baseline expectation is for US economic data to remain strong through May, leaving open the possibility that the Fed may sound less dovish in run-up to its June FOMC.
The continuous economic recovery has given a positive impact; however, more effort is required to get to the pre-pandemic condition.
Global economic recovery is depicted on IMF’s statement regarding the economic growth revision for 2021. It had been previously at 5.5% and now has been revised into 6.0%. For Indonesia specifically, the effort for economic recovery that has been continuously done by the government has shown positive results whereby the activity of Indonesian manufacturers has now rebounded to the level of pre-pandemic condition at 53.2 expansion for March 2021. Inflation rate is being controlled at 1.38% for February 2021.
Additionally, the Indonesian government has been working with Bank Indonesia in order to improve the economy that had been suffering due to the COVID-19 pandemic. President Jokowi stated that the role of Bank Indonesia is not only to maintain the currency, but also to unceasingly support the growth of economy and create work opportunities continuously while maintaining its independence.
The pressure to JCI has returned at the end of the first quarter of 2021. JCI is stated to has weakened 4.11%. The weakening of the domestic market is due to the IDR 1.16 trillion worth of foreign investment exiting the Indonesia’s equity market throughout March 2021. The lack of domestic catalyst, added by the news of a few company’s stocks being sold by BPJS, has caused the equity market to be weakened.
Nonetheless, together with the vaccine distribution progress, both globally and domestically, we believe that the prospect of equity is positive. In the short term, we predict that the spread of JCI will be approximately 6,000 to 6,200.
After the weakening of the bond market in March up to the point of the highest yield since the beginning of the year, which is at 6.8%, the yield of government bond with 10-year tenure is finally decreasing in early April. The yield increase of those bonds follows the trend of US Treasury’s bond increase, which is at 1.75%.
The yield increase of both global and domestic bond is due to the rising expectation of US economy recovery, the statement of The Federal Reserve regarding the direction of their monetary policy, and the plan to reduce asset purchase/tapering. Along with the economic recovery process improvement, the inflation rate is predicted to increase faster, which has the potential to push the central bank to tighten its monetary policy even faster. The plan for additional stimulus from Biden for infrastructure purposes also has the potential to push the yield of US Treasury’s bond higher. The yield of US Treasury bond with 10-year tenure is predicted to move with spread of 1.5 up to 2.0% for medium term. This event will in turn push the increase of domestic bond’s yield to approximately 6.5 up to 7.0%.
After previously being weakened, Rupiah has strengthened slightly against USD for 0.24% and is at approximately IDR 14,505 as of the beginning of April 2021. With the prospect of US economic recovery and the increasing yields of US Treasury’s bond, the US Dollar Index (DXY) seems to have been strengthening since the beginning of the year, which results in the limitation of Rupiah’s movement. We predict that the exchange rate of Rupiah against US Dollar will be at approximately 14,500-14,700 in the short term.
Juky Mariska, Wealth Management Head, OCBC NISP
The overall trajectory of the global economic recovery remains intact, pointing to a strong rebound in corporate earnings this year as economies reopen more fully. – Eli Lee
The global economy’s recovery from the pandemic is set to pick up over the second quarter of 2021, as winter virus waves ease and vaccinations accelerate. We forecast global GDP will expand by almost 6% this year - its fastest pace in five decades - after last year’s slump of -3.4%. China and America will lead the rebound among the major economies, with very strong growth of 8.1% and 6% respectively in 2021.
The favourable macroeconomic outlook for risks assets, however, faces three main challenges over the next few months:
Extended restrictions on economic and social activity raise the risk that Europe will suffer a second ‘lost summer’ for its important tourism and travel industries.
We thus expect economic growth in the Eurozone will be slower now, and have downgraded our GDP forecasts for 2021 from 5.5% growth to 4.5%
This concern has already driven 10Y US Treasury yields up from 0.90% at the start of the year to over 1.70% as financial markets have become concerned that the Federal Reserve will start lifting its Fed funds rate from current levels of 0.00- 0.25% as soon as next year.
We are less concerned about inflation risks this year. The US economy still has high levels of unemployment and millions of jobs lost during the pandemic have yet to be recovered. We expect the Federal Reserve will not start raising interest rates anytime soon.
This fear has increased since March’s National People’s Congress set a GDP growth target this year of “above 6%”.
We believe, however, the PBoC and China’s government will not act to slow growth this year given the still uncertain outlook for the pandemic outside China.
In short, Europe’s vaccinations, America’s inflation fears, and China’s debt concerns may keep financial markets volatile in April. But we expect strong growth, dovish central banks and further fiscal stimulus will continue to favour risk assets this year.
Broadly, we continue to see equities as relatively attractive and expect equities to outperform bonds in this phase of the business cycle, given that equity earnings yields still far exceed real yields.
– Eli Lee
For equities, we expect to see market turbulence persist over the near term, especially as inflation fears are set to intensify in mid-2021 as inflation measures rise mechanically due to base effects.
We continue to recommend that clients stay invested in risk-assets as the outlook remains favourable, given that a vaccine-driven global economic recovery is firmly underway, super-charged by powerful US fiscal stimulus and ongoing support by major central banks.
Within our asset allocation strategy, we maintain a risk-on stance through our overweight positions in equities, where we prefer the US and Asia ex-Japan. In terms of sectors, we maintain our overweight calls on Energy, Financials, Industrials, Materials and Real Estate.
With the vaccination roll-out and recovery, we believe that profitability for the S&P 500 should rebound in 2021, driven in part by expanding profit margins, which could help support ROE expansion at the index level and particularly for some cyclical companies that suffered the most in 2020.
Valuations for MSCI Europe remain relatively elevated, but investors do not seem to be particularly worried about the third wave. The region’s bourses has a heavier focus on value/cyclical stocks which stand to benefit from the ongoing economic recovery.
Following its March 18-19 policy review, the Bank of Japan (BOJ) removed the lower band of its ETF purchase policy that targets an annual ¥6 trillion purchase while retaining the maximum limit of buying up to ¥12 trillion yearly, signalling the central bank’s readiness to step in to support Japanese equities should there be meaningful correction.
The COVID-19 situation in Asia has seen some stability in recent months. Geopolitical tensions in the region also remain on investors’ minds, as there are increasing concerns over Taiwan and China.
Looking ahead, there has been a gradual upward revision of earnings per share (EPS) projections for 2021 in the region, while valuations also appear more reasonable with the recent correction in share prices.
China’s fundamental economic outlook remains positive and we expect its recovery to continue solidly into the remainder of 2021. The recent National People’s Congress signalled clearly the authorities’ intent to take a carefully calibrated approach to normalising monetary policy.
We have highlighted four key investment themes for investors:
We believe that the energy and materials equity sectors are attractively valued and would further benefit from the White House’s subsequent focus on its infrastructure plan to rebuild the country’s aging fixed assets in line with its long-term decarbonisation and sustainability goals.
The fall-out from the economic reflation on the fixed income markets has been profound. The 10Y US Treasury yield reached 1.75% last month, up more than 80 basis points since the beginning of the year.
– Vasu Menon.
Meanwhile, the US Treasury yield curve, as measured by the gap between the 2Y and 10Y yields, also steepened to widest level since 2015 as investors price in expectations of rising economic growth.” Volatility remains elevated as the market continues to challenge the Federal Reserve with respect to its intentions and strategy toward managing inflation.
On the positive side, expectations for economic improvement and below-trend defaults have underpinned ongoing tightening in credit spreads. New issuance globally in credit markets remains at record levels even amidst rising interest rates.
Maintain below average portfolio duration but remain nimble and opportunistic. Given our view that rates will continue to rise over the coming months, we consider it prudent to continue to maintain a below-market overall duration on portfolios.
Volatile session for China High Yield provides a window to pick up good credits. Month-on-month in March, the China HY segment returned -0.75% while average YTW (yield-to-worst) stood at almost 9%, an increase of 1.5 percentage points since the beginning of the year. Tight onshore liquidity, on-going defaults and profit warnings at certain property companies shook investors’ confidence.
We are maintaining our overweight stance on EM HY and underweight recommendation on EM IG based on the following rationale:
The cyclical oil upswing has room to run, but it is too early to call for a super-cycle. Higher oil prices will be met with significant additions to supply later, which could temper price increases. – Vasu Menon.
Our view on oil remains unchanged: near-term weakness before further strengthening. We expect the recent oil pullback to be temporary as OPEC+ acted to offset the European Union demand headwinds caused by renewed lockdowns. OPEC erred on the side of caution by mostly rolling over its production cuts into May, with Saudi Arabia extending its voluntary 1 million barrels per day curb by one more month.
A bounce in gold is still likely after being challenged by rising US real yields. The outlook for US yields is turning more two-sided in the near-term following the dovish March Federal Open Market Committee meeting. Resumption of US Dollar (USD) weakness and stronger demand for jewellery from China and India as emerging market growth recovers should push gold price back higher. Physical demand is showing signs of revival, with Indian imports getting back on track. We expect gold prices to make a return to US$1850/oz (old forecast: US$1900/oz) in 6 months’ time before drifting lower to US$1800/oz (US$1850/oz) in a year’s time as focus shifts back to anticipating Fed tapering and rate lift-off.
A number of pro-USD arguments coalesced into a coherent strong-USD theme in March. At the root of it, we think, is the Fed’s position on
The “Rising Yields” theme have been the highlight of global capital markets in the month of February. The upward trajectory of the US Treasury yield has been bad news for risky assets as investors become more and more weary of the implications it may arouse.
As for the domestic capital markets, the equity market cherished the declining COVID-19 numbers while the bond market suffered, dragged down by the rising US Treasury yield. From a data perspective, Q4 2020 GDP numbers released at the beginning of February showed that the economy contracted 2.19%; a little bit lower than what had been anticipated by economists and the local government. Inflation numbers for January did not help soothe sentiment at 1.55% YoY, as opposed to 1.68% in the previous month.
An update regarding the government’s continuous effort to support the economy, President Joko Widodo decided to increase the “Pemulihan Ekonomi Nasional” (PEN) program from Rp 300 Trillion to Rp 699 Trillion for 2021. This decision comes as the government continuously assess the economic condition and decided that more help is needed to achieve the 5% growth target for 2021.
The JCI rebounded above the 6,000-psychology handle in the month of February, recording a 6.5% gain to close the month in the 6,200 – 6,300 range. COVID-19 vaccine inoculations have somewhat given a sentiment boost for investors, in tandem with lower daily new COVID-19 cases. However, the equity market has been moving sideways the past few weeks, as domestic investors are seeking for the next possible catalyst to help propel the JCI toward higher levels. Nonetheless, we still see a huge upside potential in domestic stocks, as earnings growth start to materialize in the second quarter of 2021. The IHSG should be trading in the range of 6,200 – 6,500 in the near future.
Domestic bond market mirrored the US Treasury market, recorded steep losses in the month of February. The 10-year government bond yield moved up 650 basis points (6.5%) in February to close the month at 6.6%. More domestic stimulus may lead to more bond issuance, which has experienced a relatively lower figure during the last two auctions, yet still able to hold a bid-to-cover ratio at around 2.5 to 3 times. As global investors are pinning on higher inflation figure due to expected recovery, this may continue to put pressure in the bond price in the near term.
The Rupiah depreciated against the USD for as much as 1.5% in February to close the month at 14,235 per greenback dollar. The decision by Bank Indonesia to cut the 7-Day Reverse Repo Rate by 25 basis point to 3.5% contributed to the weakening of the Rupiah, a move which had been anticipated by most. Along with the aftermath of increased size of PEN, we see the USDIDR to be trading in the range of 14,200 – 14,450 for the remainder of Q1 2021.
Juky Mariska, Wealth Management Head, OCBC NISP
The macro environment remains positive. As the vaccine rollout continues, major economies are slated to attain herd immunity over the next 12-24 months. – Eli Lee
This year, government bond yields have increased sharply across the major economies. The surge in yields is driven by higher inflation expectations and stronger economic prospects, as explained by the following factors:
Over the last decade, core inflation has largely been below the Fed’s 2% goal. Thus, the central bank is now prepared to let inflation moderately exceed its 2% target for up to a full year before it would consider lifting its Fed funds rate from the current 0.00-0.25% range.
We expect government bond yields will rise further during 2021. We now expect the 10Y Treasury yield to reach 1.90% over the next 12 months.
The Biden administration’s new round of emergency aid will still provide largescale stimulus to the US recovery. At the same time, the Fed has tolerated rising yields this year as Treasury rates remain at very low levels.
In the near term, the surge in US yields increases the risk of volatility in financial markets. But the broad rally seen in risk assets over the past year should continue over 2021, as the Fed’s very dovish stance on inflation and unemployment is likely to prevent a major sell-off in government bond markets. Thus, 10Y Treasury yields may rise further but still stay at historically low levels below 2.00%.
Thus, a further surge in yields beyond our new one-year forecast of 1.90% for 10Y Treasuries seems to be the main near-term threat to the global economic recovery. But we would expect the Fed to react if risk assets were to sell off sharply, for example by explicitly delaying the start of tapering.
Source: Bank of Singapore
While a further sharp increase in yields could portend more volatility in equities ahead, we do not expect this upswing in yields to derail the long-term post-pandemic bull market. – Eli Lee
In recent weeks, all eyes have been on rising US Treasury yields and growing inflation expectations, which have led to concerns about short-term turbulence. Still, we believe that the Federal Reserve will keep policy very accommodative, and the ongoing vaccine-driven recovery should keep the broad outlook for risk assets positive.
Cyclical and value sectors are likely to feature favourably, as vaccine rollouts increase investors’ confidence of a gradual push towards reopening of economies. We reflect this view through our overweight calls on Energy, Financials, Industrials, Materials and Real Estate. From a regional perspective, we continue to maintain our overweight positions in the US and Asia ex-Japan.
We continue to remain neutral on Europe but overweight on UK equities, given cheap valuations and an improving outlook. In China, we maintain our relative preference towards the onshore A-shares, given that it offers more sectors and/or companies that could benefit from long-term structural growth opportunities and is relatively less affected by US/China tensions.
Overall, while a further sharp increase in yields could portend more volatility in equities ahead, we do not expect this upswing in yields to derail the long-term post-pandemic bull market.
Following a better-than-expected 4Q2020 earnings season, we are seeing consensus 2021 earnings per share estimates being revised upwards. We believe that corporates, especially in cyclical sectors, will focus on growing revenue and margins, especially as several companies possess significant operating leverage.
As companies continue to report 4Q2020 earnings, what we are seeing so far is a strong net beat – 62% of companies have beaten expectations and 17% have missed, giving a net beat of 45% – the highest on record in recent history. However, price action has thus far been muted, suggesting that a strong 4Q2020 results season is largely priced into the market.
As for Asia, markets currently look healthy. Looking at the Covid-19 situation, we note that the number of new infection cases for major economies in Asia ex-Japan has largely been stable in recent weeks. Vaccination roll-outs across Asian countries offer optimism that the path to normalcy may not be too far down the road, although the pace of inoculation in the region remains slow.
And in China, we believe rising US rates and normalising China monetary policy are likely to cap the expansion of valuation multiples. As such, earnings growth would be the key driver for market performance. The upstream sectors, such as energy and materials, have seen the strongest earnings upward revision momentum.
Given our upgraded forecast for 10-year US Treasury yields to reach 1.90% in 12 months, we are downgrading our position in Emerging Market Investment Grade bonds to underweight from neutral in our overall asset allocation strategy. – Vasu Menon
Bond markets face headwinds from rising yields. Nevertheless, we maintain a risk-on stance in our asset allocation strategy, including an overweight position in Emerging Market (EM) High Yield (HY) bonds, which still offer attractive carry and are a beneficiary of the global search for yield.
However, we are now underweight in both Developed Market (DM) and Emerging Market Investment Grade (IG) bonds, which face headwinds from a further steepening of the yield curve.
We have downgraded our position in EM Investment Grade bonds to underweight from neutral, given our higher forecast for higher 10-year US Treasury yields over the next 12 months.
In 2021, rates are dominating the performance of the various bond segments. There is an almost 100% correlation between bonds with higher duration and weaker performance, with the lowest duration bond segment - US HY - performing the best. This is followed by EM HY, EM IG and US IG (the highest duration and worst performer).
With almost 11 million fewer Americans employed than before Covid-19, we believe that the Fed will continue to remain accommodative, which should underpin support for bonds. Vaccine roll-outs and the opening of economies should bolster top-line growth, while bottom up fundamentals remain more than adequate with below-trend default rates.
Being short duration in nature, China HY bonds are less affected by concerns of rising long-term rates, but more of lingering credit fears following on-going onshore defaults as maturity looms. Month-on-month, the China HY segment returned only +0.009% in February while average YTW (yield-to-worst) stood at 8.5% on 25 February compared to other major geographic segments in Asia.
We are maintaining our overweight stance on EM HY. From a valuation perspective, it appears the most attractive of the bond segments. Furthermore, its higher credit component should provide.
more of a cushion against what we believe will be rising rates in the coming months. We are lowering our recommendation on EM IG to underweight based on the following rationale:
Given rising US bond yields, we have cut our 6-month gold price target to US$1900/oz and 12-month target to US$1850/oz from US$2100/oz previously for both. – Vasu Menon
The oil market is tightening faster than expected. Efforts by OPEC+ to restrain oil supply, along with stronger global oil demand, has propelled Brent crude oil above US$60/barrel, largely erasing its Covid-19 inflicted losses. We raise our 6 and 12-month Brent oil forecast to US$72/barrel respectively. The forecast change anticipates further near-term oil price gains before oil prices plateau by late 2021.
It’s challenging times for a no-yield commodity like gold as rising US real yields makes it more costly to hold gold. It seems, at the margin, that gold also faces competition from alternative assets such as Bitcoin. While we view investments in cryptocurrencies as a speculative trade, the sheer size of the inflow is likely to have taken some gloss off gold. As such, we cut our 6-month gold price target to US$1900/oz and 12-month target to US$1850/oz from US$2100/oz previously for both.
The gyrations in US Treasury yields caused currency markets to shift focus from recovery-centric drivers to yield-based arguments. Increased volatility in rates has caused market turbulence and hurt risk appetite. This should spur some safe-haven demand for the US Dollar (USD) while keeping cyclicals under pressure. Thus, there is room for the USD to make further gains in the near term.
Global economic recovery will be the most anticipated highlight in 2021, after most of the world economy contracted last year. Various fiscal and monetary easing, along with the vaccination process that has begun are expected to be the main drivers for the recovering global economy.
In the United States, the labour market seems to be recovering at a moderate rate. Inflation is still way below the central bank’s target of 2%; the reason why The Fed still maintains its main rate at low levels. The new USD 1.9 trillion fiscal stimulus package that has been approved by the Senate is expected to smoothen the recovery path for the economy.
Looking at Asia, the road to recovery can be verified by looking at manufacturing data in most countries, although a little bit subdued in the last month due to COVID-19 resurgence in several areas. The PBOC have decided to tighten its monetary policy by withdrawing money from its banking system; to mitigate potential risks associated with the system. Nonetheless, the central bank is still determined to support the economy from its policy stance.
Domestically, January 2021 economic data have showed a hint of resiliency for Indonesia’s economy amid this pandemic. PMI Manufacturing went up to 52.2, while the central bank’s foreign reserves reached a new all-time high record at USD 138 billion. For the whole of 2020, GDP recorded a contraction of -2.70%. Overall, the country will rely on its vaccination process that has begun in order to propel the fundamental recovery of the economy.
The January-effect phenomenon only lasted the first two weeks of the month was unable to elevate the JCI; recording a drop of -1.95% in January 2021. The strong rally which has been driven by the initial vaccination process at the start of the month was off-set by the profit taking action by investors at month-end. In the short term, we see persisting volatility in the equities market; with COVID-19 daily numbers still at its high. Nonetheless, vaccination along with governmental support will provide the positive sentiment needed for the equities market in the long run.
The bond market was suppressed in January, with the yield on the government 10-year up 5.45% to 6.21%. We think that the bond market is currently at an attractive level, with more upside potential due to a potential rate cut by the central bank, low inflation, and a stable local currency. The government and central bank will continue its joint-efforts to provide an accommodative environment to support the recovering economy. We see the yield on the government 10-year to be in the range of 6.00% - 6.20% in the first quarter of this year.
The Rupiah appreciated 0.15% against the USD, successfully closing the month below the 14,000 level. The currency is expected to still strengthen, with the added prospect of more fiscal stimulus in the US which will subdue demand for the greenback as a safe-haven currency.Juky Mariska, Wealth Management Head, OCBC NISP
The global recovery is likely to be broad-based with developed economies forecast to expand by 5.3%, and emerging economies to rebound by 6.3% in 2021. – Eli Lee
In 2021, the world’s economy is set to expand at its fastest pace in five decades, as vaccines, monetary and fiscal stimulus, low government bond yields and a weaker USD all spur a strong rebound in global growth led by China and the US. Virus waves, vaccine setbacks, sudden inflation and early monetary tightening are potential threats. But the macroeconomic outlook is likely to keep favouring risk assets.
Key factors that will support recovery in 2021:
The pandemic and resulting lockdowns of 2020 are set to give way to a strongly reflationary environment in 2021.
Fiscal stimulus in both the US and Eurozone is set to boost economic recovery in 2021.
The USD 1.9 trillion package from Biden administration have resulted in our 2021 US growth forecasts being upgraded from 5.0% to 6.0%.
The European Union’s new € 750 billion Recovery Fund will, providing a boost of more than 2% of GDP a year to the Eurozone’s economy.
We expect the Federal Reserve will not start tapering its current pace of quantitative easing (QE) until 2022, because of employment rate and core US inflation that below the central’s bank 2% goal.
The European Central Bank (ECB) is unlikely to scale back its €1.85 trillion QE Pandemic Emergency Purchase Programme, given core inflation is currently far from the ECB’s 2% target.
Very low inflation rates in China, Japan and the UK will also allow the People’s Bank of China, the Bank of Japan (BoJ) and the Bank of England (BoE) to refrain from raising interest rates in 2021.
The combination of central banks keeping short term benchmark interest rates anchored close to 0% (as in the case of the Fed, ECB, BoJ and BoE) while governments undertake further fiscal stimulus will result in longer term bond yields steepening.
USD is likely to stay weak in 2021 as risk-seeking investors reduce demand for the safe-haven greenback, and as the Fed keeps interest rates at current near zero levels to push inflation back to a 2% average rate.
The global recovery is likely to be broad-based with developed economies forecast to expand by 5.3% and emerging economies to rebound by 6.3% in 2021. – Eli Lee
We see a conducive setup for global equities, on the back of improved growth prospects, accommodative monetary policy, positive progress in the rollout of vaccines thus far and the reflationary backdrop globally.
Our constructive view is expressed through our overweight positions in US and Asia ex-Japan. On a sector basis, we turn more positive on Financials and Industrials, while maintaining our overweight call on Real Estate, Materials and Energy. Still, the road to recovery is unlikely to be a straight one; expect a bumpy road ahead.
The global recovery is likely to be broad-based with developed economies forecast to expand by 5.3% and emerging economies to rebound by 6.3% in 2021
With pre-inauguration jitters now behind us, we believe that the US presents interesting opportunities within the Cyclical and Value sectors, as the setup for the Growth sector looks increasingly complex.
We adopt a constructive view on US equities, despite spikes in the rate of COVID-19 infections remaining a potential source of near-term volatility. The combination of an economic recovery and rising inflation from low levels forms a sweet spot for markets. Importantly, in this phase of the business cycle, we believe that there is sufficient leeway for the Fed to maintain a loose monetary policy stance.
While the market has cheered positive developments on the vaccine front, consumer confidence in key countries such as France and Germany have been impacted by lockdown restrictions, and we would not be surprised by market caution prior to a wider roll-out in vaccine.
We remain neutral on Europe, we are turning more positive on UK equities, following the Brexit deal in December 2020.
While we favour maintaining core positions in select growth stocks, we expect some sector rotation to take place, which should favour last year’s laggard sectors (which offer less demanding valuations), such as energy, financials, industrials and real estate.
The MSCI Asia ex-Japan Index has continued its strong momentum in 2021, coming in as the top performer among the major regions. This was driven largely by the Chinese equity market.
We maintain our relative preference towards the onshore A-shares. We believe A-shares offer more sectors and/or companies that could benefit from long-term structural growth opportunities and are relatively less affected by ongoing US/China tensions. In addition, there will be chances of further global index inclusion.
While near-term market pullback is possible, we believe this would offer opportunities to accumulate stocks that are set to benefit from favourable structural trends and supportive government policies in the 14th Five Year Plan.
On fixed income instruments, we maintain a positive view on high yield (non-investment grade) bonds in Emerging Countries, which will benefit from investors' need for high yields, - Vasu Menon
Early 2020 did not provide benefits for fixed income instruments, this condition was reflected in the movement of High Yield and Investment Grade bonds from Emerging Countries, which decreased by -0.1% on average, while US bonds decreased -0.8%.
Although so far, capital inflows into Emerging Country bonds are still relatively high, either into major currencies or local currencies, the amount inflows in the first month of 2021 almost matched the total inflows for 2020.The default rate in emerging markets is relatively low
While we may have experienced the worst recession in nearly a century, this is not reflected in EM default rates. EM High Yield's default rate at the end of 2020 was below 3%, below the long-term average. The current default ratio has decreased and is showing no improvement towards default in the near future.Shorten duration
Over the past few weeks, US bond yields have risen, and the yield curve shows anticipation of an increase in fiscal spending, along with the proposed USD 1.9 trillion COVID-19 stimulus assistance package, which is expected to boost economic recovery through increased consumption, thus gradually can end the trend of low interest rates. Keeping the duration of the portfolio lower would be wise to do in current conditions.Maintain the “overweight” position on the “High Yield” (Non-Investment Grade) bonds
We maintain our overweight position on HY bonds in developing countries, but neutral on Investment Grade bonds. With the current risk-on condition, non-IG corporate bonds in Emerging Countries are deemed good for safekeeping, because they will provide more profits. In addition, when compared to US-owned non-IG corporate bonds and historical averages, the valuation is much more attractive.
We have upgraded out oil price forecasts on the back of OPEC+ supply discipline and stronger US commodity demand. – Vasu Menon
We are revising up forecasts for oil prices. The US oil industry is bracing itself for a period of upheaval following the inauguration of Joe Biden as president. One of his first moves was to block the Keystone pipeline project. Biden has also said he will look to limit the drilling activity on federal land and waters. The initial steps taken by the Biden administration may not have any impact on US near-term producer activity, but it will likely keep shale supply growth in check over the long-term.
Gold has been struggling to convincingly recover past the USD 1,850/oz psychological level, held back by concerns of early Federal Reserve tapering. We do not think that the Fed will start slowing or ‘tapering’ its current pace of quantitative easing from USD 120 billion a month of bond buying until 2022. This is because, US unemployment is set to remain above full employment - i.e. jobless rates of around 3.5% of the labour force - for the next couple of years. Similarly, we don’t expect the Fed to start hiking its Fed funds interest rate from the 0.00-0.25% range until as late as 2024 or 2025.
We expect relative central bank dynamics to affect currency markets. The major central banks are still in an ultra-accommodative mode. However, there has been signs that some central banks may be exiting (or hint at exiting) earlier than others. Rhetoric out of the Fed and ECB suggest that they will remain on the dovish extreme of the spectrum, especially after renewed concerns over the recovery momentum in the US and Europe.
Overall, expect near term direction of the USD to be affected by equity markets, especially for risk-sensitive pairs like the Australian Dollar-USD. Further out, we are still not detecting sufficient progress on US growth and Fed taper to build a coherent strong-USD thesis. This should leave the broad USD consolidative at best for now.
New Year, New Hope
With the deadline for the final voting results of the US presidential election in December approaching, it is almost confirmed that Joe Biden will be elected as the 46th President of the US. With the election of Joe Biden, it is expected that the US will adopt more diplomatic and lenient trade agreements towards US trading partners, especially China. In addition, the planned appointment of Janet Yellen as Treasury Secretary in the Joe Biden era, can be a positive catalyst for the US economy. Janet Yellen, as a former Fed governor, is notorious for having a very dovish view of the benchmark interest rate policy, which is needed to boost the current economic recovery process. In addition, stimulus negotiations are currently still an ongoing discussion which the Republican and the Democratic party have not been able to see eye to eye. The difference in the scale and amount of stimulus each party proposes presents a challenge in the realization of the stimulus.
From a pandemic risk standpoint, the number of COVID-19 cases globally has reached 68 million, with the US currently still being the country with the highest infection rate with 15 million cases. Several analysts see the risk of case numbers increasing due to Thanksgiving holiday, and as the US enters the winter season. However, investors seem to be prepared and ready for this to happen, especially with the successful trials of a number of pharmaceutical companies such as Pfizer / BioNTech and Moderna. In fact, several vaccine manufacturers have produced and succeeded in distributing vaccines to several countries in early December. Pharmaceutical companies such as Astra Zeneca, although the effectiveness of their vaccine is lower than the other two companies, Astra Zeneca vaccine have the advantage in terms of storing, distribution processes, and more affordable prices, making them the main choice for countries in the world that are currently at war. with the pandemic.
Meanwhile in Europe, increasing COVID-19 infections and the uncertainty over post Brexit UK-EU relations are still the main focus of market participants. Britain claimed itself to be the first country to be able to carry out a mass vaccine in the near future; while social restrictions and regional quarantine policies in Europe have again put pressure on economic activity. A number of economic indicators, such as manufacturing activity and employment have recorded further contraction in November. The European Central Bank is expected to continue providing stimulus to support the economic recovery process in the region.
Regionally, as Asia’s largest economy, China is the only country that is expected to close out 2020 with positive economic growth. China's economic indicators still show some resilience amid the global economic recession. China itself is expected to reach the peak of its economic recovery in the first quarter of 2021. However, the Chinese government's plan to enact new regulations (SAMR) related to the anti-trust law for companies operating in the internet sector could provide negative sentiment for some e-commerce companies originating from China. Short-term risks are also evident from the escalation of trade war tensions against China recently.
Domestically, the economic data released in November have shown a sustained recovery and have provided support for domestic capital markets. The balance of payments figure for Q3 2020 shows a surplus of USD 2.1 billion and this has proven Indonesia's economic resiliency. From the consumption side, inflation in November showed an increase from 1.44% in October to 1.59% in November; meaning that that the purchasing power of consumers is at an incline. The various economic policy efforts undertaken by the Indonesian government and Bank Indonesia have given confidence in the continuation of economic recovery, and this is also evident in the manufacturing PMI activity data for November which showed an expansion from the previous level of 47.8 to 50.6. However, central bank's foreign exchange reserves in November recorded a slight monthly decline due to external debt repayments, falling by USD 100 million in November 2020 and currently standing at USD 133.6 billion.
Last November, the Jakarta Composite Index (JCI) recorded the highest monthly gain throughout 2020 by 9.44%. However, since the beginning of the year, the JCI still posted a decline of 10.9%. The return of investor’s risk appetite is supported by positive developments in the domestic COVID-19 vaccine and abundant global liquidity has successfully boosted stock market performance. Fundamentally, these two things are still expected to support the stock market performance at the end of the year or window-dressing. Amid the risk of continued increase of COVID-19 cases especially due to regional elections and the long holiday period, this can cause a return to social restrictions, which if it happens it can give a technical correction in the stock market. Investors can use this correction to gradually return to accumulating asset classes.
Looking ahead, with the number of domestic vaccines available which are expected to increase at the beginning of the year, risk appetite is expected to continue to improve. Abundant liquidity, low interest rates, improved corporate profits, and Omnibus Law will support the JCI to return to the range of 6,500 - 6,800 in 2021.
Positive performance was also seen in the bond market, with the 10-year government bond yield dropping from 6.6% to around 6.1% at the end of November. Several things have supported the bond market in early Q4 2020 such as the strengthening of the Rupiah which also played a very important role for the bond market in October and early week of last November. Then, with the risk appetite of global investors starting to increase in line with the positive development of vaccines, Indonesia as an EM country will benefit from an abundance of foreign capital flows. Attractive real yields, a low interest rate environment and low yields on global bonds are driving up demand for government bonds.
In the last two auctions of government bonds on 17 Nov and 1 Dec 2020, it was recorded that the total incoming bids reached IDR 198.9 trillion, with the amount absorbed amounting to IDR 50.2 trillion. The increase in demand shows the high interest of investors in domestic bonds, after the cut in the benchmark interest rate by Bank Indonesia from 4% to 3.75%. Going forward, we assess the potential for 10-year government bond yields in the range of 5.8% to 6.2% in 2021, especially with the potential for further interest rate cuts by Bank Indonesia.
Domestic currency, Rupiah is currently showing its best performance in 2020 in line with increasing domestic sentiment. The rupiah strengthened 3.55% against the USD in November 2020, closed the month at 14,120 per USD level, and is currently trading at 14,110 per USD as of December 10, 2020. The US Dollar Index or DXY weakened to reach 90.7 levels in early December. Janet Yellen's nomination as US Treasury Secretary, prompts expectations of a longer low interest rate until 2025. This has resulted in the USD weakening, as investors' risk appetite returns to other currencies and riskier assets, especially to emerging currencies, including Rupiah. But at the same time, of course, with Rupiah strengthen too much, it can also burden to the performance of domestic exports, so that with the potential for further cuts in interest rates by Bank Indonesia to hold back the strengthening of the currency, we estimate that USD / IDR can be traded in the range of 13,800 - 14,300 until early 2021.
Juky Mariska, Wealth Management Head, OCBC NISP
New Hope in the New Year
As we head into 2021, the path to a vaccine-catalysed recovery in the new year is becoming increasingly clear, despite near term headwinds from surging new Covid-19 cases in the US, Europe, Japan and the UK. - Eli Lee
The new year is likely to bring new hope to the world economy. The macroeconomic outlook will favour financial markets as global growth rebounds strongly in 2021, new vaccines prevent fresh virus waves, central banks remain very dovish, political risks ease in the US, Europe and Asia, government bond yields stay low and the US Dollar continues to weaken to the benefit of risk assets.
A strongly reflationary outlook
Following the worst shock to the global economy since the 1930s Great Depression, the Covid-19 pandemic and resulting lockdowns of 2020 are set to give way to a strongly reflationary environment in 2021.
There are still several near-term risks to navigate before this year ends. The US, UK, Eurozone and Japan are suffering second or third virus waves. In addition, the European Union and the UK must agree to a fresh trade treaty before the end of December to avoid a chaotic “no deal” exit when their current trading arrangements expire as 2020 finishes. Last, President Trump still has not conceded the US election.
Strong economic rebound in 2021
Despite risks, forward-looking financial markets are likely to discount near term threats and focus instead on the favourable longer-term outlook for risk assets in 2021.
First, the global economy is set to rebound strongly in the new year as the distribution of vaccines allows consumers to spend freely again, releasing pent up demand from this year’s lockdowns.
We project the world economy to expand by 5.6% in 2021 after contacting by -4.1% in 2020. This would be a much faster pace of growth than the 3.5% average annual rate achieved by the world economy over the last five decades.
Further, the global recovery is likely to be broad-based. We forecast China to keep leading the rebound with GDP set to grow by 8.1% in 2021 after a likely 2.5% expansion in 2020.
Similarly, we see other emerging economies in Asia rebounding by 7.9% next year compared to a likely steep contraction of -7.4% this year.
Developed market economies are also likely to experience strong growth in 2021. We forecast the US, Eurozone, Japan and the UK to expand by 5.0%, 5.5%, 3.6% and 4.7% respectively.
Financial markets face further uncertainty. The US elections have now passed but vote counts in several states are being challenged in the courts. In addition, the US, UK and Eurozone are suffering new virus waves.
But once the US electoral results are clear, financial markets are likely to focus again on the favourable outlook for risk assets underpinned by the global recovery, upcoming vaccines, very dovish central banks, low government bond yields and a weaker US Dollar.
Positive developments with vaccines
Second, the development of viable vaccines will prevent fresh virus waves over the next few quarters.
Already, governments have become more effective at managing new virus waves even before the widespread distribution of upcoming vaccines begins in 2021.
During the first lockdowns in the spring of 2020, economic activity plummeted as schools, factories, offices, restaurants and leisure venues were all closed. But in the second lockdowns occurring now this winter, governments in the US, Europe and Japan have restricted gyms, sporting events, indoor dining and other entertainment but have allowed schools, factories and more offices to stay open.
The purchasing manager indices - an indicator of economic activity that signals contraction for readings below 50.0 and expansion for prints above 50.0 - shows that composite PMI has fallen sharply again in the UK and Eurozone in Q4’20. But the monthly PMI surveys are nowhere near as weak as they were during Q2’20.
In 2021, viable vaccines should reduce the outbreak of fresh virus waves and governments will have more experience of limiting the adverse impact on economic activity.
Central banks could add monetary stimulus
Third, central banks are set to remain very dovish and are likely to add further monetary stimulus if needed to support economic recovery.
The Federal Reserve may increase its current pace of bond buying from USD80 billion a month of US Treasuries and USD 40 billion of mortgage-backed securities if the US economy suffers from America’s current virus waves.
Moreover, even if the Fed does not expand its quantitative easing any further, the central bank is likely to keep its fed funds interest rate unchanged at 0.00-0.25% until as late as 2024 or 2025.
Inflation - as measured by changes in core personal consumption expenditure prices (PCE) - remains well below the Fed’s 2% goal at just 1.4%YoY for October. We expect that core PCE inflation may not recover to average 2% for several years given the shock from the pandemic.
Thus, the Fed, having shifted to a new strategy of average inflation targeting in August this year to achieve inflation around 2% over time, appears unlikely to start hiking its fed funds rate before 2024 or 2025.
Similarly, the European Central Bank also seems likely to add further monetary stimulus. The ECB has already signalled it is willing to expand its EUR1.35 trillion Pandemic Emergency Purchase Programme (PEPP) given core inflation is currently just above zero percent in the Eurozone.
We expect the central bank will announce at its last meeting of the year in December that it will increase its planned bond purchases by another EUR500 billion and keep its quantitative easing PEPP in place throughout 2021.
Interest rates to stay very low for next few years
Fifth, government bond yields are likely to stay at very low levels despite the global economy’s rebound in 2021. The improving economic outlook has resulted in our projections for longer term US Treasury yields and swap rates being revised upwards while our forecasts for shorter term bond yields have stayed largely unchanged.
Thus, we now expect 10Y and 30Y US Treasury yields to rise to 1.20% and 2.15% respectively over the next year after hitting our earlier long term forecasts of 0.90% and 1.75%. But we still project government bond yields to stay at historically low levels overall given the Fed will not raise interest rates until the middle of the decade and inflation will likely stay below the central bank’s 2% target on average over the next few years.
US Dollar looks set to keep weakening
Last, the US Dollar is set to keep weakening in 2021 as risk-seeking investors reduce demand for the safe-haven greenback and the Fed keeps interest rates at current near zero levels to push inflation back to a 2% average rate.
Political risks have receded
Fourth, political risks appear set to recede in 2021. The EU and UK remain likely to agree to a trade deal before the end of 2020, President-elect Biden will move into the White House in January and a new US government is unlikely to raise tariffs any further on imports from China, Europe, Mexico and Canada, marking a clear break with the unpredictable trade policies of the Trump administration.
Overall favourable macro outlook
Thus, the macroeconomic outlook is likely to be favourable for financial markets in 2021. The global economy’s rebound in 2021 will contrast strongly with the major shock suffered during the pandemic in 2020.
Thus, the overall macroeconomic outlook – rebounding growth, potentially less political risk, a weaker US Dollar, low bond yields and dovish central banks - continues to favour risk assets despite renewed virus waves as 2020 ends.
Hopes for a new normal
We hold an overall overweight view on equities, with a preference for Asia ex-Japan markets. In our view, China’s solid growth trajectory will form a key tailwind for Asia’s growth in the post-pandemic economic cycle. – Eli Lee
In our view, the long-term risks for markets have eased significantly with a favourable US election outcome, meaningful progress on vaccine development, and global monetary policy still very supportive of risk asset prices. In the US and Europe, the ongoing surges in Covid-19 cases could inject some near-term market turbulence, though we expect investors to look through this volatility in anticipation of a normalisation of economic activity. In China, data continues to be encouraging while low inflation could also create room for the PBOC to allow the recovery to continue without having to increase interest rates.
Still, we recognize a fair degree of volatility in the near-term, given President Trump’s executive order banning US persons from investing in selected Chinese companies deemed to have ties with the Chinese military, as well as the release of draft anti-trust guidelines against monopolistic practices in the Chinese internet industry.
We had recommended clients with significant exposure in growth/momentum stocks to rebalance into value/cyclical ones – this has indeed been playing out thus far. We believe this rotation story still has legs, with our base-case expectation that at least one major drug-maker would receive regulatory approval by 1Q 2021.
Markets are understandably buoyant for numerous reasons. Uncertainties around the US elections are mostly out of the way, with a Biden Presidency widely expected to see the US adopt a diplomatic approach to global trade deals. Positive vaccine-related news has lifted sentiment, while 3Q20 corporate earnings have broadly been better-than-expected. The Fed is also likely to remain dovish, in-line with our house view that the fed funds rate could remain at 0-0.25% until as late as 2025.
Still, we see potential for near-term volatility; valuations are not cheap, control of the Senate remains in play, and events such as Treasury Secretary Mnuchin’s unexpected request to the Fed to return funds would require investors’ attention. While surges in Covid-19 cases could also inject turbulence ahead, we would be buyers on dips, assuming further encouraging developments on the vaccine front.
On the Technology front, we have been cautioning clients on the rich valuations and potential for a near-term pullback and this was seen in the recent rotation from growth to value. In addition, China decided to throw a spanner in the works by releasing a draft soliciting public feedback on anti-trust guidelines relating to monopolistic practices in the internet industry. While regulations relating to anti-trust have been rolled out over the years, this is the first time detailed guidelines specifically designed for anti-trust activities in the internet space have been mapped out.
Still positive on EM High Yield bonds
Interest rates in developed markets are expected to stay near ultra-low levels for an extended period. This will drive the search for yield across the investment landscape as we move through 2021, which should benefit Emerging Market High Yield bonds. - Vasu Menon
As we move into 2021, central banks across major developed markets have signalled their determination to keep policy rates at near-zero levels for years to support the post-pandemic recovery. With interest rates pinned at ultra-low levels, we see limited capacity for nominal government bonds to offer a buffer against sharp drawdowns in risk assets within portfolios. Investors will need to seek alternative ways to increase portfolio resilience, including allocating to emerging market high-yield bonds.
Epic November for global corporate bonds
EM HY spreads tightened a staggering 70 basis points (bps) in November. The Total Return of 2.9% makes it one of the top ten performing months for EM HY corporate bonds dating back to 2010. Meanwhile, EM IG spreads tightened an impressive 18 bps. In Developed Markets, US HY spreads tightened an incredible 100 bps for a 3.8% return while US IG tightened 22 bps.
Positive on EM corporate bonds
The outlook for Emerging Market (EM) corporate bonds is currently the most promising it has been in some time. Growth is accelerating and we appear to have an effective vaccine. The US Dollar is weakening, and bellwether commodities such as copper are strengthening - both traditionally positive for EM corporate bonds. Under President-Elect Biden, US Foreign Policy should be more multilateral and policy based, which should also be salutary for the asset class. Furthermore, even under a divided US Congress, we should see a sizable fiscal stimulus bill which should stimulate economic growth and provide an impetus for risk asset deployment. We recommend and overweight on EM High Yield (HY) bonds and a neutral weight on EM Investment Grade (IG) bonds.
Robust inflows into EM corporate bonds
Inflows into the asset class have been consistently strong over the past three months. Total outflows year-to-date (YTD) are now only USD -3.85 bn versus more than USD -20 bn a month ago. Local currency bonds still have outflows of USD -6.2 bn YTD but hard currency inflows are a robust USD 5.85 bn YTD.
EM default rates are not high
While we may have endured the worst recession in almost a century, this is certainly not reflected in EM default rates. Currently, JP Morgan is expecting a year-end 2020 default rate of 3.5% for Emerging Market Credit, which is roughly at the long-run average. They are projecting a further decline to 2.8% in 2021. Distressed ratios, which are a fairly accurate predictor of future default rates at are pre-Covid levels.
We are maintaining our preference for Asia in HY. Asia enjoys a yield advantage compared to countries such as Brazil or Russia which have much lower yields. We believe that the recent trends in onshore Chinese defaults merit monitoring, but do not view them as systemic threats to the offshore market. Furthermore, as discussed above, we view a Biden Presidency as more traditional and diplomacy-based than his predecessor, which should result in lower risk premia for Chinese corporate bonds.
Maintain overweight rating on EM HY and neutral EM IG
We are maintaining our overweight stance on EM HY and neutral stance on EM IG. In a “risk-on” environment HY should be well-placed to benefit. Furthermore, its valuations both on a historical basis and relative to US HY appear attractive. Finally, its higher credit component should provide more of a cushion against what we believe will be rising rates in the ensuing months.
FX & COMMODITIES
Glimmer of light for oil markets
There is potential for higher oil prices in 2021 as travel disruptions diminish amid vaccine progress. Oil fundamentals are on the right track to warrant an upgrade of our 12-month Brent forecast to USD56/barrel from USD50/barrel previously. – Vasu Menon
Oil fundamentals are on the right track to warrant an upgrade to our 12-month Brent forecast to USD56/barrel versus USD50/barrel previously. There is potential for higher oil prices in 2021 as travel disruptions diminish amid vaccine progress and with the OPEC+ likely to delay January's oil-output increase.
Despite new waves of Covid-19 in the US and Europe, the medium-term oil demand outlook is turning increasingly positive amid vaccine progress that could break the link between infection and mobility. Although uncertainties remain on logistics and the roll-out timeframe, vaccine roll-out, when it happens, should lead to normalisation of economic activity, especially in sectors that have a relatively high correlation with oil demand, such as travel, hospitality and food services. US energy demand, for example, is still principally driven by the transportation (68% according to US Energy Information Administration) and industrial (26%) sectors.
We expect OPEC+ will continue to fine-tune the duration of its pledged voluntary supply cuts with market developments. With OPEC+ likely to delay its planned January output increase, this should help limit near-term risk of oil markets tipping back into a glut.
Prospects of an imminent and effective vaccine could limit the room for extended gains in gold prices over the medium-term. Concerns that vaccine progress could slow or diminish the need for further monetary stimulus, led to higher US yields and lower gold prices. However, it is too early to throw in the towel on gold. We believe gold’s main drivers -- weaker US Dollar and low real interest rates -- are likely to provide support over the coming year. We think US Dollar depreciation can continue into 2021. A lower-for-longer Fed is set to keep the US Dollar, as a funding currency of choice. In other words, low US interest rates makes it attractive for foreign investors to currency hedge US Dollar-denominated assets to guard against a declining greenback.
We are also positive on gold because a lower-for-longer Fed should help limit the rise in the long-end US yields. Gold should benefit from better reflation prospects that pushes up inflation expectations and keeps real interest rates negative. We favour a buy on dip approach and expect gold prices to trend higher to USD2,100 in 6 to 12 months’ time.
The quick succession of positive vaccine developments, and the fizzling out of Trump’s challenges, allowed the market to move on from the US elections in a rather positive mood. This is offset by the rising Covid cases in the US, and other more risk-positive developments, such as the delay in US fiscal support.
The market has, however, turned largely immune to the rising pandemic cases. Market sentiment has been risk-on, but not bubbling over into a euphoric state. Into December, we expect this to continue. The market will balance expectations of the first vaccine approvals against the rising Covid cases. Questions over the vaccine availability and uptake will be pushed into 2021. Overall, this translates into a rather negative posture for the broad US Dollar (USD), as safe-haven demand continues to fall. Nevertheless, we do not see any immediate catalyst for the broad USD to fall sharply, leaving USD weakness to be more of a slow grind. This provides scope for periodic, technical-driven USD bounces, which we do not expect to negate the currency’s downside bias.
We expect the antipodeans to benefit most from USD weakness. Global risk cues and firmer commodity prices, together with the re-rating of expectations about the Reserve Bank of New Zealand, should augur well for the Australian and New Zealand currencies.
The Euro should also continue to surpass resistance levels against the USD in a largely USD-driven move. Note, however, that the macro picture in Europe is still largely anaemic and it may be difficult to justify a significantly firmer Euro.
The USD-Japanese yen cross may however stay largely range-bound, as USD weakness is offset by risk sentiment.
In Asia, we continue to back Renminbi (RMB) strength. The resilient RMB should continue to help other Asian currencies to strengthen too. In addition, a better growth outlook has also allowed portfolio inflows to return to Emerging Asia, providing further support for the local currencies. These positives are set against increasingly edgy central banks, who are concerned about its negative impact on exports. This should slow down the appreciation of Asian currencies, without necessarily denting its overall trajectory.
For the Singapore dollar (SGD), we expect it to be held within a narrow range on a basket basis. This, however, implies that there will be downward pressure on the USD-SGD amid persistent USD weakness.
The long-awaited US election has finally reached its verdict, in which Joe Biden has been declared as the next and 46th President of the United States, beating Donald J. Trump 290 – 214 in electoral votes across the 50 states of Northern America. Joe Biden, along with his vice president Kamala Harris, the nation’s first Black woman and first Asian American woman to hold such a position will take their helm in the official inauguration on January 20th, 2021 for the 2021 – 2025 term. Going forward, though some challenges may persist as the majority of the Senate are still Republicans, investors are quite optimistic as this would provide more balance of interests in the future in passing new policies and regulations.
With everything that’s been going on politically in the United States, the nation has recently surpassed the 10 million mark for COVID-19 infections; which still presents another uncertainty for capital markets. However, investors are becoming more and more resilient towards news surrounding COVID-19, as progress on the vaccine front remains positive. Finally, investors’ focus will now be directed back at the US stimulus package which had been anticipated for months now.
Meanwhile in Europe, rising COVID-19 infection and uncertainty over UK-EU relations post-Brexit are still the two-main headlines for investors. Hotspot countries such as England, Germany, and France have imposed new lockdown measures as daily infection and death numbers keep climbing. From a data perspective, the ongoing lockdowns start taking a toll on the economic activity. Both manufacturing and service activities contracted in October, while unemployment climbed to its highest since 2009 as job cuts soar. If the UK is unable to reach an agreement with the EU soon, the economic impact of COVID-19 on both the economy will become even more devastating.
The MSCI Asia Pacific Index was up 3.43% in October, led by China and is currently on track to making new highs for 2020. China, the only country expected to record growth in 2020, posted its Q3 GDP numbers at a staggering 4.9% growth, recording the highest quarterly growth for any country during this pandemic crisis. Meanwhile, Japan and Hong Kong are still struggling with their demand for consumption. Nonetheless, Asian investors cheered as the spread of COVID-19 has significantly dropped in the area, while the situation in developed countries such as the United States and Europe worsened. In the last quarter of 2020, most Asian nations are well on track for a strong recovery from an economic perspective.
Domestically, economic indicators released early November have shown continued recovery; and have somewhat provided support for capital markets. GDP numbers for Q3 were released at -3.49% YoY, up from -5.32% in the previous quarter; hence verifying that the domestic economy is on a recovery phase in the third quarter. COVID-19 daily infection has also dropped significantly in October, from approximately five thousand a day to one-to-two thousand a day. This has also provided a positive sentiment for markets, especially for conservative investors. In terms of consumption, inflation was steady in October, even slightly higher at 1.44% YoY as opposed to 1.42% in the prior month. The easing of PSBB regulation by DKI Jakarta Governor Anies Baswedan has given a much-needed boost for domestic consumption as well as for October PMI Manufacturing data, which recorded a slight gain from 47.2 to 47.4. On the other hand, the central banks’ foreign reserves recorded another monthly decline due to the payments of overseas debt, down USD$1.5 billion in October and is currently at USD$133.7 billion.
The JCI climbed 5.3% in the month of October, recording its biggest monthly gain of 2020 after falling for as much as 7.0% in September. However, by the end of October, the JCI is still 18.6% lower compared to the beginning of 2020. For technical reliant investors, this would imply that the stock market still has a huge potential to minimize its losses in Q4 propelled by the recovering economy as can be seen from recent economic indicators. The US presidential election results have also been a sentiment booster for domestic markets, along with positive progress on the vaccine front. Foreign investors recorded a net buy in the month of October, which also generates a sort of confidence promoter for domestic investors. Looking inward, investors also cherished the legitimization of Omnibus Law by the Indonesian government, amid a chaotic physical demonstration by the labor market on the streets of Jakarta. The Omnibus Law is believed to be a vital element in the coming quarters as foreign businesses will more likely to consider Indonesia as a viable and attractive place to expand their business, which in return will hugely benefit the stock market. In terms of forward Price-to-Earnings Ratio (PER) for the JCI, it currently stands at 14x-15x. However, with increasing positive forecasts for company earnings in the Q4, we consider the present level would be able to justify stock prices as we get close to year-end. We have upgraded our forecast for the JCI to 5,700 – 5,900 by the end of 2020.
The bond market also appreciated last month, with the 10-year government bond yield dropping from 6.93% to 6.6% by the end of the month; a decline of approximately 4.6%. Even through the first two weeks of November, the yield kept going down and is currently in the range of 6.2% - 6.3%. Several things have supported the bond market at the start of Q4 2020, the first one being the relatively higher real-yield domestic bonds offer. As global investors turn risk-on, EM bonds such as that of Indonesia wouldn’t come as a surprise to once again attract yield hunters. Second, the strengthening of the rupiah also played a crucial role for the bond market in October and the beginning weeks of November. Last but not least, the burden sharing scheme by the government and central bank which provides foundational support for not just the bond market, but the currency market as well, plays a major role in market stability; while still keeping an eye on inflation around-the-clock. We expect the central bank, Bank Indonesia to exercise another rate cut in the near future to give domestic consumption a nudge. We have also revised our year-end forecast for the 10-year government bond yield to the range of 6.0% - 6.5%.
The domestic currency, rupiah is currently on its best run of 2020. Appreciating 1.4% against the USD in the month of October to close the month at 14,600 per USD, and is currently trading at 14,000 per USD as of 11 November 2020. The first main driver for the rupiah these past few weeks is what many would call the “Biden-effect”. With Joe Biden voted as the new president-elect, the probability of a new stimulus package becomes higher; and has pushed investors to leave the safe-haven currency asset. The potential increase in money supply in the US will also put pressure on the greenback. Moreover, increasing inflow towards EM markets such as Indonesia have created extra demand for the domestic currency; with more and more foreign investors needing the local currency to make investments. However, from here onwards we see limited upside for the rupiah as the central bank themselves would not want the currency to be too strong that it may weigh on exports. Therefore, we see the USDIDR to be trading in the range of 13,950 – 14,200 by year-end.
After The US Elections
We see overall world economic growth weakening by 4.1% this year before recovering by 5.6% next year with China’s economy leading the rebound. – Eli Lee
Financial markets face further uncertainty. The US elections have now passed but vote counts in several states are being challenged in the courts. In addition, the US, UK and Eurozone are suffering new virus waves.
But once the US election results are clear, financial markets are likely to focus again on the favourable outlook for risk assets underpinned by the global recovery, upcoming vaccines, very dovish central banks, low government bond yields and a weaker US Dollar.
The pandemic’s resurgence across the US, UK and Eurozone is a significant near term threat but the impact of renewed restrictions on social and economic activity in 4Q2020 will be much less severe than those imposed during the first lockdown in 2Q2020. Thus, the global recovery is unlikely to be derailed by second virus waves as 2020 nears the end.
For example, Eurozone’s composite Purchasing Managers’ Index (PMI) - a forward-looking indicator covering both the manufacturing and services sectors - fell from a two year high of 54.8 in July to 50.0 in October. A reading below 50.0 indicates firms are expecting activity to contract while a reading above 50.0 signals companies expect business to expand. For November and December, the Eurozone’s PMI survey is set to fall further as economic activity is restricted to contain the pandemic. But the PMI data is unlikely to return to the very weak levels of March, April and May when the composite survey fell to 29.7, 13.6 and 31.9 respectively.
Though European governments have closed social venues including restaurants, bars, cinemas and sporting events, schools and most businesses remain open. Thus, the economic impact of renewed restrictions is likely to be far less than in the first lockdown in 2Q2020.
We forecast fresh virus waves in 4Q2020 will cause Eurozone GDP to contract by 3.8% QoQ, similar to its decline of 3.7% QoQ at the start of the pandemic in 1Q2020 but much less than the 11.8% QoQ slump of 2Q2020. We also expect US GDP to weaken now by 0.8% QoQ in 4Q2020.
But our overall GDP projections for 2020 remain unchanged for both the Eurozone and the US. This follows much stronger than expected rebounds in 3Q2020 of 12.7% QoQ in the Eurozone and 7.4% QoQ in the US after their economies re-opened during the summer after their first lockdowns.
Thus, as the table shows, we continue to forecast Eurozone GDP contracting by 7.6% this year before rebounding by 5.5% next year. Similarly, we keep our forecasts for a 4.0% decline in US GDP for 2020 before expanding by 5.0% in 2021.
Renewed virus waves have also caused us to lower our GDP forecasts for emerging markets to -3.3% this year with emerging Asia ex-China set to contract by 7.4% now in 2020. But Beijing’s success in containing the pandemic has resulted in our estimate for China’s GDP growth to be raised from 1.7% to 2.5% in 2020 and from 7.1% to 8.1% in 2021.
We thus see overall world GDP weakening by 4.1% this year before recovering by 5.6% next year with China’s economy leading the rebound.
In our view, the overall global recovery will continue despite second virus waves in 4Q2020 with the development and distribution of vaccines in 2021 supporting the economic rebound.
The US political scene after the election results are confirmed, looks increasingly likely to support the outlook for risk assets.
The prospects of a Biden administration supported by a Democrat House of Representatives and opposed by a Republican majority in the Senate will result in ‘gridlock’ between the White House and Congress.
This may make it difficult to reverse the corporate tax rate cuts undertaken by the Trump administration to the benefit of risk assets. It may also reduce the threat of increased regulation under a Biden administration aimed at sectors like technology.
A gridlocked Washington DC, however, is unlikely to pass a second large scale fiscal stimulus programme to support the US recovery. At the height of the pandemic in March and April, US lawmakers approved a huge US$3.0 trillion of emergency aid for the economy. But government benefits worth around US$1.5 trillion have already expired, leaving the US recovery at risk to another downturn if second virus waves are not contained easily.
We would still expect a fresh fiscal package to be passed by 1Q2021 but a Biden administration faced with a Republican Senate may only be able to get Congress to approve a more limited new round of emergency aid worth US$0.5-1.0 trillion.
Long term 10-Year and 30-Year US Treasury bond yields had steepened in anticipation of the Democrats winning both the White House and the Senate. But under a ‘gridlock’ scenario, we would expect limited fiscal stimulus now to keep US Treasury yields very low by historical standards.
We thus maintain our interest rate forecasts for long term Treasury yields to rise modestly to 0.90% for the 10-Year and 1.75% for 30-Year bonds as the US economy recovers over the next one year. The overall low level of yields will continue to support risk assets.
A Biden administration is also likely to benefit risk assets through pursuing a less aggressive stance on trade. The Trump administration’s tariffs pushed up the US Dollar in 2018- 2019. But we expect the greenback will keep weakening now as demand for the safe-haven currency wanes and exporters in Europe, China, Japan and the rest of Asia benefit from a more predictable trade environment.
We see the longer-term outlook continuing to benefit from central banks remaining very dovish.
We think the Federal Reserve will not raise its benchmark fed funds interest rate from its current range of 0.00-0.25% until as late as 2024 or 2025 given the central bank’s recent shift to average inflation targeting.
The Fed is now aiming for inflation to average 2% over the business cycle. As inflation has fallen short of the central bank’s 2% goal for much of the last decade, the Fed is seeking inflation to moderately exceed 2% for the next few years. This makes it very likely the central bank will keep the Fed funds at near the zero levels for up to the next four-to-five years until inflation averages 2% on a sustained basis.
Thus, the overall macroeconomic outlook – rebounding growth, potentially less political risk, a weaker US Dollar, low bond yields and dovish central banks - continues to favour risk assets despite renewed virus waves as 2020 ends.
We see a Biden presidency and a divided Congress as favourable for Asian equities, particularly Greater China. Hence, we upgrade our position in Asia ex-Japan equities from Neutral to Overweight. – Eli Lee
The US elections have been and continue to dominate headlines globally. With a Biden Presidency and a divided Congress, the expectation is that the new administration will be more strongly qualified to manage the Covid-19 pandemic, will enact a new relief aid stimulus package in 1Q2021, and take a more multilateral approach towards US-China tensions.
We see this as favourable for Asian equities, particularly Greater China, and upgrade our position in Asia ex-Japan equities from Neutral to Overweight. In terms of valuations, we see Asia ex-Japan as relatively undemanding versus global peers.
We believe that the initial phase of the post-election equity rally will be led by growth stocks, such as the key technology sector. But if the recovery continues, and economic activity normalises with vaccines becoming widely available in the middle of 2021, we expect the rally leadership to rotate into value and cyclical segments. This will benefit Asian equities more, as value and cyclical segments form a larger component of the Asian markets compared to the US, which is more dominated by technology.
As at 2 November, based on 62% of S&P 500 companies that have reported thus far, 87% have beaten 3Q2020 earnings estimates while 78% have beaten revenue estimates. Despite high beat rates, the muted to negative price reactions – particularly for companies with strong performance – suggests the market has priced much of the upturn.
We see some positives with a Biden Presidency and a split Congress. Higher taxes and regulatory changes in the near term appear unlikely, bringing relief to certain sectors like Technology and Healthcare. While a more modest relief stimulus package and infrastructure spending is expected (relative to that under a Blue Sweep), these are balanced out against the more robust response that the Biden administration is likely to adopt towards the ongoing pandemic, as well as the tailwinds for corporates from more systematic trade and foreign policy.
The 3Q2020 earnings season has started and as at the time of writing, about half of the companies in MSCI Europe which are expected to report earnings have reported.
Of these, 59% of companies have beaten EPS estimates by 5% or more, while 18% have missed, resulting in a strong “net beat” of 41% of companies. If maintained, this would represent the broadest beat based on data back to 2007, though this could moderate as the earnings season progresses. Weighted earnings are currently on track to contract by 23% YoY, a sharp improvement from the 61% contraction seen in 2Q2020.
Price action, however, has been negatively skewed so far, suggesting that to some degree, the good news around 3Q earnings was already priced in, and perhaps the bigger drivers for markets are the rising Covid-19 cases in Europe and softer PMIs in the region.
Japanese equities lagged their global peers in October with select profit taking activities seen in more defensive healthcare and utilities sectors with rotational interest favouring the materials, technology and consumer discretionary sectors.
While the ongoing 2Q earnings releases for companies with February-March fiscal year (FY) end should still result in another quarter of YoY profit decline, we expect relatively less cautious corporate guidance and a smaller quarterly contraction in profits as economic activities continue to normalise. As concerns on the pandemic continue to ease, corporate guidance could also be revised to a more constructive tone, which should help support the market and improve consensus earnings forecasts currently projecting close to -10% earnings decline for FY ending March 2021.
We are upgrading Asia ex-Japan from neutral to overweight. With a Biden Presidency and a divided Congress, the expectation is that the new administration will be strongly positioned to manage the Covid-19 pandemic and the emergence of a more multilateral and measured trade and foreign policy could potentially reduce uncertainties related to US-China tensions. Asia ex-Japan’s valuations are also more reasonable compared to the US.
In Asia, there has also been some positive developments on the Covid-19 front, as India reported its lowest increase in daily cases since July, while South Korea’s President Moon Jae-in said that his country has contained the virus. Moon also highlighted in his parliamentary speech that his administration is seeking to increase its budget by 8.5% in 2021 to create jobs and aid the economic recovery.
In Singapore, the ongoing earnings season for S-REITs has delivered some encouraging results so far and reaffirms our view that the worst is likely over, although operational performance on a year-on-year basis is still largely soft.
We note that most S-REITs have been able to maintain or even improve their portfolio occupancy rates slightly. However, rental reversions have come under pressure as one of the priorities of REIT Managers is to retain their tenants and minimise vacancy risks, which means that they would have to be more flexible on the rental front.
Looking ahead, this trend would likely continue in the foreseeable future, but sequential improvement in distribution per unit is still possible as long as the number of locally transmitted Covid-19 cases remain stable. The three local banks have also reported their 3Q20 results, with all three beating Bloomberg consensus’ earnings estimates.
We continue to remain constructive on China and believe investors should increase exposure to sectors that will benefit from China’s “dual circulation” strategy, which aims to drive domestic consumption, onshore sourcing and import substitution.
The Fifth Plenum of the 19th Party Congress was concluded at the end-October. The key focus is on quality growth, innovation and market reform, and emphasizing China’s “dual circulation” development strategy. Over the next few months, the National Development and Reform Committee will prepare a more detailed draft of the 14th Five Year Plan (FYP) (2021-2025) in consultation and coordination with other government ministries, which will be submitted for final approval at the “Two Sessions” in March 2021. Thereafter, various sector regulators will issue respective sector policies. We would also watch out for the Central Economic Work Conference in late 4Q2020, which will have more details on sector implications and guidelines.
The summary of the plenum reiterated the direction towards quality growth and highlighted the longer-term, non-numerical goals of China’s 2035 development vision and guidelines for the 14th FYP. In terms of its long-term focus, China aims to achieve socialist modernisation with GDP per capita reaching the level of mid-income developed economies by 2035 and to expand its mid-income population, with a strong emphasis on innovation and market reform.
Key highlights of the plenum include:
Both MSCI China (offshore) and CSI300 (onshore A-share) outperformed the regional market over the past month. Valuation of MSCI China has remained elevated at 15.2x FY21E P/E and is trading at more than 2 standard deviations above the historical average. Valuation of CSI300 is relatively less demanding. With MSCI China trading towards the high-end of the trading range, we will focus on the investment theme of key policy beneficiaries.
While detailed sector guidelines and policies have yet to be announced, we believe the emphasis on the “dual circulation” development strategy to support quality growth, innovation and market reform will benefit sectors like clean and renewable energy, domestic consumption, high-end industrial, internet and “new infrastructure” sectors like data centres, artificial intelligence, 5G applications, internet of things, new energy vehicles, electric vehicle charging piles and ultra-high voltage power transmission projects.
We maintain our preference on autos, internet and insurance. We are getting less negative on Chinese banks and expect it to stage a cyclical rebound in the near term. The latest quarterly results highlighted signs of net interest margin compression pressure stabilising and Chinese banks as a sector trading close to the low-end of their valuation.
The absence of a “Blue Wave” led to a rally in Tech stocks again. We continue to believe that Tech should be a core holding for investors, given:
1) the accelerating secular digital trends as a result of Covid-19;
2) the strong financial positions of key tech names; and
3) our assumption of rising but marginally higher yields.
However, for those with outsized positions in the sector, we have been and continue to recommend investors to rebalance portfolio weights into cyclical and value names with resilient balance sheets and stable business models.
Regulatory risk is also a concern not just for US investors – this risk was highlighted for investors worldwide when ANT Group’s IPO was suspended at the last minute due to new regulations impacting the sector.
As for Energy, the sector has been weighed down by lower oil prices due to the resurgence of Covid-19. On the other hand, in the US at least, a split Congress may mean that legislative options to constrain the oil and gas industry would be more difficult to implement compared to a Blue Wave scenario.
EM Bonds Could Benefit From US Elections
Emerging Market credit posted gains in October despite US election uncertainty. Under a Biden Presidency, the asset class should benefit from a less fractious and confrontational approach to China. - Vasu Menon
Within fixed income, our overall allocation moves to broadly Neutral from Overweight, with the Underweight position in Developed Market (DM) Investment Grade (IG) bonds balanced by our continued Overweight position in the Emerging Market (EM) High Yield (HY) segment, which provides attractive carry in a search-for-yield environment. Within EM HY, we maintain our preference for Asian High Yield.
We reduced our position in DM IG bonds to Underweight from Neutral to position for a steeper yield curve. We forecast 10-year Treasury yields to be 0.90% in 12 months. With DM IG spreads at its current tight levels, we view the return offered by this asset class to be relatively unattractive and see the risk-reward here to be middling.
A Biden Presidency should prove to be salutary for Emerging Market Credit. Foreign policy should be less confrontational, more measured and more deliberate. Consensus building with traditional European allies will also likely be a major objective.
Furthermore, even under a divided Congress, we should see a sizable fiscal stimulus bill which should provide impetus for risk deployment.
Recent economic indicators globally point to a gradual if uneven economic recovery. Furthermore, while Covid-19 remains a formidable foe with second wave infections in many places in Europe and the US, overall morbidity rates appear to be largely declining in most countries.
Additionally, under a Biden Presidency the US may implement a more disciplined and coherent approach to the pandemic. Perhaps more importantly, there seems to be little tolerance globally for the crippling lockdowns of the spring. However, the key architect underwriting performance corporate bonds over the medium-term remains the US Federal Reserve, and lower for longer rates has morphed into lower for much longer rates, with Fed funds rates not likely to be raised for a number of years.
Our view remains that the Fed funds rate could stay near zero until as late as 2025. The Fed’s most recent forecasts show core personal consumption expenditures inflation – the Fed’s preferred measure of inflation – returning to 2% only in 2023.
In HY, Asia has underperformed in the past several months in what we believe is a “relief rally” in Latin America which has still under-performed year-to-date.
Nonetheless, we are still maintaining our preference for Asia and believe that the recent underperformance has solidified value. The yield advantage for Asia is such that in a constructive or even neutral environment for Credit this incremental “carry” will prove difficult for countries such as Brazil or Russia with much lower yields to overcome.
However, the global economic recovery should reveal opportunities in other countries outside Asia as well; we would look to them for incremental High Yield investments.
In IG we would pivot away from Latin America toward Asia. This change is based on several factors: 1) Under a Biden Presidency, Asia (which is primarily China) should benefit from a less aggressive policy stance and
2) Latin America has a significantly higher duration, which will be a significant tailwind during an expected period of high rates and steepening yield curves.
Weak sentiment in the China HY segment continued into October, driven by the general pull back in risk appetite affected by idiosyncratic events of prominent issuers coupled with the US presidential election. The heavy bond supply post Golden Week from Chinese issuers (more IG than HY) also weakened the technical backdrop in the secondary market. Performance of new issuances in the secondary market is mixed; IG bonds have notably performed better than HY bonds signifying the market’s risk-off appetite during the month.
On 29 October, China’s 19th Communist Party of China (CPC) Central Committee released a range of long-term development objectives and draft of the new 14th 5-year plan for the nation. These include building the nation into a technology powerhouse, to develop a robust domestic market and aspire to be a developed economy by 2035.
While not directly benefiting the property sector, the direction of sustained economic growth supported by technological advancement and consumption is supportive of the property sector and the urbanisation trend. This means sustainable stable fundamentals for Chinese property bonds.
Post the US elections, our Overweight in China property bonds remains unchanged supported by stable fundamentals, and good relative value.
The Fed appears to be committed to keeping short-term rates low (and near zero) for at least the next several years However, the longer end is driven largely by market forces.
Our house view calls for rising longer-rates and further steepening in US Treasury curves over the coming year. As a result, we would maintain a short duration bias in portfolios.
We are maintaining our Overweight stance on EM HY and Neutral stance on EM IG.
Our constructive view on the HY asset class remains, driven by unwavering support by the Fed, increasingly fewer compelling fixed income alternatives, a gradual improvement in economic growth and a likely fiscal stimulus bill. A Biden Presidency should provide further tailwinds should foreign policy friction decrease.
Gold - A Tightly Coiled Spring
The gold rally still has legs and reflation will be gold's new friend. Fiscal relief, accommodative central banks and stronger emerging market demand should keep the backdrop supportive for gold. – Vasu Menon
The return of oil price pessimism is set to put pressure on OPEC+ to postpone an increase in production currently scheduled for January. OPEC+ has until it's 1 December meeting to decide whether to postpone plans to add 1.9 million barrels per day to crude output as current cuts of 7.7 million barrels per day are eased to 5.8 9 million barrels per day under the original plan.
The near-term outlook for oil prices remains challenging.
First, stagnant crude prices reflect a slowing demand recovery as Covid cases rise again. Surging Covid-19 cases have forced European governments to progressively tighten containment measures, weighing heavily on the short-term economic outlook.
Second, rising oil supply is also a headwind for oil. The Libyan oil supply is returning at an inopportune time. The other bearish risk for oil on the supply front is that a likely Biden victory in the US elections raises prospects of a diplomatic breakthrough between the US and Iran could open the door for the return of Iranian crude.
The gold market is coiling, a term that is associated with relatively rangy markets that are getting ready to make big moves. The gold rally still has legs in our view.
First, we think post-election reflationary policies will be gold's new friend. Lower real interest rates are positive for gold. Real rates can fall if markets believe that the economy will reflate on the back of the Fed doing more to support the economy with a gridlocked government. Prospects of higher inflation will benefit gold as an inflation hedge.
Second, we are positive on gold because central banks can print money but not gold. Major second Covid-19 waves could lead to more central bank stimulus soon. As central banks step up quantitative easing, currency debasement fears are set to drive gold higher against major currencies such as the US Dollar, Euro and Australian dollar.
Third, emerging market demand for gold jewellery could start to strengthen as growth improves. One bright spot is China where growth pick-up is becoming more broad-based.
A widely available vaccine would make us more cautious of the outlook for gold, but that is more a concern for 2022 or beyond. We continue to forecast gold prices to rise to US$2150/oz in a year's time.
The “Blue Wave” failed to materialise, and consequently we do not expect the floor under the broad US Dollar (USD) to crumble. Nevertheless, so long as the market remains focused on the US election and its aftermath, the USD may still come under pressure.
Firstly, hopes for a quick fiscal stimulus that is sufficiently large to spur US macro outperformance relative to Asia and Europe has effectively dissipated. With a divided Congress, fiscal stimulus negotiations will likely remain protracted and the final package limited to pandemic relief. This would be USD-negative.
Secondly, the equity markets have found sufficient reasons to turn higher. This should diminish the safe-haven appeal of the USD.
Finally, if the Trump campaign chooses to launch a robust challenge to the election results, this could cause the USD to soften. We prefer to be long on the Japanese yen (JPY) if Trump challenges the election result.
Beyond the elections however, we should not automatically expect the USD downtrend to continue over a one- to three-month time horizon. Much depends on the pandemic situation globally at that time as well.
One thing to note though, is that other major central banks are now moving closer to the Fed in terms of dovishness.
The Reserve Bank of Australia (RBA) has pledged not to raise its policy rate until inflation is sustainably within its target range. This is not unlike the average inflation targeting adopted by the Fed. The RBA and Bank of England (BOE) have also announced asset purchase programmes that are more dovish than initially expected.
The European Central Bank (ECB) may also expand its Pandemic Emergency Purchase Programme (PEPP; a temporary asset purchase programme in response to Covid-19) in December. This contrasts with the Fed, which is not expected to expand its asset purchase programme for now. So, the Fed is no longer the biggest dove in town, and this may prove favourable for the USD.
In Asia, this outcome is arguably the most RMB-positive, and the sharp gains in the RMB points to that. In the medium term, if a new US administration adopts a more conventional and rules-based approach towards China, we may see the risk of geopolitical flare-ups decline. This coupled with the China-centric RMB-positives (eg. economic recovery on-track and yield differentials supportive) should augur well for the RMB in the medium term.
In Singapore, our stance on the Singapore Dollar (SGD) Nominal Effective Exchange Rate (NEER) is unchanged, i.e. we expect it to remain locked within a narrow range just above the parity levels.
This leaves the USD-SGD a by-product of the broad USD and RMB directionality. In the short term if the USD faces some downward pressure, expect the USD-SGD to see some downside pressure as well.
Opportunities amid risks
The global economic recovery is still the main focus for investors right now, where the US jobs data, one of the main economic indicators, continues to show improvement. Unemployment rate recorded another decline in the month of September, dropping from 8.4% to 7.9%. However, the US job market still has a long way to go before going back to pre-pandemic levels. Added risk also comes from fiscal stimulus negotiations, where the government still hasn't been able to reach an agreement on the new package. With the US election just around the corner, volatility may persist as investors’ focus will be geared towards it in the coming weeks.
Meanwhile in Europe, increasing uncertainties come from unsuccessful Brexit negotiations as well as COVID-19 cases which are on the rise again. Some countries in the Euro area include France, Spain, England, and even Russia are currently the new epicentres for the coronavirus. The increasing number of new cases have triggered back lockdown restrictions for some of those countries, which would hinder the recovery for European countries and prolong the recession in Europe.
In Asia, the month of September saw significant volatility. With infection rates increasing in several countries, coupled with several global uncertainties such as US fiscal stimulus and elections have dampened market sentiment. Nonetheless, Asian economic data still show ongoing improvements led by China. China economic recovery is currently on the right track, with PMI Manufacturing data still recorded higher in September compared to the previous month. For this year, China is still expected to achieve positive GDP growth and safe from recession; which may prompt the PBOC to be less aggressive in regard to monetary easing policy, however it will remain accommodative. In addition to that, the initiative by PBOC to make the Yuan currency a major player in the digital currency world will also have an effect on the overall monetary system.
Domestically, the month of September presented quite a challenge for capital markets; with several economic indicators falling from previous levels. Due to the decision of implementing back the PSBB regulation, manufacturing fell back below to contraction levels at 47.2, after having recorded an improvement in the previous month. Deflation happened for the third straight month, which implies that domestic consumption is still weak. Moreover, foreign reserves declined to USD$135.2 billion after hitting a record USD$137 billion in the previous month. The decline was caused by the payment of government loans as well as the open market interventions by the central bank in order to maintain a stable exchange rate for the Rupiah. Overall, we see that Indonesia is still showing fundamental resiliency; taking into account the increase in daily new COVID-19 cases nationwide in the midst of a recovering economy. The Omnibus Law which had recently been passed has the potential to change the climate for Foreign Direct Investments (FDI) in Indonesia, making it more attractive for overseas investors.
The Jakarta Composite Index (JCI) had a rough month in September, recording a significant decline of 7.03%. The projection of a negative growth for 2020 has produced a negative sentiment that pushes investors to be Risk-Off. The ongoing pandemic has continuously put pressure on the economy, and recession was believed to finally arrive in the third quarter. Moreover, with the implementation of PSBB (lockdown) again in early September for Jakarta, economic activities have been significantly held back; where the capital city Jakarta itself contributes for about 17% of the economy. Total lockdown had been implemented because infection rate has not slowed down. Regarding the handling of the novel virus, the government has so far done a good job in supporting the suffering economy. The central bank is also continuously increasing liquidity to help the credit market.
In the short run, we see that volatility will persist in tandem with the high number of daily COVID-19 cases. Market participants are also still closely monitoring the news surrounding the coronavirus vaccine. External factors such as the uncertainty of another round of US fiscal stimulus, as well as elections have dampened market sentiment. However, with the total lockdown going back into the transition phase in early October, we hope that the economy may resume normality. Aside from that, the newly passed Omnibus Law in early October, including the plans for a Sovereign Wealth Fund is believed to be able to provide a sentiment boost towards the economy as well as capital markets in the long run.
The bond market also recorded a decline in September, with the 10Y yield going up 1.32% to 6.96% by the end of the month. Domestic bond market is rather stable considering the various uncertainties present, supported by the burden sharing scheme between the government and the central bank. The burden sharing scheme is estimated to be extended till next year, because the government needs more time to disperse their planned fiscal stimulus. The governor of Bank Indonesia, Perry Warjiyo, issued a statement saying that his administration is closely monitoring the effects of the stimulus on inflation and Bank Indonesia’s balance sheet. Not to mention, we see that demand for domestic government bonds are still high, both for local as well as foreign investors, due to a high Real Yield it offers which makes it an attractive investment. Hence, continuation of the burden sharing scheme and higher capital inflows toward the domestic bond market should push yields lower to the range of 6.5% - 6.6% by year end.
Like the equity and bonds market, Rupiah also recorded a decline last month. Rupiah weakened by 2.18% against the USD, and ended at 14,880. The decline was caused by high uncertainty in financial markets, both due to global and domestic factors, thus making the high demand of the USD as a safe-haven currency. In the future, Bank Indonesia sees that Rupiah has the potential to strengthen due to its undervalued level fundamentally, supported by the potential capital inflow of Ciptaker Law. A low interest rate policy from the US will also hold the USD relatively weak when compared to other countries' currencies. Thus, rupiah is expected to move in the range of 14,700 – 14,900 until the end of the year.
Juky Mariska, Wealth Management Head, OCBC NISP
Navigating near term risks
Despite near-term threats, we see the macroeconomic outlook continuing to favour risk assets. We foresee the global economy recovering further in 2021 and interest rates staying very low as the Fed is likely to leave rates unchanged until as late as 2025 to support the US economy. – Eli Lee
The very clear trends over the summer of buoyant equities, a weaker US Dollar (USD), very low government bond yields, steeper yield curves and record gold prices have given way to renewed financial market volatility.
Investors have become more cautious owing to greater near-term risks to the outlook.
Resurgence of virus in Europe
First, new virus waves across Europe have affected corporate sentiment, as national governments imposed new curbs on economic activity to contain fresh virus outbreaks.
Fading fiscal stimulus
Second, the inability of America’s Congress to approve further fiscal stimulus is raising concerns that the US economy will experience much weaker growth in 4Q 2020 after a strong rebound in 3Q 2020. This is because US$1.5 trillion of the huge US$3 trillion of federal emergency aid passed earlier this year to support the economy at the start of the pandemic has already expired or is becoming exhausted.
So far, US lawmakers have been unable to agree upon fresh fiscal support and are unlikely to do so now ahead of the presidential election on 3 November.
The lack of additional government support, however, may already be holding back growth and thus slowing America’s labour market recovery. Initial jobless benefit claims soared at the start of the pandemic from around 200,000 applications a week to almost 7 million. After Congress authorised emergency aid in March and April, employment began to recover, and jobless claims fell steadily. But, more recently, benefit applications have stopped falling and remain stubbornly high just below 900,000 a week. Similarly, continuing claims - a measure of total unemployment - shows more than 12 million workers are continuing to apply for jobless benefits.
Concerns that US elections may be contested
Third, financial markets have become concerned that a close US election result on November 3 will be disputed and result in voting recounts and court cases lasting for weeks. A contested election outcome could even cause a major constitutional crisis if neither President Donald Trump or his Democrat opponent Joe Biden accept the results.
US-China tension broadening
Fourth, tensions between the US and China continue to broaden across a wide range of issues from trade to technology.
Fears of a chaotic Brexit
Last, the risks of a chaotic ‘no deal’ exit are rising between the UK and the European Union if the two sides cannot reach a fresh trade agreement when their current trading arrangements expire at the end of 2020. Even if a new EU-UK trade deal is finalised before the end of the year, we estimate UK GDP will still contract by -10% in 2020 - a much worse performance than the US, Eurozone or Japan as our table of GDP forecasts shows. But if no deal is agreed by year-end and the UK loses its tariff-free access to EU markets, then Britain will suffer a second serious downturn in 2021.
Risks exists but we are not negative
Significant near-term risks are thus likely to keep investors cautious in October. But financial markets already appear to be pricing in much of the potential bad news - given their recent volatility - and we see the threats as tail risks only to our base case of continued global economic recovery led by China and very dovish central banks keeping risk assets supported over the longer term.
For example, second virus waves across Europe have hurt business sentiment after the summer but governments are using targeted restrictions rather than returning to the broad lockdowns imposed during the first virus waves.
Similarly, fresh fiscal stimulus is unlikely before the US elections, but the prospects will rise again after November’s vote as both parties favour further government aid to support America’s economic recovery.
Further, President Trump - as he remains behind in the polls - continues to claim without any evidence that the increased use of mail-in ballots owing to the pandemic will lead to widespread voting fraud during November’s elections. Thus, investors are concerned that Trump will not accept the results if he loses and will instead demand the Supreme Court override vote counts. But senior Republicans including Senate leader Mitch McConnell and Senator Mitt Romney have rebuked Trump and insisted there will be an orderly transition if the president loses November’s election.
Trump is still likely to dispute the results if he loses. But he will only be able to try if November’s outcome is very tight.
Similarly, the risks of US-China tensions affecting financial markets is limited by the slim prospects of fresh tariffs being imposed before the US elections while the unpopularity of the UK government - due its poor handling of the pandemic - has increased pressure on London to compromise and secure a trade agreement with the EU to avoid a damaging no-deal exit by the end of the year.
Maintain neutral position in equities
For now, we continue to believe that investors should be positioned for a rotation from growth/momentum to cyclical/value stocks, and we maintain our neutral overall position in equities. – Eli Lee
Despite the bruising performance registered across global markets recently, we believe that volatility is unlikely to recede in the short term. In our view, the upcoming US presidential election would be the key risk event for equity markets, with concerns over a potentially drawn-out contested election process in play.
Still, we remain constructive on the long-term outlook of markets, with China in particular a bright spot, as latest activity data demonstrates that the Chinese economy continues to lead the global recovery in 3Q 2020 after its V-shaped recovery in 2Q 2020.
While we remain constructive over the longer term, we believe that the likely reasons for this recent pullback remain valid in guiding the near-term outlook on US equities. First, there remains significant uncertainty as to whether a stimulus package can be passed before the elections. Second, a renewed wave of Covid-19 infections remains a live possibility. Third, some market participants are concerned that inflation could become a potential headwind for equities, though we would point out that history demonstrates that valuation multiples can remain high or continue to expand when inflation increases from a relatively low starting point. Lastly, and probably most importantly, the possibility of a lengthy contested election process remains a key risk for markets moving forward.
In Europe, the story so far for 2020 has been a strong multiple expansion to partly offset the collapse in earnings. The key questions now are whether earnings are turning and just how much further P/E multiples can expand. With regards to the former, the latest set of company results have shown that negative earnings revisions are stabilising and that 2Q 2020 may very well mark the bottom, but this is on the assumption that the region does not see renewed large scale lockdowns on the back of rising Covid-19 cases. Currently, the situation is in a flux, as cases seem to be rising again.
Indeed, in the UK, the country seems to be in a more perilous position with regards to Covid-19, along with renewed concerns of a no-deal Brexit. Investors in UK equities may wish to be reminded that domestically exposed UK stocks typically underperform more foreign-exposed ones in periods of sterling weakness and vice versa.
Following the leadership transition in late September, where Yoshihide Suga won the internal LDP party election and was appointed as the next Prime Minister for ex-PM Shinzō Abe’s remaining one-year term, we expect policy continuity for expansionary fiscal and monetary policies in Japan, with near-term focus on pandemic management and re-opening of the economy. With approval ratings for the new administration rising, an earlier general election may be called before the end of the PM’s official term in September 2021, contingent on the pandemic situation.
With PM Suga’s track record of past reforms in the Abe administration, the market appears to be more hopeful of new structural reforms driving productivity and growth. However, we have a more circumspect view, given that meaningful progress in reforms will take time. Key sectors PM Suga is expected to focus recovery efforts on include tourism and agriculture, while the telecommunication sector is likely to face continued pricing pressure. Valuations remain extended. MSCI Japan last traded at 15.4x forward P/E, close to 2 standard deviations above its 10-year average multiple of 12.8x. Corporate earnings forecast for the financial year ending March 2021 have been trimmed steadily over the past three months, and are expected to contract 7% year-on-year from a year ago, with a stronger rebound of +40% expected in FY March 2022E.
The MSCI Asia ex-Japan Index reversed three straight months of increases, falling slightly in September. However, performance was relatively more resilient compared to the US market.
There were some positive developments on the geopolitical front, as China and India have held new rounds of diplomatic discussions with the aim of de-escalating tensions given their ongoing border dispute. While the daily number of new Covid-19 cases in India remains high, there appears to be some recovery in consumer demand as lockdowns ease, coupled with an increase in spending ahead of the key festive season.
In Southeast Asia, uncertainties remain over Malaysia’s political landscape. Indonesia’s Parliament approved a state budget for 2021 with a target of bringing GDP growth to 5% and a fiscal deficit estimated at 5.7% of GDP. The Singapore government announced in late September that it was allowing more employees to return to office, although each employee must still work from home at least half the time and no more than half of employees are allowed at the workplace each time. While restrictions are still in place, this slight easing does provide a positive sentiment boost to office REITs, coupled with recent media reports of Bytedance, Tencent and Amazon considering expanding in Singapore. The workplace easing also provides immediate tangible benefits to retail REITs with downtown malls near office buildings such as CapitaLand Mall Trust, Starhill Global REIT and Suntec REIT (35% of Suntec City mall’s tenant mix is F&B). F&B outlets in downtown areas have certainly suffered with a significant proportion of the workforce working from home.
Looking ahead, October will see the start of the earnings season again, with S-REITs kicking it off. While we are expecting a sequential recovery compared to 2Q20 due to the impact of rental concessions given to tenants, performance on a year-on-year basis is likely to remain weak with the exception of data centre and logistics exposed S-REITs. Key indicators to look out for include rental collection rates and pace of recovery of shopper traffic and tenants’ sales.
China will hold its plenary session at the end of October to discuss the 14th Five Year Plan (FYP) (2021-2025), which will be a key event to watch out for. We expect the “dual circulation” strategy to be a key policy focus and certain government policies will be needed to facilitate this development. The “dual circulation” strategy will focus on domestic demand as the main driver, supported by a network of domestic and international circulations that complement each other. In our view, this strategy is a shift towards self-reliance and a re-emphasis on the large-scale potential of China’s domestic economy amid an uncertain global environment and ongoing US-China tensions, which have resulted in uncertainty on external demand.
Domestic consumption could be boosted and supported by structural reforms and effective investment not only in traditional infrastructure projects, but also through investment in new infrastructure and new urbanisation projects. As such, potential beneficiaries would be broadened to new infrastructure sectors like data centres, artificial intelligence, 5G applications, internet of things, electric vehicle charging piles and ultra-high voltage power transmission projects. We prefer sectors focused on domestic consumption, such as autos, internet and insurance, and expect these sectors to have more policy support. While the healthcare sector should also benefit, we would only accumulate on dips companies with a domestic focus, given the sector’s outperformance and relatively rich valuations.
Remain overweight EM High Yield
Bonds continue to be supported by overwhelming central bank policy support. We remain overweight on Emerging Market High Yield credit and maintain our preference for Asian High Yield bonds. – Vasu Menon
The rally in corporate bonds ended after four consecutive positive months. Emerging Market (EM) corporate bonds was down -0.3%, EM High Yield (HY) was down -0.8% EM Investment Grade (IG) was down -0.1%. In Developed Markets (DM), HY fell -1.3% while IG was the sole market positive for the month, rising 0.3%.
Over the past month Asia was the clear underperformer in HY, down -2.7% versus -1.5% for Latin America and -0.6% for Europe Middle East Africa (EMEA). The decline in Asia was driven by China (and more specifically China Property), which was down -3.6%. The weakness in Chinese High Yield did not spill over to the Investment Grade market.
Expect turbulence in the short term
US presidential and congressional elections are weeks away and polls forecast a sweeping defeat for both President Donald Trump and the Republican party. This could engender enhanced histrionics or even extreme actions by the incumbent. Additionally, while just a few weeks ago a fourth fiscal stimulus deal was assumed, this seems a distant dream given an increasingly fractious Congress that now appears more consumed with a potential new Supreme Court nominee and does not want to give the other side “a win.” Finally, a second wave of Covid-19 is emerging in major European countries including France, England and Spain. The above factors could cast a pall over corporate bond markets in the coming weeks.
But constructive medium-term view remains intact
Recent published leading economic indicators (housing starts, PMI, retail sales) and high frequency data in the US point to a gradual if uneven economic recovery. Furthermore, while Covid-19 remains a formidable foe, overall morbidity rates appear to be largely declining in most countries. Perhaps more importantly, there seems to be little tolerance globally for the crippling lockdowns of the past. Moreover, in November political uncertainty in the US may ease and we may see a substantive fiscal stimulus bill regardless of the presidential outcome. However, the key architect of the nascent recovery remains the US Federal Reserve, and recent announcements indicate lower for longer rates has become lower for much longer.
Prefer Asia High Yield
In HY, Asia has underperformed in the past several months in what we believe is a “relief rally” in Latin America which has still underperformed year-to-date. Nonetheless, we are still maintaining our preference for Asia and believe that the recent underperformance has solidified value. However, the global economic recovery should reveal opportunities in other countries outside Asia as well.
Despite China HY bonds returning -2.8% month-on-month, our overweight call in China HY especially China property bonds remains unchanged. We continue to prefer BB to B-rated bonds as macro-level uncertainties remain. The drop in the HY Chinese property sector represents a better entry point to add exposure of better quality HY names than last month. Currently, China HY bonds YTM is 9.4% vs Indonesia 9.4% and India 7.43%.
In IG we would prefer Latin America. From a valuation point of view, Asia, and China in particular, appears rich.
FX & COMMODITIES
Strong case for higher gold prices
With the Fed expected to keep interest rates near zero until as late as 2025, there is a strong case for higher gold prices in the medium term. We forecast gold prices to rise to US$2,150/oz in a year’s time. – Vasu Menon
The near-term outlook for oil prices remains challenging. First, stagnant crude prices reflect a slowing recovery in demand as Covid-19 cases rise again. Traffic and flight data show the recovery is decelerating.
Second, OPEC+ is on a gradual schedule to roll back supply cuts. Third, Libya’s oil supply is returning at an inopportune time after oil production had been previously shut by the ongoing conflict.
However, we expect supply side rebalancing to offset slowing oil demand pickup to keep oil prices supported. While they have not yet been reflected in a decisive downtrend in oil inventories, we think they will in the coming months.
First, we expect OPEC+ collectively to continue to deliver a high level of compliance with its pledged supply cuts for the rest of 2020. Saudi Arabia hinted that it is ready for new production cuts and lambasted cheating OPEC+ members.
Second, radical reductions in drilling across the world should remain in place until oil prices start to rise above US$50/barrel. According to a Dallas Fed Survey, US$50-60/barrel WTI is needed to stimulate fresh drilling activity.
Gold suffered a bout of liquidation in September, as stronger US Dollar and rising real rates suppressed investors’ appetite.
Increasing growth concerns have weighed on inflation expectations and pushed real rates higher (and gold prices lower) with US 10-year nominal bond yields roughly unchanged.
However, we believe gold’s safe haven appeal will remain strong, as policymakers can ill-afford to ignore a further pickup in volatility in the equity market and allow accidental fiscal policy tightening to happen. The more “risk off” action there is, the more likely that the Fed will also step in.
With the Fed expected to keep its Fed funds rate near zero until as late as 2025, there is a strong case for higher gold prices in the medium term.
We forecast gold prices to rise to US$2,150/ounce in a year’s time.
As we head into the 4Q 2020, the global environment has turned decidedly more jittery due to several developments.
First is the rising virus counts in Europe that has compelled countries to consider and restart movement restrictions.
Second is the perceived stalling of the global economic recovery momentum.
The reversion to movement restrictions may further impact the services sector in Europe which is already stalling.
Financial markets also perceive that the US economic recovery will fade if the next round of fiscal stimulus fails to materialise.
Finally, central bank-fuelled reflation trades have also started to unravel and put a pause on the risk-on market sentiment.
While each of the factors above, on their own, may not be sufficient to turn around the weak-US Dollar (USD) trajectory, the convergence of these factors has hurt risk appetite and benefited the USD.
If these developments remain in place or worsen, the USD may regain favour on the back of safe haven buying. Given this backdrop, we may see the Euro and Australian dollar underperforming the greenback.
The upcoming key event risk is clearly the US presidential elections. If a contested outcome becomes likely, expect it to translate into a US-centric risk-off episode. This could be near-term negative for the USD. However, USD weakness in this form is likely to be narrowly restricted to other reserve currencies, primarily the Japanese yen.
In Asia, the structural positives for the Renminbi (RMB) remain very much in place. The post-pandemic economic recovery is arguably the most on-track in China, and favourable yield differentials further support the Chinese currency.
We retain a positive outlook for the RMB, expecting it to strengthen to 6.7100 against the USD in the near term. A steady recovery in China and a firm RMB has allowed markets to overlook the mostly weak state of recovery in Asia (ex-China). This provides a degree of shelter for Asian currencies. So, even if the USD rebounds further, we expect its upside versus Asian currencies to be rather limited.
In Singapore, the macro outlook appears to be improving, even though the overall picture remains soft. With fiscal policy being the preferred tool to support the economy, there may be little pressure on the MAS to further ease monetary policy ahead of its biannual policy meeting. We expect the Singapore Dollar Nominal Effective Exchange Rate policy parameters to stay unchanged during the meeting.
The Recovery Continues
Continuous recovery headlined the month of August, with global risk assets seen continuing their recent rallies. Tech stocks have been the most prominent in supporting Wall Street, with the likes of Tesla, Apple, Amazon, and Microsoft leading the charge. Jobs data from the US, which is one of the most watched economic indicators that represents the recovering global economy is still showing improvements. Unemployment Rate is finally down to single digits at 8.4%, as opposed to 10.2% in July; due to a jump in Non-Farm Payrolls and a decrease in the weekly Initial Jobless Claims data. Number of COVID-19 case growth in the US has been seen to decrease substantially in August despite the ongoing noise on the reason CDC changed its testing guidelines on COVID-19, where asymptomatic cases may need no testing.
However, recent weeks have confirmed that investors’ risk appetite have also simmered down since the US elections are just around the corner. Regarding polls and surveys, Joe Biden is the clear favorite as of right now; although the same can be said four years ago by Hillary Clinton. President Trumps’ latest hail-mary would be the next round of government fiscal stimulus; believed to play a crucial role in the probability for his reelection. Investors are taking a more conservative approach towards investments, due to the nature of uncertainty during elections; hence causing the recent correction in its stock market which has rallied on a stretched valuation.
Looking at Europe, the Eurostoxx 600 recorded its best month in August 2020, since 2009. Hopes for a “V-shape” recovery continues to build up; with the government revising up its 2020 GDP growth from -6.3% to -6.0%. However, the Euro area has found itself a new obstacle, present in the inflation numbers for the month of August. The Eurozone experienced a deflation of -0.2%, contradicting market expectation for inflation of 0.2% and well below the inflation target set by the ECB at 2%. ECB President Christine Lagarde believes that inflation would only start to pick up in early 2021, while the remaining of 2020 will still revolt around groundbreaking recovery. The central bank is expected to maintain its bond buying program of 1.35 Trillion Euro, with a probability of increasing it to 1.7 Trillion at its upcoming meeting; while deposit rate remains, and expected to be at -0.5% until the end of 2022.
The MSCI Asia ex-Japan recorded an incline of 3.39% in August, with Chinese stocks leading the charge although economic data from China is showing a slowdown in the economy’s recovery path, as can be seen from the PMI and inflation numbers. The majority of other Asian bourses saw modest gains as well in August. Investors particularly in Asia were shocked upon receiving the news of Japan’s Prime Minister, Shinzo Abe to step down due to health complications. However, it seems that investors quickly indulged the idea of the frontrunner replacement candidate; Yoshihide Suga, the Cabinet Secretary to replace Abe.
Domestically, economic data for August showed an uneven recovery path for the economy. Inflation numbers dropped further to 1.32% from 1.54% in July; bringing the YTD numbers for CPI to 0.93%. Consumption has not picked up and is believed to be subdued for the remainder of 2020. On the bright side, PMI manufacturing data and the consumer confidence index remained on its recovery path. The central bank has also increased its foreign reserves from USD135.1B to USD137.0B to further prove its commitment in keeping economic and market stability.
The JCI recorded its fifth straight month of gains in August, closed 1.72% higher for the month. The rally in the equities market should have been higher in August if not for the MSCI Index rebalancing, that contributed to a decline of 2.02% in the last trading date of the month. This was immediately followed by a rebound in the next day. However, recent noise on the government plan to revise the central bank’s independency, has brought another jittery in the domestic market, coupled with the negative sentiment on global tech stocks, has successfully toned down the risk appetite of the local investors. As the investors try to balance and observe the situation, the capital city Governor, Anies Baswedan, decided to pull the emergency break of total quarantine, as the number of COVID-19 cases has grown at an exponential rate of more than 3,000 cases a day nationally. The action was deemed necessary to reduce exhaustion on the limited healthcare facilities. Without total quarantine, Jakarta would run out of hospital beds by Sept 17th. This decision alone caused a stock market rout in the following day. JCI was down more than 5% on the day, and had to be suspended. However, compared to the first total quarantine in the early pandemic, which was considered as lack of guidelines, preparation, or let alone proper health protocol; in the current quarantine, most of the companies and people are well-versed on the work guidelines and health protocol and how to keep the business going with some flexible work arrangement. Government also allows more sectors to open during the quarantine, as compared to the previous.
The JCI is currently trading at approximately 18 times forward price-to-earnings ratio, but yet also a reflection of a rough 17% earnings downgrade for 2020. Foreign money has also continuously flowed out of the stock market since the start of the pandemic, leaving the domestic investors as the sole supporting pillars for the stock market. The number of local daily stock investors was seen rising from 51k in March to 93k in July 2020 as more and more retail investors take interest in the domestic stock market and boost JCI. Going forward, volatility may still persist, as investors are observing whether or not the quarantine would be extended to more cities, which will mean another break in the economic recovery. Nevertheless, equity market is almost certain as forward looking and will attempt to price-in any economic recovery in the future as the nation is racing on the vaccine development and pouring more fiscal stimulus to avoid the prolonged recession. Thus, JCI is expected to close in a range between 5,000 – 5,400 in the remaining of the year.
The bond market closed flat, unfazed in the month of August, as indicated by the yield on the 10Y government bond stayed firm at 6.8%. The central bank and the government have decided to extend their “burden sharing” scheme to 2022, which means the budget deficit will continue to widen due to more bond issuance. This has dampened market sentiment, especially for the bond and FX market. In addition to that, the ongoing discussion on the revision of the central bank’s independency regulation has put more stress on the asset. Nevertheless, as investors’ risk appetite gradually increases over the next coming months, especially after the US elections; domestic bonds will again take the spotlight as it provides a relatively higher real-yield compared to neighboring ASEAN and other EM countries.
The yield on the 10Y government bond should hover in between 6.5% - 7.2% in Q4 2020, with higher probability leaning towards the lower bound due to another potential rate cut by the central bank as well as the improving global economy that would drive investors for better yielding bonds.
In regards to the Rupiah, the USD/IDR saw some volatility in the middle of August, but closed the month flat at around 14,500; after experiencing a spike to around 14,800 in mid-month. The exchange rate in recent months have been quite stable, implying that what the government and central bank is currently doing are acceptable and good enough for investors. However, volatility in the FX market in the near future is to be expected, with a higher probability for Rupiah depreciation in the near future. This could be off-set by the steadily growing amount of foreign reserves that Bank Indonesia have prepared for in recent months. With the uncertainties present both domestically and internationally, the USD/IDR trading range would most likely be in the range of 14,500 – 15,500; taking into account the total quarantine measure, as well as global risk appetite which may move the greenback to strengthen against Rupiah.
Juky Mariska, Wealth Advisory Head, OCBC NISP
The recovery continues
Economic activity around the world has begun to rebound over the summer as the major economies have reopened following their pandemic-induced lockdowns in the first half of 2020. We expect the macroeconomic outlook will continue to support risk assets this year. – Eli Lee
Financial markets have seen very clear trends over recent months, with equities buoyant, the US Dollar weaker, bond yields very low and gold hitting record highs. The broad trends have been driven by the global economy starting to recover from the virus shock and by central banks setting near zero interest rates. We expect the macroeconomic outlook will continue to support risk assets this year.
Economic activity around the world has begun to rebound as major economies re-open following their pandemic-induced lockdowns in the first half of 2020.
The cyclical recovery in the global economy should not be surprising, given the scale of the downturn in the second quarter of 2020.
Emerging economies to rebound in 2H2020
We expect emerging economies in Asia and around the world to recover in the second half of 2020 and during 2021. But only China is likely to experience positive GDP growth this year among the major emerging economies.
We forecast China’s economy to expand by 1.7% in 2020, and by 7.1% in 2021 owing to the authorities successfully containing Covid-19, after China became the first country in the world to succumb to the virus in 1Q2020.
The pace of China’s recovery has slowed in Q32020, compared to its V-shaped rebound in 2Q2020, when China’s GDP expanded by 11.5% quarter on quarter (QoQ), after its severe -10% QoQ contraction in 1Q2020. But that is not surprising, given that the easy post-lockdown gains have now been largely realised, with industrial production already expanding again by 4.8% year on year (YoY) in July.
China’s consumers, however, have remained more cautious. Retail sales are down -1.1% YoY in July, leaving more scope for China’s recovery to continue if residents become less concerned about the virus or uncertain jobs prospects and instead raise consumption again.
In contrast, we expect all the other major developed economies to contract for the whole of 2020.
US GDP forecast upgraded but Eurozone forecast unchanged
We have upgraded our forecasts for US Gross Domestic Product (GDP) after America’s 2Q2020 data was revised higher, and as the economy kept rebounding in 3Q2020 despite second waves of the virus. We now see US GDP falling by -4.0% in 2020.
We have kept our forecasts unchanged for the Eurozone; we expect the region to suffer a deeper contraction than the US, one of -7.6% in 2020 while we have downgraded our projections for Japan, expecting GDP to fall by -4.4% this year, as the country faces second waves of Covid-19 infections and after its 2Q20 GDP data came in worse than expected.
Macro outlook supportive of equities
Despite all our downgrades to growth and the risks from fresh waves of infection, we think the macroeconomic outlook is now supportive of equities, commodities, emerging markets and other risk assets, as economies recover.
Importantly, forward-looking financial markets are set to keep anticipating a return to more normal growth rates in future once a Covid-19 vaccine is developed and widely distributed. Thus risk assets are likely to stay supported, provided economic activity continues to pick up over the next few quarters (as we are forecasting), assuring investors that the global economy can return to its pre-crisis trend growth rates over time.
Fed turns even more dovish
Last month, the US central bank made a major change by shifting from its strategy of aiming for inflation to hit 2%, to one of seeking for inflation to average 2% over time.
This is in response to the Fed largely missing its 2% inflation goal since it began targeting a 2% rate from 2012. The central bank observed: “Following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.”
We think the Fed’s shift to seek inflation modestly above 2% to make up for when inflation has fallen short of its 2% target is very significant. The central bank may now keep its Fed Funds interest rate unchanged at 0.00-0.25% for up to the next five years, and thus support risk assets and gold prices, while weakening the US Dollar through anchoring US Treasury yields at their current, historically low levels.
The Fed’s willingness to allow inflation to moderately exceed 2% is increasing inflation expectations. Longer term 10-year and 30-year US government bond yields are rising, causing the Treasury curve to steepen. But overall, we expect yields to remain very low as strong inflationary pressures will be hard to generate over the next few years, given the shock from the pandemic to employment.
Thus, the broad trends favouring buoyant equities, a weaker US Dollar and record gold prices are all set to remain underpinned by historically low Treasury yields and by the global economy’s recovery over the next few quarters.
Long-term outlook remains sound
For equities, we believe the longer-term risk-reward remains sound as we emerge from the Covid-19 recession and enter the next expansionary cycle, and this underpins our equal weight stance in equities in our asset allocation strategy. – Eli Lee
For equities, we believe the longer-term risk-reward remains sound as we emerge from the Covid-19 recession and enter the next expansionary cycle. This underpins our equal weight stance in equities in our asset allocation strategy.
Over the near term, however, we see the risks for equity volatility to be higher than average, considering that valuations have largely priced in the initial phase of the recovery to 2021, and that major risks related to renewed Covid-19 infections, the US elections and US-China geopolitics loom in the background.
In our view, while investors maintain core positions in growth sectors such as technology and healthcare, this is an opportune time to rebalance portfolio weights out of growth and momentum stocks that have outperformed dramatically, and into cyclical and value names with resilient balance sheets and stable business models, as these are the ones likely to benefit from the long-term economic recovery.
The S&P 500 index has surged to all-time high, erasing all Covid-19 related losses. However, there is a clear discrepancy in performance across sectors and names, with key tech firms driving a significant portion of the index’s recovery.
The November US Presidential Election is coming into greater focus. This event historically contributes to rising equity volatility in the months prior to the election. This volatility could be further heightened by the potential inflaming of tensions against China by President Donald Trump, who remains behind in the national polls. Also, a failure by Congress to introduce a new fiscal aid package could see the effects of a sharp fiscal cliff hurting what has been an impressive recovery in US equity markets.
On a sector level, we prefer those that benefit from domestic investment and consumption, in light of the government’s focus on its “dual-circulation” strategy. Quality cyclicals can also benefit from improving revenue and a stable operating margin environment. We prefer consumer discretionary, construction and infrastructure-related sub-sectors like machinery and materials. We maintain our underweight recommendations on banks with the earnings contractions.
Overweight EM High Yield
Bonds continue to be supported by overwhelming central bank policy support. We remain overweight on Emerging Market High Yield credit and maintain our preference for Asian High Yield bonds. – Vasu Menon We have an overweight position in fixed income, where we continue to overweight the Emerging Market High Yield (EM HY) segment, which provides attractive carry in a search-for-yield environment. Within EM HY, we maintain our preference for Asian HY, especially in the Chinese property sector, where our view remains constructive over the medium term.
Emerging Market High Yield bonds still attractively valued
EM HY spreads tightened 26 basis points (bps) in August and at +589bps have erased around two third of the loss since 23 March. Nevertheless, EM HY spreads are significantly higher than the spreads for EM Investment Grade (IG) bonds which tightened 18bps in August to +203 bps, still well off the pre-pandemic 2020 tight of +150 bps.
EM HY spreads are also about 71 bps above the 5-year average of 518 bps and 271 bps above the 5-year low of 318 bps.
Prefer Asian High Yield within the Emerging Market space
In HY, Asia has underperformed in recent weeks in what we believe is a “relief rally” in Latin America, which has still under-performed badly year-to-date. Nonetheless, we are still maintaining our preference for Asia.
Within Asian HY, we remain overweight in Chinese property bonds. During August, Chinese HY bonds continue to outperform China IG bonds. We acknowledge that the relative value of Chinese HY bonds now appears less compelling relative to China IG. However, given that we prefer BB over B credit names in the face of uncertainties, including the ongoing Covid-19 impact on the global economy and the US Presidential election in November, we find that relative value in quality Chinese property HY names continue to be attractive.
Under the current market environment, the appropriate strategy for the rest of 2020 is to look for return from higher carry. On the one hand, we see downside supported by stable fundamentals, as the Chinese property sector is domestically focused and less affected by US-China conflicts. On the other , we see that China’s recovery from Covid-19 has largely been reflected in bond spreads, therefore, upside is limited. The US Treasury curve steepening towards the end of August also benefits Chinese HY bonds that are shorter dated.
Maintain overweight rating on High Yield and market weight on Investment Grade
We are maintaining our overweight stance on EM HY and neutral stance on EM IG. However, given the potential for periods of higher volatility emanating from both economic and political noise in the coming months, we would focus on the lower beta “BB” portion of the market. HY has outperformed in recent months, as the markets have pivoted from focusing on worst-case outcomes to better economic data from re-opening of markets and ongoing central bank support, anchored by the Fed. Unless there is a significant recurrence of the pandemic in key markets, we expect this trend to continue in the coming months.
FX & COMMODITIES
Gold to benefit from dovish Fed
If we are right that steepening in the US yield curve is likely to be modest and higher inflation expectations will hold down real yields, low opportunity costs of holding gold, and the potential for a weaker US Dollar could lift gold to US$2,150/oz in 12 months’ time. – Vasu Menon
The global oil demand recovery from the Covid-19 crater in April continues in 3Q2020, although there are signs that oil demand pick-up is starting to wane. Road fuel demand is making clear strides, with mobility levels picking up but the recovery in jet fuel remains slow. We also wonder to what extent the improvement in road fuel demand is less a sign of any normalisation of economic activity and more a reflection of the sharp increase in people getting to their vacations by car, thus taking their holiday within the country rather than travelling abroad. There remains plenty of uncertainty about whether demand for transportation fuels will ever return to normalcy.
We expect supply side rebalancing to offset slowing oil demand pickup to keep oil prices supported. OPEC+ compliance is likely to remain strong and supportive of oil prices, while radical reductions in drilling across the world should remain in place until oil prices start to rise above US$50/bbl.
The Fed’s dovish shift to average inflation targeting at Jackson Hole is on balance supportive of gold despite prospects for a steeper US yield curve. The pace of gold ETF inflows slowed in August following robust buying in July. We expect inflows to rebound strongly in September, into and after the September Federal Open Market Committee meeting. The revised Fed policy framework raises the bar for strong inflation or the labour market to trigger hawkish policy shifts. While the combination of significantly higher inflation tolerance in the absence of yield caps suggests nominal long-term interest rates can rise much more than perhaps markets are currently expecting, the Fed is unlikely to welcome yield curve steepening without an attendant rise in inflation expectations. If we are right that the steepening in the yield curve is likely to be modest and higher inflation expectations will hold down real yields, low opportunity costs of holding gold, and the potential for a weaker US Dollar could lift gold to USD2150/oz in 12 months’ time.
After spending the whole of August in a flat-to-heavy posture, the broad US Dollar (USD) is poised to break lower as USD-negative drivers remain in place. In the near-term, the risk-on/firmer equities market dynamics shows no signs of exhaustion, and the positive correlation between the equity and FX markets leaves the broad USD firmly pinned to the downside.
Further out, there is still limited relief from US fiscal stimulus as the Democrats and Republicans have yet to strike a deal. This keeps the markets cautious on US macro recovery, and the USD undermined from a relative macro outlook perspective. Perhaps more importantly, the Fed has turned even more dovish after the annual symposium at Jackson Hole, effectively committing to an ultra-accommodative monetary policy stance for the foreseeable future. While the other central banks can be expected to follow suit eventually, relative central bank dynamics, as it stands now, is not favourable for the USD.
Thus, the environment remains starkly negative for the USD. One potential positive is back-end rate differentials. If the Fed can engender sufficient market confidence in its new policy framework’s ability to lift inflation down the road, longer dated US Treasury yields may react and move higher. However, for this to gain traction, 10-year US Treasury yields will need to move materially higher towards the 1% area. Overall, with the USD is still biased to the downside as risk sentiment is supported by central bank accommodation. Expect the cyclical currencies (especially the Australian and New Zealand Dollars) to potentially lead the next leg of USD weakness.
In Asia, sentiment remains broadly positive after Sino-US trade relations were reaffirmed, and the market continues to shrug off tensions in other areas. Furthermore, the fact that the Renminbi has strengthened given USD weakness augurs well for Asian currencies vis-à-vis the USD. However, do watch out for idiosyncratic domestic weaknesses, especially from currencies like the Korean Won and the Thai Baht.
In Singapore, the Monetary Authority of Singapore continues to view monetary policy as “appropriate” despite the recent string of subdued data. This leaves us to believe that the underlying Singapore Dollar (SGD) nominal effective exchange rate (NEER) policy will not change just yet. The SGD NEER should remain broadly anchored around the parity level, and the USD/SGD movement reactive to global cues. Expect the SGD to strengthen against the USD given the weaker USD and the stronger Renminbi vis-à-vis the USD.
And the beat goes on
Further recovery of the US economy still provides an ongoing optimism surrounding the markets, driven lately by the latest unemployment rate number that showed a decline from 11.1% to 10.2% in the month of July. This is somewhat proof of an improving economy emerging from recession; which in the second quarter of 2020 saw a contraction of 32.9% QoQ. On the other hand, COVID-19 cases still present a major uncertainty with the US contributing roughly 25% of total cases globally. There are high hopes currently in the race to finding a vaccine by major corporations around the world. Fiscal stimulus talks by policymakers is also another component of the overall positive sentiment felt in markets; but the verdict seems to still be out of reach with the Democrats and Republicans clearly having different views on how much to spend.
The Euro Zone has officially entered recession, with Q2 GDP contracting 15% YoY, due to vast lockdowns in the second quarter of 2020. Spain’s economy was hit the hardest because of it, contracting 22.1% YoY, followed by Germany at 11.7% YoY, while France saw a modest 5% YoY contraction. However, recession was of no surprise as it was anticipated by investors. The 750 Billion Euro stimulus by the ECB in mid-July have helped support markets, with an additional 1.1 Trillion Euro fund prepped to be utilized in 2021 – 2027. These steps taken by the central bank have given a sense of a safe recovery path for the Euro Zone overall.
Meanwhile in Asia, the MSCI Asia ex-Japan soared in the month of July, recording an 8.02% jump. Market sentiment in Asia was also driven by aggressive monetary and fiscal easing by central banks, in the midst of growth uncertainties for Asian countries. For instance, the PBOC have also recently decided to inject another CNY 50 Billion into the financial system to provide ample liquidity. China was still able to record positive growth in Q2 2020, a 3.2% YoY growth after recording a contraction of 5.8% in the first quarter. PMI data in the majority of Asian countries have also shown improvement amidst the New Normal era which had begun. However, escalating Sino tension recently has dampened market sentiment and it is feared that it may hinder global recovery.
Domestically, the month of July has been the best month for equities in 2020. Economic indicators are also showing signs of an improvement. However, the economy deflated 0.1% in July due to the falling prices of several food ingredients, therefore pushing down inflation to 1.54% YoY. Similar to the majority of nations, Q2 GDP was in the negative territory, recorded at -5.32% YoY. However, foreign reserves at the end of July showed a significant jump from USD 131.7 billion to USD135.1 Billion. The increase was mainly due to the issuance of Global Bonds and also higher borrowing by the government. In addition, PMI Manufacturing numbers also recovered, up to 46.9 from 39.1 in the previous month. Overall, most of the economic indicators are on the positive side; while COVID-19 numbers are still on the rise. The Government’s response and handling of the novel virus is still rated adequate up to this point, in return providing support and optimism for markets.
The Jakarta Composite Index experienced a 4.91% gain in July, still driven by optimsm about economic recovery, indicating that the stock market has bounced almost 30% from its lowest point in March. The investors responded to positive improvements in July that were seen from business activities and the release of economic data, after being depressed in the second quarter. Currently the price to earnings ratio is in the range of 19x, investors are optimistic enough that the Indonesian economy will recover in the third quarter, with Indonesian economic growth maintained in the range of 0 to 1%.
On the other hand, the COVID-19 case in Indonesia is still not showing a declining trend. There is also an increasing tension between the US and China, that can be a risk for the equity market. However, with the various roles of Indonesian government that are quite evident in supporting Indonesia's depressed economy due to COVID-19, and also the cooperation between Indonesian company Bio Farma with the biotechnology company China Sinovac to produce vaccine which is currently in the third stage of clinical trials, JCI has the potential to continue its uptrend. Thus, the correction on the equity market can be utilized as a momentum to invest in the equity market.
The bond market also recorded a gain in July, with a government 10-year benchmark yield declining from 7.2% to 6.8%; and stable enough in the range of 6.8% until the middle of August. High demand from both foreign and domestic investors in the bond markets shows that Indonesia's bonds are still quite appealing. Capital flows to emerging economies, including Indonesia began to recover after a massive capital outflow in March. Foreign investors today are seen continuing to add ownership to the Indonesian bonds market. The burden sharing scheme between Bank Indonesia and the government has also started to run, which in the beginning of August is the first transaction for the fulfilment of some public goods financing has been done by the government. The issuance of debt with the private placement scheme to Bank Indonesia reached a total of Rp 82.10 trillion. This burden sharing scheme is expected to reduce the supply burden on bonds. Therefore, government 10-year benchmark yields are expected to continue to strengthen amid the low inflation rate, as well as further interest-rate cuts to boost the economy.
Unlike the equity and bonds market, Rupiah ended up weakening 2.35% against the greenback at the end of July, at the level of 14.600. The Rupiah underwent a weakening trend in the first three weeks, and improved in the last weekend. The surge in cases that still occur in different countries makes investors sell the Rupiah and move to safe haven assets, even gold records a strengthening of nearly 11% during the month of July. Demand for the US dollar as a safe haven currency is also still high, along with the uncertainty that still struck. With further interest rate cut, the Rupiah is expected to move in the range of 14.500 – 15.000 until the end of 2020.
Juky Mariska, Wealth Advisory Head, OCBC NISP
Rebound amid continued uncertainty
The recession is officially over, as restrictions ease and economic activity picks up, but business conditions are likely to remain very difficult. – Eli Lee
While we believe the low of the cycle is behind us, a full recovery to pre-Covid-19 levels of output will not happen until 2022.
China now seems likely to record positive GDP growth for the full 2020 year, while Europe is set to contract by 7.9% and the US by 5.1%, both slightly worse than previously expected. As a result, world Gross Domestic Product (GDP) is set to fall 2.2% in 2020, with the improved outlook for China accounting for an upward revision from last month’s forecast of -2.5% global GDP growth.
After widespread shutdowns in Q2 2020, we should not be surprised that simply turning the lights on again resulted in an initial sharp spike of growth from an extremely low base. The danger lies in extrapolating this initial sharp bounce to a complete V-shaped recovery. The path of global recovery remains highly uncertain and heavily dependent on ongoing policy support.
Reduced policy support and, in some cases, renewed outbreaks of Covid-19 will undermine momentum. In many developed economies, activity will not return to pre-crisis levels until late in 2021 or 2022. As a result, policymakers are likely to proceed with caution when attempting to unwind policy support measures.
Overall, the pace of economic recovery worldwide is set to become more uneven after the initial surge that followed the easing of lockdowns.
Growth momentum plateauing
In our base case, the reality of a drawn-out recovery process will be uneasy with the optimism in markets today, and already we are beginning to see signs of growth momentum plateauing.
In the US labour market, after 15 weeks of consecutive declines in initial jobless claims numbers, from its peak in March at 6.9 million to 1.3 million, the figure has turned and increased in the two weeks to 24 July. Of note, the Conference Board Consumer Confidence index also fell in July, to 92.6 after three consecutive months of increase to 98.3 in June.
Even in China, which is more advanced in the process of controlling the pandemic, high frequency monitors suggest that the pace of normalisation in activity is moderating. This should not be surprising, given that global economic weakness is posing a significant headwind for China, for which international trade and exports are major economic components.
Rising infection trends unlikely to lead to widespread shutdowns
The recovery momentum has been hindered by rising infection rates in various hotspots. In the US, the good news is that the rate of new cases has started to decline.
We do not expect US policymakers to return to widespread lockdowns, given reduced political will and a more subdued death rate due to the lower average age of those infected.
In the absence of an effective vaccine however, the threat of subsequent waves of infection will continue to loom large. This continues to affect the pace of re-opening and negatively impact consumer and investor confidence.
Wide-ranging stimulus to remain
At the July Federal Open Market Committee meeting, the Federal Reserve reiterated their “whatever it takes” stance to support the recovery.
The Fed also extended seven of this year’s crisis programmes, including the Primary and Secondary Market Corporate Credit programmes and the Paycheque Protection Programme Liquidity Facility, all due to expire over September to end-December.
In 2H 2020, we further expect the Fed to further strengthen their commitment to keeping rates at near-zero levels, using an ‘average inflation targeting’ framework which effectively represents a further easing in US monetary policy.
On the fiscal side, coming on the heels of the historic €750 billion stimulus passed in the European Union, we expect another US fiscal package soon.
Vaccine race gathers momentum
The successful eventual release of Covid-19 treatments should limit the long term impact of the virus on global growth.
As we move through the second half of 2020, scientists around the world are racing against time to overcome the overwhelming Covid-19 related hurdles that stand in the way of a full re-opening of the global economy.
At the end of July, there were at least 139 candidate vaccines in pre-clinical evaluation, and 26 candidate vaccines in the clinical evaluation stage.
Given the speed of clinical trials progression amid the deepening health crisis, there is limited clarity and alignment at this point from various regulators globally on what constitutes acceptable standards for a safe and effective vaccine. This poses a challenge.
Definitions of a successful vaccine can vary as well, given that some vaccines work on triggering the immune system to fight as opposed to preventing infection, while others do not produce sterilising immunity (production of neutralising antibodies blocking the virus from entering the cells).
Maintain neutral position
We continue to maintain our equal-weight position in equities given the risks and uncertainties ahead, even as economic data offer some support as economies re-open. – Eli Lee
For equities, we see the longer-term risk-reward to be sound as we emerge from the Covid-19 recession and enter the next expansionary cycle, and this underpins our equal weight stance in equities in our asset allocation strategy.
Over the near term, however, we see the risks of equity volatility to be higher than average, considering that valuations have largely priced in the initial phase of the recovery to 2021, and that major risks related to renewed Covid-19 infections, the US elections and US-China geopolitics loom in the backdrop.
In our view, while investors will need to maintain core positions in growth sectors such as technology and healthcare, this is an opportune time to rebalance portfolio weights out of growth and momentum stocks that have outperformed dramatically, and move into cyclical and value names with resilient balance sheets and stable business models, as these are expected to benefit from the long-term economic recovery.
The 2Q2020 reporting season saw consensus expecting a deep 42% year-on-year (y-o-y) decline in earnings per share for the S&P 500 index.
The pull-forward of digital trends, as well as an environment of low rates provide conducive conditions for the strong year-to-date performance of growth stocks in the US. However, record market concentration represents a risk to aggregate index performance. Exceptionally large index weights of mega-cap technology names could result in the S&P 500 index being susceptible to sector- or company-idiosyncratic shocks.
In our view, potential catalysts for a rotation from growth to value/cyclicals include
Europe did not disappoint when all came together to approve the European Union (EU) Recovery Fund. The approval was amply reflected in the foreign exchange market with the prompt appreciation of the EUR.
In equities, however, the price action of European indices such as MSCI Europe has been relatively muted, with the already rich valuations. Though this development should lower the risk premium of the region, the direct impact of the measures is more medium-term in nature (rather than short-term) and hence is unlikely to be reflected in earnings forecasts anytime soon. Furthermore, the massive Euro rally would be negative for exporters that derive a significant portion of revenue overseas.
Looking ahead, investors are likely to focus on how smooth the recovery trajectory will be for various economies, and managements’ commentary on the outlook during this earnings season, after a record number of companies withdrew guidance in the last round of earnings.
With limited growth drivers, Japan’s equities trailed its global peers and moved in a tight range for July, with some rotational buying interest continuing in small and mid-cap stocks with higher growth exposure. During the month, the raising of the alert level in Tokyo on renewed viral infection cases weighed on investor sentiment and diminished some of the risk-on appetite.
Near term, we expect further market consolidation with subdued sentiment, due to ongoing concerns over Covid-19 resurgence, heightened US-China tensions and subdued guidance expected from the 1Q2020 reporting season. Attention should focus on Japanese corporates’ first full year guidance and outlook statement, given this was previously put on hold due to dim visibility from the Covid-19 outbreak during the FY2019 reporting period.
Overall, valuations of the Topix index at 16-17 times forward FY2021E price-to-earnings ratio (PER) level appears to have priced in recovery scenarios, although buoyant market liquidity could continue to lend support to extended valuations. Within the current modest growth environment, we prefer accumulating quality names in stages, given our view that consensus estimates remain on the optimistic end.
The MSCI Asia ex-Japan Index appreciated for a second consecutive month in July, following a firm rebound in June.
However, the fallout from the Covid-19 pandemic has continued to exert pressure on the financial system, as illustrated by the Reserve Bank of India’s latest Financial Stability Report. It highlighted that the gross non-performing ratio of all commercial banks may increase from 8.5% in March 2020 to 12.5-14.7% by March next year.
S-REITs kickstarted the earnings season in Singapore. What we have seen is an affirmation of the trend where the logistics and data centre sub-sectors have been resilient, while performance for the retail and hospitality REITs were lacklustre. However, for retail, there is some optimism based on operational data, where occupancy rates and rents have only come off slightly for the suburban malls. Asset valuations in Singapore have also unsurprisingly seen some impairment by low-to-mid single-digits. This was largely due to rental assumptions being moderated.
What did come as a surprise to the market was the announcement by the Monetary Authority of Singapore (MAS) to call for the locally-incorporated banks headquartered in Singapore to cap their total dividends per share (DPS) for FY2020 at 60% of FY2019’s DPS, and also to offer shareholders the option of receiving their dividends in scrip instead. While the latest dividend cap for the banking sector is a disappointment for investors this year, mandating prudence on capital usage is largely in line with regulators’ cautious stance globally amid the Covid-19 outbreak. We believe Singapore banks are still relatively less constrained than European banks despite this latest development.
2Q2020 macro data showed economic activities continuing the path to recovery, with better-than-expected infrastructure and property activities. While headline retail growth was still in negative territory, the robust momentum for online retail sales remained intact. The rebound in 2Q2020 could lower the government’s incentive to ramp up the intensity of policy support in the near term, but we believe the possibility of lowering policy rates remains.
The onshore A-share market outperformed offshore China equities, Hong Kong and Asia ex-Japan in July. Comparing the strong outperformance of the China A-shares market with the previous rally in 2014-15, our view is that the current situation is relatively healthy, with better control in overall leverage and a more targeted and disciplined monetary easing. We believe the government would be ready to step in to pre-empt a replay of the “2015-rally” if needed.
At current levels, PER valuations of MSCI China index look stretched and are beyond the +2 standard deviation level to historical average. The launch of the Hang Seng TECH Index would be positive for market sentiment and is expected to draw passive fund flows with the expected launch of exchange-traded funds (ETFs) tracking the HS TECH index.
Given the stretched valuations, the market is set to be more volatile and vulnerable to consolidation and profit taking on the back of renewed US-China tensions and potentially disappointing 2Q2020 results. Multiple headlines on US-China tensions would add to uncertainties in the near-term and this remains our biggest concern for the Chinese equities market.
Still positive on EM High Yield
The extent to which the second wave of Covid-19 infections adversely impacts the global economic recovery remains the biggest risk facing corporate bond markets. – Vasu Menon
For the third straight month, global corporate bonds rallied strongly, helped by policy support from the Federal Reserve. Emerging Market (EM) corporate bonds were up 2.2%, with High Yield (HY) up 2.3% and Investment Grade (IG) up 2.1%. In Developed Markets (DM), IG rose 3.1% while US HY rose a remarkable 4.4%.
Emerging Market spreads stage big rally
EM HY spreads tightened 26 basis points (bps) in July and at +630 bps have erased around 60% of the loss since 23 March. Meanwhile, EM IG spreads tightened 20 bps to +270 bps, still well off the pre-Covid-19 tight of +190 bps.
Technical picture improves with positive inflows
For the week ending 29 July, EM bonds recorded net inflows of US$0.18 billion on top of the US$ 1.22 billion and USD 1.89 billion in positive inflows the previous weeks. Despite the more positive recent numbers, there has still been outflows of USD 47.4 billion during 2020. However, outflows in hard currency bonds have been much more muted, accounting for only US$7.1 billion of this total.
Prefer Asian High Yield
We remain overweight in Asian HY, especially Chinese HY property bonds. During July, Chinese HY outperformed its IG counterparts, reflecting the optimism from the reopening of China’s economy, continuous recovery in sales for the property development sector, and the abundance of market liquidity from central bank stimulus. The credit spread margins between Chinese IG and HY sector tightened to 587bp from 671bp at end-June. This compares to 473bp at the beginning of the year. It means Chinese HY bonds are still better relative value. The plentiful market liquidity also limits a major risk -- refinancing risk -- for HY issuers. These factors continue to support our overweight call for the Chinese HY property sector.
We acknowledge intensifying uncertainties in the coming quarter as the US presidential election in November this year approaches, given that China-US relations is perceived to be a strategy to win votes. Any escalation of conflict between the two countries could cause volatility, more so in Chinese HY bonds. As a result, we prefer quality HY names and investors should become more selective than previously, given the rally of HY bonds versus IG bonds since the March low.
Maintain overweight rating on High Yield and market weight on Investment grade
We are maintaining our overweight stance on EM HY and neutral stance on EM IG. However, given the potential for periods of higher volatility emanating from both economic and political noise in the coming months, we would focus on the lower-beta “BB” portion of the market.
HY has outperformed in recent months as the markets have pivoted from focusing on worst-case fat-tail outcomes to better economic data from re-opening of markets and ongoing central bank support, anchored by the Fed. In the absence of a significant recurrence of the pandemic in key markets, we expect this trend to continue in the coming months.
FX & COMMODITIES
Higher for longer gold prices
The possibility of central banks attempting to inflate away a debt overhang in a world of near-zero interest rates and worries of currency debasement, means that gold will remain attractive as a safe-haven – Vasu Menon
We are raising the 12-month Brent oil price target to US$50/barrel versus US$45/barrel previously. Oil prices could be choppy for a bit longer as another wave of infections and recovering North American oil supply will likely weigh on oil price sentiment. The rise in gasoline and distillate inventories, which come amid the US summer driving season -- when demand usually rises sharply, and inventories normally fall -- also warns that easy gains in oil prices are behind us. This all comes as the market is preparing for the OPEC+ alliance to pull back from unprecedented production cuts in August. But any weakness in oil prices is likely to be temporary.
We expect oil demand to continue to grind higher and next year might surprise on the upside if international trade recovers. In addition, OPEC+ compliance is likely to remain strong and support oil prices, while radical reductions in drilling across the world should remain in place until oil prices start to rise above US$50/barrel.
Gold has outshone other reserve currencies such as the US Dollar (USD), Japanese Yen (JPY), Euro (EUR) and Swiss Franc (CHF) this year. Risk of central banks attempting to inflate away a debt overhang in a world of near-zero interest rates and worries of currency debasement should keep gold as a “haven” asset of choice.
Gold is well supported by falling US real yields. This will limit corrections and keep gold as a “haven” asset of choice versus other traditional “safe assets” such as government bonds, given that the benefits of declining nominal yields are mostly exhausted with interest rates at virtually zero in the US and little indication that the Fed intends to drop them into negative territory.
Gold’s rise is also an indication of currency debasement fears stoked by expansion of central bank balance sheets. Gold does not have the comparative negatives of other “haven” currencies such as the USD, JPY, EUR or CHF, as central banks can print money but cannot print gold.
The broad US Dollar (USD) decline has accelerated over the past four weeks, and there may be little in the horizon that could halt this decline. What we may be seeing is a broad-based USD sell-off beyond the typical risk-on/risk-off dynamics.
In the near term, the virus situation in the US remains severe, and it is a negative factor for the USD. Uncertainty about fiscal policy support for the US economy also weighs on the greenback and may even be structural negative for the greenback. Meanwhile, a dovish Federal Reserve means US Treasury yields will be depressed, further compromising the rate differential advantage of the USD.
Thus, USD-negative drivers are in plain sight. The issue is that everyone is on the same side of the boat now, and price movements are starting to look stretched. This leaves room for a potential USD rebound. In particular, the major currencies are running into key support/resistance levels against the USD, and any sign of fatigue may quickly develop into a stronger USD as profit-taking kicks in.
In Asia, broad-based USD weakness means stronger Asian currencies against the greenback. However, we see several factors that are also supportive of the USD vis-à-vis Asian currencies. In the near term, Sino-US tension and a tight correlation between USD-CNH (Chinese currency) and selected USD-Asia currency pairs, may offer support to the USD vis-à-vis Asian currencies.
Portfolio inflows into Asia have also softened. In addition, we note the ongoing weakness of aggregate Asian economic prints (except for China) relative to the US and Europe. This should also limit the room that Asian currencies have to appreciate.
On the Singapore Dollar (SGD) front, even though the USD/SGD has broken lower, the SGD NEER (nominal effective exchange rate) remains anchored to the parity level. This suggests that the USD/SGD decline reflects broader USD weakness, rather than any domestic SGD-positive drivers.
Note that the correlation between the USD/SGD and the DXY (USD) Index is also tight. Thus, do not rule out further declines in the USD/SGD, especially if the broad USD continues to capitulate.
Rebound amid continued uncertainty
The easing of lockdowns has clearly sparked optimism that the economy is on the path of recovery. One of the main scopes to gauge the improvement is by looking at the bettering of job numbers; nonfarm payroll employment rose 4.8 million, pushing the unemployment rate down from 13.3% to 11.1% as the US employment situation has taken a big leap out of its darkest times. However, the unemployed persons number still stood at 17.8 million nationwide. Meanwhile, the COVID-19 infection rate has not shown improvement as major states start contemplating softer physical distancing measures to keep it under control. Also, global investors are warming up to the idea of having Joe Biden as the next 46th President of the United States as Joe Biden of the Democratic party is currently leading the polls versus its counterpart.
The UK is evidently the worse region compared to other developed nations such as the US and Japan. While EU, as a whole, has shown improvements in the past few months but apparently still causes pessimism amongst policymakers as the bloc’s growth projection has been lowered by a full point to -8.7% this year. In regards to Brexit, Prime Minister Boris Johnson has been clashing with the bloc over trade relations, among other things. The European Union had encouraged Johnson to postpone the timeline for Brexit until 2021, but the idea was turned down by the Prime Minister. Johnson had iterated that England would leave the Union, regardless of whether there is a trade deal or not on the table.
Moving towards Asia, the MSCI Asia ex-Japan index recorded a gain of 5.4% in June, the best performing month during the COVID-19 era. Sentiments are lifted in Asia as the second wave of COVID-19 is not as bleak as expected. Countries such as China, Korea, Japan, and Singapore have seen declines in terms of daily new cases even though their economies have resumed towards New Normal. However, as long as COVID-19 vaccine is still unavailable there is always be a threat of a resurgence in the novel virus. Asian investors’ focus is now geared more towards the geopolitical tension between several nations such as US-China, China-Hong Kong, and China-India. These political tensions may hinder economic recovery even more; especially if tensions rise.
Domestically, the month of June has been good towards capital markets. Fundamentally, June economic indicators have leaned towards signs of recovery. The central bank also lowered its main rate 25bps to 4.00% for the 7-Day Reverse Repo Rate. Although inflation was recorded lower due to subdued demand for consumption, dropping from 2.19% to 1.96% from May to June; other indicators were seen otherwise. Foreign Reserves rose from USD130.5B to USD131.7B, and has provided positive sentiment towards the appreciation of domestic currency. The amount is equal to 8.1 month of imports plus international debt payment. Finally, PMI Manufacturing data showed a spike in reading, leaping from 28.6 to 39.1. All in all, it is evident that the reopening of our domestic economy has put us on the path to recovery sooner than it had been anticipated.
The stock market rallied for 3.19% in June, stipulated by the growing optimism on the reopening of the economy through New Normal. Currently trading at 17.2 times of forward price-to-earnings ratio, above the five-year-average, the investors are pricing in a potential recovery in the second half of the year, having downgraded the corporate earnings to roughly 15 to 20% in last April. Domestic investors remain the major player that dominated the trading activity. However, as the number of cases continued to rise domestically, the government has shown dissatisfaction towards the budget utilization on COVID-19 related. This has sparked speculation on the imminent cabinet reshuffle. Historically, during Jokowi’s first term, cabinet reshuffles had a positive impact on the capital market.
Although equity has rebounded as much as 29% from March low, one should stay reminded that Jakarta Composite Index is still trading at discounted of 21% from the January high. As the economy and corporate earnings continue to recover through 2021, JCI is estimated to retrace previous highs. However, looming risks include the growing tension of US-China, and should the number of COVID-19 cases continue to rise exponentially. Therefore, investors are advised to manage risk by dollar cost averaging, by utilizing market correction as an entry window.
The bond market weakened in the month of June, with the government 10-year benchmark yield recording an increase from 7.15% to 7.21%; somewhat of a flat movement due to relatively balanced in and out flows by mainly domestic investors. Suffice to say, most predicted that the bond market would be under more pressure with the government’s plan to increase state issuance to help finance the planned COVID-19 fiscal stimulus of about Rp 695.2 trillion equal to 6.34% of national GDP to support the hurting economy. Oversubscriptions have verified the attractiveness of global bonds issued this year as well, and have been nothing short of expectation both for domestic and foreign investors. From June to December this year, the government still plans to issue another Rp 990 trillion worth of government bonds, including Samurai and Diaspora bonds to cover the widening deficit.
In early July, Bank Indonesia has agreed on burden sharing to absorb the zero coupon bonds issuance in 2020 as much as Rp 397.56 trillion through private placement, which will be allocated for public goods spending. Moreover, BI will continue to participate through market mechanism to support funding to non-public goods up to Rp 505.9 trillion, by receiving a discounted interest for 2020. The move is expected to provide demand support as the issuance increases, as well as reducing volatility. Domestic investors, namely banks, have overtaken the bond ownership. Ownership increases from 26% in January to 33% in June.
Hence, we believe the yield on the government 10-year benchmark should be in the range of 6.8% - 7.2% for the remainder of this year, with a higher chance of it being in the lower bound by year end.
In regard to the Rupiah, volatility has been high in the 6th month this year which ended roughly 1.0% appreciating against the greenback. For a brief moment, the USDIDR took a dive in the first week of the month slipping below 13,900; lowest level since February. However, the exchange rate has gone back to 14,265 by the end of June and is currently in a depreciating trend against the USD. Several factors both domestically and globally have caused this trend shift;
The Rupiah should be in the range of 14,300 – 14,750 for the remainder of 2020, as the government will keep more of a close eye towards it for the remainder of this year.
Juky Mariska, Wealth Advisory Head, OCBC NISP
Rebound amid continued uncertainty
Economies are rebounding as coronavirus-related restrictions ease, but there is still a lack of clarity over the depth of the slump and the speed of the recovery. – Eli Lee
The “base case” for forecasts of economic growth or corporate earnings is that the shock to activity quickly fades as containment measures ease. Excess capacity is then absorbed over the next one-to-two years, supported by government policy stimulus and healthcare innovations, such as more effective testing, treatment and prevention.
Hopes for the “bull case” – that summer weather or early discovery of a vaccine would lead to a rapid rebound have diminished over the past couple of months. However, the risk of a “bear case” – where renewed outbreaks lead to further dips in activity – is still alive. Restrictions in Beijing have been re-imposed after infections spread, while several large US states continue to see cases rise. The bear case does not necessarily depend on government measures – it could be that a frightened public decides to self-quarantine in response to
Chinese economy on the mend
The latest data from China does not capture the recent outbreak and shows a pattern of what we can expect in other economies, as it was the first to impose, and then ease, restrictions. Manufacturing has recovered quickly, whereas the service sector is understandably lagging, although both sides of the economy have shown a sharp improvement in just a few months.
European economies doing poorly
In terms of economic performance, among developed economies Europe is clearly faring the worst, due to the combination of the severity of the outbreak and the harshness of the counter-measures. The UK is one of the few countries to produce a monthly GDP series and that showed activity in April almost 25% lower than a year earlier, suggesting the country could see around a double-digit decline for the full year. As a whole, the EU has not been as badly affected as the UK, but is still set to see output decline by far more than the US or Japan in 2020. Factoring in the weak monthly data for the region, we have cut the 2020 forecast from -5.4% to -7.7%.
US and Japanese economy faring better than Europe
In contrast, economic releases in the United States and Japan have been surprisingly solid over the past month. In particular, the US housing market looks reasonably resilient, perhaps helped by lower borrowing costs, while softness in consumer and small business confidence looks relatively moderate compared to the scale of the short-term shock to the economy.
Mixed views from Fed officials about US economy
The Fed’s policy meeting in mid-June illustrated the diversity of opinions, as they updated their medium-term forecasts. FOMC members saw the drop in GDP in the year to 4Q20 in a range between -10.0% and -4.2%, while the unemployment rate by the end of 2021 was put at 4.5% to 12.0%. Full employment is only a touch below 4.5%, while 12.0% is still worse than the trough of the 2008-09 recession, so the range of views is extraordinary.
Fed sees no change in interest rates for a long time
Despite the stark difference of opinion inside the Fed, there was an overwhelming majority expecting no change in interest rates even by the end of 2022. This looks reasonable, considering the short-term deflationary shock from the current recession, as well as the time needed to reverse the damage to labour markets. As Fed Chair Powell remarked, they are “not even thinking about thinking about raising rates”. Remember that it took over six years after the end of the 2008-09 recession before the Fed started to raise rates and the current downturn is much more severe.
Other central banks are also ready for aggressive policy action
Reflecting the scale of the task ahead, central banks across developed markets are intent on allowing no room for doubt about their determination to leave the liquidity tap fully open. Over the past month the European Central Bank and Bank of England announced increases to their respective quantitative easing programmes, while the Bank of Japan took similar steps in late May. The effectiveness of these measures is debatable now that financial markets have stabilised, but the signalling is clear.
Fed against negative rates
The Fed seems to be clear in its rejection of negative interest rates. If it decides that further measures are warranted then some form of yield curve control looks more likely. This could see the Fed commit to purchasing US government bonds in order to hold yields below, say, 1% in order to aid the recovery and limit the strains on government finances.
Fiscal policy needed for economic support
Most of the potential for further economic support lies with fiscal policy, although the sense of urgency has clearly faded. The main issue to be resolved is whether the European Union can take a step towards a region-wide fiscal policy, effectively increasing the scale of transfers to the poorer members. At a time of budgetary stress everywhere, the proposal is unsurprisingly controversial, even though there is a clear need for more government support.
In the US, discussion has again turned to a large-scale infrastructure programme. This looks unlikely to progress ahead of the November election, regardless of the merits of the different plans, due to disagreement over whether to provide funding through higher taxes. Each side also seems wary of allowing the other to claim a political victory so close to a major election.
In the second half of the year, we believe that increasing uncertainties related to the US Presidential elections as well as the state of US-China tensions will come into focus as key market drivers. –Eli Lee
A rising tide of Covid-19 outbreaks in the US and grim forecasts by the IMF have brought renewed focus to the stark disconnect between equity markets and feeble economic conditions. While a risk-on approach did well in April-May, we believe that a neutral stance is now more appropriate and this is a conducive environment for selective stock-picking, given that valuations are less attractive at current levels.
The longer-term risk-reward for equities is still sound as we emerge from the Covid-19 recession and enter the next expansionary cycle. This underpins our neutral stance in equities in our asset allocation strategy. Over the near term, however, we see the risks of equity volatility to be higher than average considering that valuations have largely priced in the initial phase of the recovery to 2021, and that major risks related to rising infections, the US elections and US-China geopolitics loom in the backdrop.
Meanwhile the race for a vaccine continues and fuels intermittent bouts of hope. At the end of June, there were at least 132 candidate vaccines in preclinical evaluation and 17 candidate vaccines in the clinical evaluation stage under development at various universities, biotech firms and pharmaceutical groups globally, according to the World Health Organisation.
Several concerns lead us to question the sustainability of stretched valuations in the US.
First, with Biden leading in the polls, there could be increasing investor worries over the possibility of a Democratic sweep of the Presidency and Congress. This could result in the rollback of the Tax Cuts and Jobs Act signed in 2017, which were a boost to corporates then. Separately, we are also seeing increasing regulatory pressure on Big Tech firms, which could increase market volatility, given that they constitute a large proportion of the overall S&P 500 index.
Second, while US-China tensions continue to manifest in key areas such as investments and tech, there is now the potential for new tariffs on imports from the European Union and United Kingdom, injecting further geopolitical uncertainty into the equation.
Lastly, second waves of infections are appearing in several US states, and this should put in perspective the prior optimism that the market had about the reopening of the US economy.
Moving into the second half of this year, investors will focus on the re-opening trajectories of economies, further stimulus measures by European Union members, and whether the EU Recovery Fund will live up to its promise. Clearly, the most aggressive pocket so far in terms of fiscal stimulus has been Germany, and the question now is whether this will encourage others to follow suit, if they are able to afford it.
On the other hand, the perceived political risk in Europe is likely to remain at the forefront. Rumours of yet another possible anti-establishment party in Italy seeking Italexit (although unlikely for now) remind us of potential confrontations with the Union, an issue which looks to be further stressed during the upcoming Recovery Fund negotiations. Fears of un-equitable access to a vaccine for Covid-19 could also lead to tensions further down the road. With the MSCI Europe Index trading at a forward price-to-earnings ratio (PER) of close to 18x, it is likely that little of the negatives have been priced in for now.
Near term, we expect market consolidation after the rebound driven by re-opening optimism, with potential risks of second wave, heightened US-China tensions and subdued guidance expected from the upcoming results season likely to weigh on sentiment. Consensus earnings estimates for the financial year ending March 2021 of about 10% remain optimistic, which should be revised after corporates provide earnings guidance, previously withheld due to limited visibility on the Covid-19 outbreak. After the gains on re-opening optimism, valuations of Japan equities have expanded. We advise to lock in selective profits, and we continue to favour a mix of quality defensive consumer staples and cyclical beneficiaries for investors with long term positions.
Besides the continued focus on the Covid-19 situation, geopolitical tensions between China and India remain high, with border skirmishes between the two nations resulting in casualties. This comes at an inopportune time as the region is grappling with a tepid economic outlook. India recently saw the largest GDP growth forecast downgrade amongst the major economies by the IMF. Growth is projected to come in at -4.5% for 2020, versus its previous forecast for a 1.9% expansion. The downgrade was the result of a longer period of lockdown and slower recovery as previously anticipated. In South Korea, its Finance Minister highlighted that its third supplementary budget which is pending approval in Parliament could be the last for the year, given that the economic shock from the Covid-19 crisis may have bottomed.
Historical trends have shown that there is no clear correlation between Singapore’s general elections and performance of the stock market. July will also see the start of the 2Q earnings season with S-REITs kicking it off in Singapore. This will attract much scrutiny as it is likely to be one of the darkest quarters ever, given the impact from the circuit breaker period, rental concessions given by landlords and border shutdowns. We expect declines in the DPU for the retail and hospitality sub-sectors.
Southbound inflows have also been robust with year-to-date net inflows at US$37.8bn, surpassing the net inflows in 2019. We believe ample liquidity could support the market to overshoot in the near term. However, investors should be mindful of the stretched valuations and any disappointment or the re-emergence of US-China tensions could render the market vulnerable to consolidation and profit taking.
We continue to favour rising online engagement as an investment theme given that the pandemic has accelerated online adoption. This structural trend will continue to bode well not just for e-commerce plays but also for companies that are leaders in digital adoption as they are best positioned to gain market share.
Having said that, we advocate that investors be mindful of potential risks and tensions associated with US restrictions, which are likely to result in heightened volatility in the sector. In the next few months, there are key milestones relating to the Holding Foreign Companies Accountable Act which could be key drivers to the share price performance of American Depositary Receipts (ADRs) in the near term.
In addition to the investment themes highlighted, we also identify laggards with an improving operating environment. Chinese insurance sector is trading at an attractive valuation and could benefit from the recovery in equity markets and a stabilisation of bond yields. Considering a robust consumption recovery with online retail sales continuing its uptrend and rising 23% year-on-year in May, we maintain our preference for domestic consumption.
Finally, with China calling on banks to forgo CNY1.5 trillion in income to support the real economy, we expect market sentiment for the sector to be negative and banks to underperform the broader market.
Search for yield to continue
The post-March Emerging Market (EM) bond rally appears intact, supported by the Fed’s monetary policy largesse and growing market confidence in an economic rebound, as EM countries gradually ease their lockdowns. – Vasu Menon
Within our tactical asset allocation, we are overweight bonds, where we continue to overweight the Emerging Market High Yield (EM HY) segment, which provides attractive carry in a search-for-yield environment. Within EM HY, we maintain our preference for Asian High Yield, especially in the Chinese property sector, where our view remains constructive over the medium term.
Market momentum continues, thanks to the Fed
EM bonds are up 0.6% year-to-date (YTD), with Investment Grade (IG) bonds up 2.6% and High Yield (HY) total returns still down 2.5%. EM HY still trades at a pretty wide 409bps above EM IG, which still offers around 60-65bps of spread pickup over US IG; while EM HY is now trading about 50bps below US HY. However, current market euphoria belies our more caution outlook on EM corporate and macro fundamentals, following the damage wrought by Covid-19 related disruptions. Despite this, we expect the near-term trend to remain positive for EM bonds – thanks to the unprecedented market underwrite of the US Federal Reserve Board.
Issuance has picked up while outflows have eased
EM bond issuance volumes picked up substantially in June, with roughly USD254bn worth of debt issued YTD. This is now almost on par with the USD259bn raised by the same time last year when market conditions were less volatile. Issuance remains uneven across regions, with most volumes still concentrated in the IG segment (68% of total issuance) and Asia (63%), while in Latin American issuance activity outside of the IG, sovereign and quasi sovereign space has virtually dried up since the March sell-off. The top three issuing sectors YTD have been Financials (32% of total issuance), Real Estate (16%) and Oil and Gas (14%).
Recent EM bonds flows also support a relatively benign backdrop, with fund outflows from EM bond funds having slowed down substantially since the end of March. Indeed, the month of June saw net positive inflows of over USD3bn, as of 22nd June. Despite the more positive recent indications, YTD flows are still negative (about USD25.0bn), following sharp outflows from the asset class in March.
Still favour Asian High Yield with a preference for China
We continue to have an overall preference for EM HY over IG – albeit with judicious positioning within the more defensive segments of EM HY. This means our HY bias is overwhelmingly tilted towards Asia/China and Chinese property sector bonds, followed by selective cherry-picking in the other regions. The Chinese property sector (about 50% of the country’s HY sector) remains in relatively good shape, post-pandemic – as exemplified by the rapid recovery in developer pre-sales from their Covid-19 troughs. From a macro standpoint, China currently enjoys the “best of all worlds”: Its post-pandemic recovery has been exemplary thus far, while its HY bonds currently offer spread pickup over IG credits in excess of 600bps – with room for further tightening as its economic recovery is cemented. IG bonds in China offer protection to be sure but appear fairly valued at current valuations – even if selective entry opportunities may avail themselves, as market sentiment ebbs and flows into the second half of the year.
Downside risks to the current outlook
There is risk of current market momentum being reversed by several factors, which investors ought to keep in mind:
1. A re-escalation of trade tensions between the US and China has the potential to disrupt current market momentum, aggravated by the recent poisoning of Sino-US relations over legislative events in Hong Kong. While this issue did not crack the previous EM bond rally, tensions may be further amplified as President Trump likely adopts a more bellicose posture towards China in the run-up to US elections in November.
2. Worsening geopolitical sensibilities across Asia, following recent skirmishes between China and India and increased tensions in the Korean peninsula, could weigh on regional (and EM-wide) asset performance.
3. Secondary wave infections of Covid-19 across the world, including in China recently, risk setting back economic recovery across the world. In addition, persistently negative news flow from the US, which is grappling to contain a recent spike in post-lockdown infections, also poses risks to the current market momentum.
4. Corporate defaults and bankruptcies across EM have increased, post-pandemic. Consensus thinking among rating agencies and sell-side analysts points to corporate default rates remaining elevated post-pandemic. While predictions range between 5-10% for EM credit in 2020, our own sense is that the rates of default will likely touch the lower end of that broad range, as default rates are still around 2% and given there will likely be a lag in deterioration of corporate credit health into 2021.
FX & COMMODITIES
Gold forecast upgraded
We have upgraded our 12-month gold price forecast to US$1,900/ounce from US$1,800/ounce due to several factors including continued Covid-19 uncertainties, trade tension and ultra-low real interest rates – Vasu Menon
Signs of US oil production returning and risk of oil demand being susceptible to new coronavirus outbreaks are set to slow the climb in oil prices. Crude oil inventories in the US are at a record high. There is also a risk that gains in oil prices recently could see some US shale producers restart wells, which could disturb the US oil market rebalancing process.
Easing lockdowns are allowing an oil demand recovery. But the rate of change in oil demand fundamentals is likely to moderate as incremental demand improvement will depend more on consumer behaviour than the loosening of enforced lockdowns. The positive start to reopening does not resolve the uncertainties about a potential second wave of infections or of a more difficult recovery beyond the easier gains of the first few months driven by pent-up demand. If the virus spread continues to worry individuals, mobility demand will likely remain subdued. A reluctance of consumers to hit the roads could dent expectations of a recovery in demand for gasoline during the US summer.
Our 12-month gold price forecast has been upgraded to US$1,900/oz from US$1,800/oz. First, the Fed seems intent on shifting to average inflation targeting before the end of this year to reinforce its commitment to keeping interest rates low for longer. The aim for inflation to exceed the 2% goal over the next few years to make up for past inflation shortfall under an average-inflation targeting regime will not only make investors nervous about inflation risks over time but also keep real yields low – all of which could fuel USD debasement fears to gold’s benefit.
Second, while the pandemic continues so will uncertainty, and trade tension is not helping. Together they should see strong safe-haven demand for gold. Gold remains a valid hedge against macro uncertainty, as any adverse growth shocks will likely lead to more monetisation of fiscal stimulus, which could add to worries of significant inflation pick-up further down the road.
Global risk dynamics have entered an uncertain and tentative patch. There remains an underlying risk-on bias on the back of some outperforming economic data and central bank policy support. However, this bias is fragile and vulnerable to periodic bouts of negative news and events.
Nevertheless, some complacency may have slipped into currency markets, judging from the lower implied volatility in the G10 and EM Asia currency space.
For now, the greenback’s prospects remain broadly consolidative and sideway trading is expected, with the US Dollar (USD) index (DXY) likely to range-trade between the 96 and 98.
In July, we are on the look-out for potential negative factors to see if they can gain sufficient traction to tilt the balance to a risk-off situation.
The immediate event-risk is a reversion to tighter restrictions amid the resurgence of COVID-19 cases in the US. There are already signs of this, with quarantines on interstate travel and halted re-openings in the most affected states. The market is still pricing in a rather swift macro recovery, and this presents a risk further out as it remains likely that the pace of recovery may not be as strong as anticipated, especially as fiscal stimuli globally start to wane. If these risk events materialise, expect volatility to spike once again.
Putting aside risk dynamics, the Pound (GBP) continues to be undermined by the risks associated with the EU-UK trade talks, and the New Zealand dollar (NZD) by its central bank’s soft policy stance. On the other hand, the Australian dollar (AUD) is supported by a rather confident sounding central bank, although it is vulnerable to developments in China. Overall, any risk-off preference may be better expressed through a short GBP or NZD position, while a risk-on bias may be better reflected through a long AUD position. Meanwhile, the Canadian dollar is likely to be subjected to the vagaries of oil prices.
Elsewhere, Asian currencies vis-à-vis the US Dollar (USD-Asia) remain exposed to divergent drivers, with positives from economic re-opening and mostly strong inflows, being increasingly offset by virus anxiety. Going forward, we expect USD-Asia to be choppy until there is a clear winner in this tussle. In the interim, domestic drivers may take centre-stage.
As for the USD-Singapore dollar (SGD) pair, we expect limited near-term movement. With the SGD Nominal Effective Exchange Rate (NEER) supported near the strong-end of the recent range, the downside for the USD-SGD from current levels appears to be limited, barring a broader capitulation in the USD.
As numerous economies start to emerge from lockdowns, we can see that global capital markets have cherished on and benefitted from the optimism that the global economic activity is finally going to resume. With both developed and developing nations' economic stand-still about to end, investors can be seen shifting from havens toward riskier assets. One of the main sentiment driver comes from the most recent US job numbers that indicated a gain of about 2.5 million jobs in the month of May, pushing down the unemployment rate from 14.7% to 13.3%. However, fear of the COVID-19 "second wave" still persists as retail stores start to open, and restaurants start serving dine-ins. Moreover, the rising tension between US and China will still be the biggest source of uncertainty in markets, especially if it keeps dragging on nearing the Presidential elections in November. Hence, capital market gains will be subdued due to the uncertainties that may lie ahead.
Europe, which has been one of the closely watched hotspots for COVID-19 recorded saw its capital markets gain modestly in May, as the economy started easing lockdown restrictions. European policymakers are still pushing for additional fiscal stimulus packages, in order to soften the harsh damage caused by COVID-19. The gloomy forecast by the OECD states that the Eurozone may potentially contract about 9.0% in 2020, with Italy, France, and the UK going over 11.0%. As for commodities, it's been a fairly good month for Gold; up 2.6%, while WTI crude oil soared 62.6% in one month close to USD$40/b due to a unified action taken by OPEC+ members to curb output. However, Saudi Arabia has announced that production cuts would not go beyond June 2020, which implies that oil's run may hit a roadblock pretty soon, unless demand picks up.
In Asia, the outcome of rising tension between the US and China still remains the key geopolitical risk for ASEAN countries. The MSCI Asia ex- Japan was unfortunately in the red, down 6.8% in May. Considering the rally seen in developed markets like the US and Europe, Asian equities seem to have lagged quite significantly. However, we believe that as valuations in developed markets start to rise, there will be an inflow of capital towards Asia and other emerging markets as investors would start hunting for assets that provide more attractive returns and valuations. Another geopolitical uncertainty that is currently brewing would be the United States' role and response towards the newly imposed Hong Kong national security law by China, which will also raise the question of what that would affect the current tension amongst the world's two largest economies.
Domestically, May economic indicators suggest that Indonesia is a quite resilient nation, both from COVID-19 as well as the ongoing geopolitical uncertainties. That assumption can further be verified by the central banks' decision to hold interest rates at 4.5%. In addition to that, inflation numbers declined from 2.67% to 2.19% in May, which means that the central bank still has leg-room to cut rates, if need be. Another positive data that lifted market sentiment would be the increase of foreign reserves from USD$127.9 billion to USD$130.5 billion. The government reportedly increased its foreign funding, which showed its commitment to do whatever is needed to support the local economy. In terms of COVID-19, recent numbers suggest that the rate of infection is currently on the rise. However, it seems that capital markets itself is pretty resilient, likewise the larger economy. With the so-called PSBB policy in the process of being lifted up, investors seem to be unbothered as long as the economy is stable and healthy.
The JCI took flight in the month of May, recorded a shocking jump of 10.4%, beating the majority of other Asian bourses; hence making it the best performing month of 2020 so far. However, since the start of the year the index is still down approximately 20%, which indicates that there is more upside potential than there is downside risk. Compared to the S&P500 that had recently just surpassed 3,230, which is the level in which the index opened 2020; which means the JCI still has a long way to go to catch up. We firmly believe that once investors realize that Asian equities strikes a better bargain than developed market equities, foreign inflow towards domestic capital markets will resume.
The biggest potential domestic risk for capital markets remains the COVID-19 which is expected to start peaking right now in early June. As the government eases restrictions, it is apparent that the infection rate would gradually increase as well. So far, it seems that equity markets have been somewhat resilient towards the growing COVID-19 numbers domestically; currently at approximately 1,000 new cases daily. Under these circumstances, our projections for the JCI at year-end would be in the 5,300-5,700 range, factoring in a roughly 15% earnings downgrade. However, if daily infection rate soars to 4,000-5,000; the government would need to impose stricter lockdown measures to contain the virus, hence putting the economy back on pause mode while investors will again hunt for safe-haven assets.
Alongside the equities market, the bond market also had a beautiful run in May. The 10-year government bond yield plunged from above 8.0% all the way to 7.35% by the end of May, as domestic investors dominated the rally alongside the equities market. Foreign inflow towards the bond market has been shocking in the month of May, as global investors hunt for high yield government bonds and developed market bond yield hovered near 0%. The biggest force in the rise of the bond market is the surprising appreciation of the domestic currency, the Rupiah. The fact that the government have been issuing more bonds did not seem to weigh down the price movement for bonds. Local demand, namely banks, has sustained the majority of the auction demand. Banks ownership recently increased to 31% of the local government bond, as compared to 26% at the start of the year. As low rates environment and the relaxed reserve requirement ratio pumped more liquidity into domestic demand.
Under these circumstances, we see the 10-year government bond yield to hover in the range of 6.8% - 7.3% by year end, while high volatility is still to be expected in the short to medium term. Nonetheless, with the relatively high real-yield that domestic government bonds provide; compared to other ASEAN and emerging markets, it would be hard for global investors to turn their heads away, regardless of the domestic COVID-19 current situation.
The Rupiah continued its rally against the greenback, up 1.83% in May continuing an astonishing appreciation since April. Currently, the Rupiah has been just under 14,000/USD compared to 2 months ago at almost 17,000/USD. The strengthening of the domestic currency is also caused by the quantitative easing measures taken by the US central bank, that had the US dollar losing ground to most of its major peers in the month of May. However, the government would be keeping an eye on the strength of the Rupiah as they would not want exporters to be hit more than they already have. A stable currency right now would be better than a strengthening one. We see the exchange rate for the USD/IDR to be in the 13,500 - 14,500 range for the remainder of 2020.
Juky Mariska, Wealth Management Head, OCBC NISP
Signs of a recovery
The path for the global recovery from the coronavirus-driven recession is becoming clearer, as more countries start to emerge from their lockdowns and activity picks up. - Eli Lee
The path for the global recovery from the coronavirus-driven recession is becoming clearer, as more countries start to emerge from their lockdowns and activity picks up. Estimates of the magnitude of the downturn are still unavoidably wide, but information over the past month does not point to any major reassessment of the scale of the damage.
Most developed economies are likely to report an unprecedented drop in output when 2Q2020 GDP data is released in late July/early August. It looks like May was a little better than April, while June should be significantly stronger. 3Q2020 should show a good rebound, although activity is unlikely to reach 2019 levels until late 2021 or 2022.
There is little change in our economic growth forecasts this month, with global GDP expected to shrink 2.1% in 2020, before rebounding by 5.3% in 2021. The primary risk to this outlook is a second wave of infections and renewed lockdowns that push recovery well into 2021.
China offers hope
China offers a blueprint for what to expect in developed markets, even though magnitudes will differ. Reflecting its position as the source of the virus, China was the first to shut down parts of its economy and the first to come out on the other side.
China's recent National People's Congress took the pragmatic step of not producing a GDP target for the year, but instead put the emphasis on job stability. Plans for a moderate amount of bond issuance point to some restraint on fiscal stimulus, which is perhaps an indication of confidence in the economic rebound.
If the government can use this opportunity to move away from the custom of GDP targeting, then in future it could allow focus to shift to a better quality of growth as well as helping to control excessive credit. President Xi Jinping can reasonably claim that China met its target of doubling incomes by 2020 and move away from a raw growth target.
Fiscal policy may be scaled back
As economies emerge from lockdowns, the focus is shifting towards finding ways of re-opening the economy and scaling back various subsidy programs. It is a fine balance between providing the right incentives to start to normalise, while avoiding too much stress on companies. The hit to the public finances has been brutal and governments are aware that they are facing many years before deficits come under control.
Monetary policy will remain loose
Monetary policy responded rapidly and aggressively to the crisis. Low interest rates look set to remain around current levels through to the end of 2021 and probably beyond.
The US Federal Reserve continues to push back against suggestions that it needs to adopt negative interest rates, while the Bank of England seems to be wavering. On balance, negative interest rates appear to provide some additional stimulus if they are well structured.
Negative rates are often labelled as a "tax on savers" but that is the basic role of interest rate cuts - they reduce the motivation to save and raise incentives to spend or invest.
Will inflation or stagflation become an issue in time?
The short-term impact of the virus-driven recession is deflationary. Demand has collapsed while the plunge in oil prices adds further downward pressure on prices, so inflation has already dipped.
Longer term, the tail risk of inflation merits attention. Supply is set to shrink and that will be exacerbated by further de-globalisation. After years of increasingly favouring capital, the pendulum is set to swing towards labour, as the crisis has highlighted the vulnerabilities of low-skilled workers. The explosion of monetary growth points to a further risk.
Inflation (or stagflation: inflation with low economic growth) is hard to imagine at the bottom of the cycle. However, it could become a concern over the next two to three years if activity rebounds and policymakers struggle to remove the array of emergency measures enacted in recent months.
Questions about the scale of monetary stimulus can translate into concern about the longer-term consequences of such an aggressive expansion of central bank balance sheets.
|Rest of Asia||4.9||1.5||7.2|
Remain neutral in equities, where we believe a balanced stance is optimal given current valuations after a sharp rally that has priced in much of recent positive developments, and still-limited earnings visibility. - Eli Lee
Multiple positive factors drove market optimism over the last few weeks, including the massive stimulus packages globally, as well as the fact that we may be past the worst of the global Covid-19 crisis as economies start to re-open. However, these are balanced out against significant risks including:
Despite dire economic fundamentals and the lack of earnings visibility, the S&P 500 index's rally since 23 March has been breathtaking. Still, we believe investors should adopt a more cautious stance, with three key risks worth considering.
First, tensions between US and China are escalating, and these are manifested in areas such as politics, financial markets, and technology. This is likely to remain as a headline risk going into the November US presidential elections.
Second, the heavy concentration of the S&P 500 Index's market cap in just 5 (tech) stocks also calls into question the durability of the rally without broader participation across sectors, and the ability of long-only funds to maintain increasingly concentrated portfolios.
Third, while lower rates are positive for multiples, they could be neutral for profit margins in the short term, given the high proportion of fixed-rate corporate debt, while the rebuilding of cash buffers through debt capital markets reduces credit risk but at the expense of lower profitability.
This earnings season will likely be remembered as one of the dimmest in terms of forward visibility in history. Of the 200 companies that reported where management commented on guidance, 42% removed guidance, 32% held, 23% cut and only 3% upgraded. The ones that raised guidance were mainly in Pharma/Healthcare. Looking at all the sectors in Europe, those that have the greatest visibility ahead are Pharma, Telecoms and Utilities, while those with the least visibility are Capital Goods and Chemicals.
Looking ahead, the extent to which the gradual reopening of economies is protracted and fragmented would likely be a key catalyst going forward. Hopes were lifted, however, by the European Union's proposal for a EUR750 billion recovery fund to help restart the region's economy.
Reflecting the urgency on mending the economic damage from the Covid-19 outbreak as daily infection rates eased, Japan lifted its state of emergency slightly earlier than scheduled last month and announced additional stimulus which included more support for small to medium sized enterprises.
While the worst in the fall in consumption may have passed, we see a subdued road to recovery ahead, with potential risks including heightened US-China tensions. Market valuations however, are at undemanding levels of about 1.1x price/book, near the previous lows of 0.9x over the past decade. We recommend a barbell approach for long term investors, favouring a mix of quality defensive consumer staples and cyclical beneficiaries.
The MSCI Asia ex-Japan Index corrected mildly for the month of May after seeing a good rebound in April. While the world's attention is undoubtedly focused on rising US-China tensions, there are also signs of geopolitical risks brewing within Asia, as China and India have both moved in more troops along a section of their border amid a border dispute.
In China, the MSCI China index has rebounded since its low on March 2020. During the same period, consensus earnings forecasts have been revised downwards by 5% and we believe there is still downside risk, with consensus forecasting 3% earnings growth this year. Concerns of a re-escalation of US-China tensions are likely going to persist into the US presidential elections this November.
The latest flare-up has expanded beyond trade and tariffs-related issues and broadened to technology (Huawei and semiconductor sectors), capital flows and access to the US capital markets (increasing uncertainties related to possible de-listing of Chinese ADRs), and more potential US responses in relation to the passing of the national security legislation at the National People's Congress.
All these uncertainties are likely to cap any significant valuation multiple expansion and we urge investors to remain cautious and selective. Any pullback in the market would offer opportunities to accumulate companies that can benefit from structural themes, such as our investment theme of rising online engagement, which should benefit internet and e-commerce related players.
|Total Returns %||12-months||YTD||January|
Benefiting from a search for yield
Aggressive monetary easing by the major central banks has driven already low interest rates even lower, enhancing the appeal of emerging market high yield bonds among investors who are in search for yield. - Vasu Menon
We see interest rates staying at current ultra-low levels for a significant period and believe that the hunt for yield will be supportive of Emerging Markets (EM) High Yield (HY) bonds over the long term despite the scope for some near-term volatility. Within EM HY, we maintain our preference for Asia, driven by our constructive outlook for China, which continues to outperform other emerging markets.
Bond markets' strong performance in May
For the second straight month, global corporate bonds rallied strongly. EM bonds were up 3.8%, with HY up 5.6% and Investment Grade (IG) up 2.7% on optimism towards global economies opening. In Developed Markets (DM), IG bonds rose 1.2% ,while HY bonds added 4.9%.
Emerging Market Credit had an outstanding month in May as investors shifted their focus away from worst-case "left tail" outcomes towards a more sanguine outlook as hopes grew that Covid-19 may lose momentum.
Emerging Market spreads stage big rally
EM HY spreads tightened an incredible 123 basis points (bps) in May and at +765 bps have erased half the loss since 23 March. Meanwhile, IG spreads tightened 50 bps to +308 bps, still well off the pre-Covid tight of +180 bps.
Several weeks ago, the Federal Reserve had also introduced a Special Purpose Vehicle to purchase US IG bonds on the open market, with the intention of unfreezing the credit markets. This is also supportive of our neutral position on DM IG bonds.
Nascent signs of optimism in EM
There are cautious green shoots of optimism in EM. The Fed's actions to calm markets and stabilise liquidity were not targeted at EM bonds specifically, but had a salutary impact, nonetheless. The aggressive monetary and fiscal easing in EM has not led to a widespread tightening of financial conditions, and capital flight has improved demonstrably since March. Furthermore, EM currencies have been relatively stable since March and oil is at its highest level in three months. From a technical perspective, the new issue market remains robust, with massive oversubscriptions.
Prefer Asian High Yield
China continues to outperform other EM year-to-date and our preference remains for China within Asia in the HY space. Despite Sino-US tensions, we continue to see value in Chinese HY USD denominated bonds in the medium term based on several factors.
Firstly, China's economy continues to recover in May. Secondly, governments around the world, including China, continue ensuring that plentiful liquidity is available in the market, by fiscal or monetary means, to curb further defaults in the economy. This would ensure keeping the lid on any potential credit crunch. Thirdly, Chinese HY names, especially properties, continue to offer good relative value against other EM counterparts.
During May, more high-yield issuers, ranging from BB+ to B rated, returned to the primary market with issuance as high as 10x oversubscribed. This is evidence that markets have plenty of appetite for Chinese HY bonds barring any short-term volatility due to Sino-US tensions. Nevertheless, in the medium term, the higher level of liquidity will need to find more stable risk assets with higher yield, at the same time and which are more insulated from Covid-19 and trade conflicts.
Maintain overweight rating on EM HY and neutral rating on EM IG
We are maintaining our overweight stance on EM HY and neutral stance on EM IG. Within the EM corporate bond space, HY has understandably borne the brunt of risk reduction since the impact of Covid-19 began in earnest in January. However, it has started to outperform.
FX & COMMODITIES
Worst is over for oil
The easing of lockdown measures and steep production declines in non-OPEC countries along with OPEC+ gives us hope that the worst is behind us in the oil market. - Vasu Menon
The collapse in supply and partial demand rebound should be enough to move oil markets back into deficit in 2H2020, providing price support which we expect to continue in the coming months. 12-month Brent crude price forecast is unchanged at US$45/bbl but we have raised the 3-month and 6-month forecast to US$36/bbl (old: US$30) and $US40/bbl (old: US$38) respectively.
The supply side has adjusted fast amid steep production declines in non-OPEC countries along with OPEC. A gradual recovery is underway in oil demand, occurring in stages with China the furthest ahead, and Europe and the US a step behind. Easing restrictions in Europe and the US is likely to lead to only a gradual rebound in transportation-driven oil demand. Jet fuel demand remains subdued and any sizeable recovery will depend on international travel restrictions being lifted.
The big balance sheet expansion by major central banks, near-zero interest rates in the US and concerns that money printing may eventually result in US Dollar debasement, keeps us positive on gold's medium-term outlook. We see the precious metal trading close to US$1, 800 per ounce in 12 months' time.
Markets seem to be ignoring negative headlines and have been broadly risk positive. Unrest in US cities should remain a domestic affair, but if it persists, it could be negative for the US Dollar (USD). The broad USD could be further affected negatively in the near term given that the DXY index has broken key support levels.
Near term, we expect a firmer Euro to be the beneficiary of USD weakness. The increased odds of a coordinated fiscal response from EU members augurs well for the Euro. Cyclical like the Australian Dollar and the New Zealand Dollar may also push higher as shorts entered on Sino-US developments capitulate.
Economic data has been poor, but generally still better than consensus estimates. This has contributed to economic optimism and if it continues, the defensive and long-USD thesis may lose further traction.
For now, we have turned less defensive, but we are still not ready to completely give up on it. Although economic data has beaten expectations, this may be because of over pessimistic estimates. We prefer to wait for stronger evidence of a recovery in data before we give up on our defensive stance.
In Asia, weakness of the Renminbi versus the USD has not translated to materially weaker Asian currencies versus the greenback. This suggests to us that although Sino-US tension has worsened, it has not been a driver in FX markets.
This may remain the case so long as both sides stick to a verbal exchange, and do not take concrete policy action to curtail trade and/or portfolio flows. In the near term, Asian currencies vi's-à-vis the USD should be driven by broad USD dynamics, which at this stage is USD-negative. As for the USD-Singapore Dollar (SGD) pair, there is possibly further downside for the greenback in the short term.
On the domestic front, however any positivity from the end of the circuit breaker period should be short-lived as most of the restrictions remain in place. The domestic economy is still expected to face headwinds, and this should limit excessive SGD strength.
The Long Path to Normal
The global economy is currently facing a major obstacle and is on the brink of the worst recession in the last decade. Strict lockdown measures by developed countries, has pushed global growth into negative territory in the first quarter of 2020. The US economy itself reported a -4.8% GDP growth for Q1 2020. Unemployment rate as of April soared to 14.7%, the highest it's ever been. In Europe, similar conditions are being reported, with GDP growth last quarter at -3.8%. Several countries are now contemplating of reopening their economies, although not fully, but is afraid that it may jumpstart the potential of a "Second Wave" of COVID-19 pushing economies deeper into recession.
Looking east towards Asia, the majority of countries reported contractions as well in regards to Q1 GDP. China reported its largest drop of -6.8% YoY for Q1 2020 GDP. Other countries followed its lead, like Singapore at -2.2%, Hong Kong at -8.9%, and Philippines at -0.2%. Numerous stimulus support, both monetary and fiscal, has been delivered by policymakers to help soften the blow caused by the pandemic. As an example, China's central bank, the PBOC, has lowered its reserve requirements as well as its loan prime rate in order to boost market liquidity, especially for small to medium banks that has been hit hard by the Coronavirus.
Moreover, the rising tension between the United States and China, caused by the accusation by President Trump that COVID-19 had originated from a laboratorium in Wuhan, has introduced a new kind of negative sentiment that has contributed to market volatility. In response, China has agreed to increase its commitment for American products purchases; which is a continuation of the agreed phase 1 trade deal last year. This act by the Chinese government has reduced the increasing tension of the world's two largest economies.
Domestically, the government has been giving their best effort to try and contain the spread of corona virus, by introducing strict social distancing measures; although COVID-19 cases seemed to keep increasing more and more. On the flip side, the recovery numbers seem to also increase in tandem with the new infection numbers. The so called "PSBB" social distancing measure has resulted in a shutdown of the economy, prompting a drawdown of Q1 2020 GDP to 2.97% YoY, which is the lowest level since 2005. Growth slowdown can also be seen from the Manufacturing PMI numbers for April, in which took a huge hit dropping from 43.5 all the way to 27.5. Amongst neighboring countries in Southeast Asia, that particular level is the second lowest after India.
The government has implemented several easings, both monetary and fiscal to support the suffering economy. President Jokowi had introduced a new law which allows the government to increase liquidity in the financial system through government entities in the corporate world, and even through government spending.
For the whole month of April, the JCI recorded an increase of +3.91%, after experiencing severe punishment in the month before. However, since the start of 2020, the index is still performing at 25.13% lower. The equity market is still burdened by the negative sentiment surrounding COVID-19, both domestically and globally. Moreover, the recent slump in oil prices to its lowest level at USD$-37.63/b had also weighed on risk assets overall. Lastly, the earnings season results that had finally concluded showed significant damages in corporate financials.
The equity market is expected to remain volatile as long as COVID-19 news are still making headlines, which is expected to moderate by the end of May or early June. Hence, the growing infection numbers domestically indicate that the government's effort, in terms of testing capacity, has significantly progressed. The recovery itself, with the help of massive government stimulus', will predictably start in Q3 2020. Nonetheless, the current volatility should be used as a window of opportunity for equity investors, with a focus on big-cap blue chip stocks, particularly in the consumer sector.
Likewise the equity market, the bond market also lifted up in the month of April, where the 10-year government bond yield was seen -1.09% lower compared to the beginning of the month, after shooting up 14% in the previous month. On the last week of April, the government auctioned seven new series of government bond in order to reach its target of 2020. The subscription amount for the overall batch was at IDR44.39 trillion, in which the government was only able to absorb IDR16.62 trillion. This proved that investors' appetite of the asset is still high, in the midst of the low interest rate environment. We believe that the bond market still has the potential to rally towards year end, closing the year at the range of 7.2%- 7.3%, with the assumption that economic recovery do really start in the second half this year.
The Rupiah recorded a huge jump in April, with a whopping 9.53%, closing the fourth month at 14,881/USD. The swap agreement between Bank Indonesia and the Fed amounting to USD60 billion has helped calm the markets. Not only that, the statement made by the governor of Bank Indonesia, Perry Warjiyo at the "Perkembangan Ekonomi Terkini" conference at the end of April, had provided positive market sentiment. He acknowledged that although the domestic economy may contract this year, we are still on the path to our longer-term growth plans. Policy reforms such as the Omnibus Law will start next year. We see that the Rupiah will hover in the range of 14,800 - 15,250 in the short term.
Juky Mariska, Wealth Management Head, OCBC NISP
Worst recession in decades
We now anticipate a longer and deeper shock versus a month ago, and have revised down our growth projections for 2020, from 0% to -2.1% for the world economy, compared to the 0.1% contraction in 2009. - Eli Lee
The world economy is facing one of the worst recessions in decades. The global pandemic and measures to try to contain its spread have led to a collapse in economic activity in all major economies.
Much of the developed world is in lockdown, although restrictions are starting to ease in several cases. The normalization process should be broadly underway before the end of the second quarter, but this will not come soon enough to prevent an unprecedented output contraction in 2Q2020.
Sharp economic contraction in China
China reported that 1Q2020 GDP declined 6.8% year-on-year. There had been doubts that the government would permit such a weak number to be reported and it sets a very low base for the year. Even with a reasonably rapid bounce from 2Q2020 (provided there is no renewed outbreak of Covid-19), it is mathematically very difficult for China to achieve a positive figure of 2020. Given its size, this has a big impact on the world growth outlook for the year.
Unimaginable shock to the US labour market
Recent data shows an almost-unimaginable shock to the US labour market, with 30 million people (out of a workforce of 164 million) losing their jobs in the six weeks after the mid-March lockdown. The unemployment rate is set to rise to around 20% by June, compared to the 10% peak during the 2008-09 recession and below 4% for the past two years. This points to an extraordinary economic contraction in 2Q20.
Less dramatic rise in European unemployment
Europe will see a less-dramatic rise in unemployment due to government-funded schemes to provide subsidies in order to protect jobs. However, the initial economic damage will be similar as a large part of the labour force is inactive, whether registered as unemployed or simply furloughed by their employer.
Through of recession may be wider than expected
Lockdowns in developed economies are persisting for longer than expected. Across much of Europe, initial periods of enforced self-isolation failed to bring down infection rates rapidly enough and have been extended or are lifting very gradually. This means that the trough of the recession may be wider than previously expected.
Forecasts revised down sharply
We now anticipate a longer and deeper shock versus a month ago. As a result, we have again revised down growth projections for 2020, from -2.9% to -4.3% in developed markets and from 1.9% to -0.5% in emerging markets (where China has a big impact). This takes the predicted outlook for the world from 0.0% to -2.1%, compared to the 0.1% contraction in 2009. As recently as the start of this year, global growth looked set to be around 3.3%, only moderately slower than the 3.8% average of the previous decade.
Base case - Lockdowns will gradually be lifted
The "base case" assumes that lockdowns will gradually be lifted, and economic activity normalises in parallel. However, if renewed outbreaks require further lockdowns, or if consumers and businesses are unable or unwilling to re-engage, then growth would be worse than expected, putting even greater strain on government finances.
Bear case - Further outbreaks
A "bear case" scenario could see further outbreaks and renewed lockdowns towards the end of this year, in which case developed economies could shrink by close to 10% in 2020 and the world economy by perhaps 5-6%.
Central bank action has helped
The risk of major dislocation in global financial markets has been forestalled by prompt and aggressive action by central banks. Market liquidity has improved, and credit spreads have narrowed.
Immediate pressure on emerging markets has also eased, partly thanks to action by the Fed. Emerging markets typically have younger populations, which should be less vulnerable, but they also have weaker healthcare systems and less room to provide a policy response.
Covid-19 could cause political issues
Amid extreme social and economic stress, perceptions of policy failures could lead to political turmoil. In democracies this can be channelled through the election process, where the focus is on the US elections in November.
Forecast of robust recovery in 2021 is tentative
While we expect a sharp contraction in the global economy this year, the expected bounce in 2021 is commensurately stronger, although in developed economies, it is not enough to recapture the losses of this year. The absence of solid information about the scale of the short-term damage to the economy and lack of clarity over the lifting of containment measures means that any forecasts are tentative.
Past recessions were typically met by policies aimed at providing an immediate boost to demand. However, this approach has little merit when weak demand is due to the medical emergency and related restrictions on activity. As such, beyond providing basic income support, policy measures have been aimed at trying to limit long-term economic damage from unemployment and bankruptcies. This may allow activity to recover relatively rapidly once containment measures are lifted and if a second wave of infections fail to materialise.
|Rest of Asia||4.9||1.5||7.2|
Lock in some gains
With the risk-reward now less attractive, we look to take advantage of the near-term rally to reduce our overweight positions in Asia ex-Japan and overall equities to neutral. - Eli Lee
Markets have been on an upward trajectory since bottoming in late March, fuelled by the concoction of largely successful containment measures, sizeable fiscal packages and loose monetary policies. Still, subsequent waves of outbreaks lurk in the background, and normalcy in the absence of a vaccine remains extremely challenging. With the risk-reward now skewed to the downside, we look to take advantage of the near-term rally to reduce our overweight positions in Asia ex-Japan and overall equities to neutral.
While the timing of the market upturn was warranted, the magnitude of the move deserves scrutiny. The widely held baseline expectation is that the global Covid-19 recession will be short-lived, but we are wary that the bear case of an extended recession longer than a year, could lead to a significant market downside ahead. Earnings estimates have moderated significantly on a YTD basis, but remain too high in our view. Corporate visibility among S&P 500 companies remains low, with many lowering or withdrawing guidance altogether. While we remain positive on selected companies with resilient balance sheets and robust long-term growth prospects, these are slim pickings for now, in our view.
Looking ahead, we are cognisant that the flattening of the virus curves in the G7 economies and the focus of policymakers moving on to exiting containment measures - plus an unprecedented degree of fiscal and monetary stimulus - is potentially a potent setup for market upside ahead.
However, given where equity valuations are and the risks that are in play, we believe that a more balanced stance is optimal at this point. We will be keen to add risk exposure ahead if valuations turn more attractive or if the key risk factors abate meaningfully.
With the effects of Covid-19 deemed to have a one-off effect on the economy, investors have increasingly been willing to anchor expectations to the expected recovery in 2021, while the unprecedented monetary policy response is certainly providing the ballast to risk assets in the near-term.
However, we believe that investors should still exercise caution. Gains in the S&P 500 index have so far been concentrated among the top companies in the index. A more broad-based participation is likely to be required from other companies in the S&P 500 index for it to continue its rise. However, this could be challenging as visibility remains cloudy, given the increasing number of guidance withdrawals among large cap corporates during the first quarter earnings season. Shareholder returns in the form of share buybacks and dividends are also at risk, given the need to conserve cash.
In Europe, earnings growth forecasts continue to be revised down quite significantly. Although this has been revised down to -19%, we suspect that there is still more downside ahead. At the sector level, we see that the Discretionary, Commodities and Materials sectors are trending down the most in year-on-year terms, with Healthcare names providing the most resilience at this early stage.
As for the 1Q20 earnings season, of the 176 companies that have reported so far on the Stoxx600, 54% have beaten estimates, while 46% have missed, giving a net beat of ~8% of companies. However, do note that consensus expectations have been thoroughly rebased given the incredibly challenging business conditions.
Japanese equities underperformed global equities in April as the nation declared a state of emergency and boosted its stimulus package to a record US$1.1 trillion to soften the economic damage from the Vovid-19 outbreak.
The Bank of Japan has revised its estimates for Japan's GDP to a potential 3% to 5% contraction in calendar year 2020, following the nearly 7% decline in October-December 2019 GDP due to the consumption tax hike.
As corporate Japan starts a new fiscal year in April, potential Yen strength on reducing risk appetite could act as a headwind for many of Japan's export companies. Market valuations, however are at undemanding levels of about 1x price/book, near the previous trough-multiple of 0.9x over the past decade. With forward earnings growth still looking optimistic at about 8%, earnings revisions and dividend cuts should weigh on the market. Looking ahead, we think the easing of global lockdown measures is one leading indicator of growth recovery.
The recovery in risk appetite has resulted in the MSCI Asia ex-Japan Index appreciates 8.9% in April. Meanwhile, EPS estimates have been revised down by 9.2% as compared to end-2019, with countries such as Hong Kong, Singapore and Thailand seeing larger downward revisions. Stronger EPS growth expectations are projected in South Korea and India. There could be downside risks to the latter, depending on how the Covid-19 situation pans out. The lockdown in India has been extended by a further two weeks to 18 May, although there was also some easing of restrictions in areas not affected by the virus.
In the banking sector, the large Chinese banks have seen an increase in their non-performing loans formation rate, while there are rising concerns of bad debts at Indian banks.
Most of the S-REITs have also either reported their 1Q20 results or provided some form of business update. Distributions declared were largely down on a year-on-year basis. Although operational metrics were still largely healthy, this is expected to deteriorate in the future. The decline in distribution per unit was also largely driven by retention in taxable income available for distribution, some of which was as large as 70-80%. This is in anticipation of more challenging conditions in 2Q20, especially for the retail REITs, where most of the rental rebates to tenants are set to kick in. Given this current situation, we believe investors would be better positioned with the larger-cap government-linked REITs which have strong balance sheets.
The latest Politburo meeting reiterated a dovish tone on monetary policies without any explicit reference to the growth targets. In our view, we believe there needs to be an easing bias in terms of monetary policy, while fiscal policies are stepped up during this period of economic recovery. It is estimated that fiscal-type policies announced so far were about 1.2% of GDP. We expect more policy support to come, including around 1.5% of GDP in additional fiscal spending, which will bring fiscal spending to around 3% of GDP.
Considering expectations of stronger policy easing, ample liquidity and the recovery in domestic activities, the offshore Chinese equities market has rebounded by 14% since the recent low in mid-March and is trading slightly above historical average level. Investors should consider taking partial profit for companies or sectors that have posted a relief rally, such as the energy sector. Having said that, the downward pressure on earnings and market volatility would offer opportunities for long-term investors to accumulate quality companies during a pullback.
|Total Returns %||12-months||YTD||April|
Bond market makes a U-Turn
We maintain a slight risk-on tilt in our overall asset allocation strategy, through our overweight positions in emerging market high yield bonds and overall fixed income securities. - Vasu Menon
After its worst month in more than a decade, bond markets rallied in April as the coordinated stimulus from central banks and policymakers globally began to bear fruit. Emerging Market (EM) Corporates rallied 3.3%, with High Yield (HY) up 4.5% and Investment Grade (IG) up 2.6%. In Developed Markets (DM), US IG was up a staggering 5.1% and HY rose 3.6%.
Positive on EM HY bonds
We maintain a slight risk-on tilt in our overall asset allocation strategy, through our overweight positions in EM HY bonds and overall fixed income.
Our long-term view on EM HY bonds, however, remains constructive. While we do expect persistent volatility and higher default rates ahead, we do not believe spreads will widen to the levels seen during the 2008-09 Great Financial Crisis as the composition of the market is far superior today from a credit quality perspective. The carry offered by this asset class also remains attractive given that we expect the hunt for yield would continue to be an important structural market driver against the backdrop of very low interest rates.
Prefer Asia both among HY and IG bonds
Among both HY and IG bonds, we maintain our preference for Asia, which is driven by China. Our constructive China outlook is based on several factors: 1) It is one of the few major EM countries likely to exhibit positive GDP growth in 2020 based on IMF projections; 2) It has demonstrated effective management of Covid-19; and 3) the country has the fiscal and monetary bullets to address economic and social challenges.
Central banks have been supportive
Proving that it will do whatever it takes, the Fed has responded with a "shock and awe" program of stimulus measures. To date these include swelling the balance sheet to close to US$7 trillion, introducing a special purpose vehicle to buy Corporate Bonds, opening up swap lines with various Central banks to increase the supply of US Dollars into the global economy and easing restrictions on banks to free up lending capacity.
On 9 April, the Fed rolled out a US$2.3 trillion program to buy high-yield bond ETFs and lend directly to Main Street businesses. Consequently, we moved our position in DM HY bonds from underweight to neutral on 10 April. Aside from Fed intervention, this upgrade was also due to less demanding pricing after a significant correction year-to-date.
Globally, literally dozens of Central Banks have followed the Fed's lead with proactive interest rate cuts, the most recent being Mexico, Turkey and Russia.
While none of the Fed's actions are specifically targeted at EM bonds, it does indirectly benefit the asset class in that it instils the sense of calm and stability necessary to restore investor confidence toward risk taking.
Several weeks ago, the Fed had also introduced a Special Purpose Vehicle to purchase US IG bonds on the open market, with the intention of unfreezing the credit markets. This is also supportive of our neutral position on DM IG bonds.
Further downside in EM bonds possible but we do not see GFC levels
The ultimate impact, scope and duration of Covid-19 are still largely an unknown. Hence, despite all the money that policymakers throw at the problem, further volatility and downside may persist in the coming weeks and even months.
However, within EM bonds we do not expect spreads to revisit the levels achieved during the Global Financial Crises in 2008/2009, where HY spreads reached over 20% on average.
Maintain overweight on EM HY bonds and neutral IG bonds
We are maintaining our overweight stance on EM HY bonds and neutral stance on EM IG bonds. Within the EM bond space, HY has understandably borne the brunt of risk reduction since the impact of Covid-19 began in earnest in January. However, given our belief that spreads will not revisit 2008/2009 levels, we think that at current levels it makes sense for longer-term investors to start gradually reengaging with the asset class.
Gold to range-trade short-term
Concerns of money printing that may result in the US Dollar debasement eventually, keeps us positive on gold's medium-term outlook. However, in the next three to six months, gold is likely to range-trade between US$1,675/ounce and US$1,750/ounce. - Vasu Menon
WTI May futures contracts turned negative for the first time ever in April, underscoring a situation of too much oil, with nowhere to put them. Oil is a story of low prices now for higher prices later, with a more-painful adjustment in non-OPEC supply as the next most logical event. The most immediate impact will be felt by the sudden fall in drilling activity in the US shale oil basins. This fall in oil production won't solve the storage issues in the short term. Cushing (Oklahoma) storage will be nearly full in the next month or so. Globally, offshore or floating storage is becoming the only viable option. This will keep oil futures volatile, particularly as they near maturity.
A possible reversal of the lockdowns lifting oil demand and US oil production cutback could help tighten the market in the second half of 2020 and beyond. We continue to project Brent crude price to rebound to US$45/barrel in a year's time.
As a result of a big and sustained balance sheet expansion by major central banks, such as the US Federal Reserve, concerns of money printing that may result in the US Dollar debasement eventually, keeps us positive on gold's medium-term outlook and we see the precious metal trading close to US$1,800 per ounce in 12 months' time.
Short-term, however, over the next three to six months, gold price may range-trade between US$1,675 and US$1,750 an ounce versus US$1,706 per ounce on 4th May. Uncertainty, risk aversion and lower inflation expectations which are usually accompanied by lower interest rates may prove less beneficial for gold going forward. This is because, the lack of willingness or capacity among central banks to cut already very low nominal interest rates, may weigh on gold prices as real rates (nominal interest rates mins inflation) could increase as a result.
Going forward, the economic uncertainties should only get more obvious, and we do not rule out further growth downgrades. This is likely to hurt risk appetite. Thus, we prefer to stay defensive and continue to see the US Dollar benefiting from safe-haven flows.
In Asia too, the short-term weakness of the US Dollar against regional currencies seems overdone. In fact, we see no signs of strong portfolio inflows into Asia. Foreign investors are still largely on the side-lines. Thus, we do not see the flow environment as positive for Asian currencies just yet.
We do not see a lot more downside for the US Dollar versus Asia currencies in the near term. We are of the view that the exchange rate between the US Dollar and Asian currencies has not adjusted sufficiently to the expected macro headwinds from the spread of the Covid-19 virus.
We prefer to be structurally long the US Dollar against Asian currencies at this point. As for the US Dollar versus the Singapore Dollar, it too continues to be led lower by the weak US Dollar. We view a lower US Dollar versus the Singapore Dollar as incompatible with Singapore's weak economic fundamentals. Thus, we see limited downside from current levels.
The corona virus has definitely stolen the spotlight for all of Q1 2020, with infection numbers escalating rather rigorously. The United States has now taken over China and other European countries to be the country with most Covid-19 cases and fatalities, with New York leading the charge. President Trump's administration has readied more than USD$2 Trillion dollars, the most by any country administration, to fight back the economic shock caused by the novel virus. This has been apparent when we take a look at the number of people claiming for unemployment benefits in the US, which was recorded at roughly 16 million people in just the last 3 weeks, with unemployment soaring from 3.5% to 4.4% for the month of March.
Looking at Europe, we can see that the infection curve flattening, as the spread in Italy, Spain, Germany, and France has started to mitigate. After a tumultuous couple of months, European countries may now have a little breathing room. In Great Britain, Prime Minister Boris Johnson was recently released from the hospital and is currently undergoing self-isolation at his estate, while resuming his role as the country's chief. In regards to the oil price war between Saudi Arabia and Russia, recently OPEC and the group of G20 has finally reached a historic agreement to cut oil production by nearly a 10th, or 9.7 million barrels a day in order to support and stabilize oil prices that in the past month has recorded one of the most volatile periods in history.
Countries in Asia such as Singapore, Hong Kong, and China are currently experiencing what they call a "Second Wave" of Covid-19 cases which was mainly imported cases and is responded in a swift manner by the affected countries. Overall, Asian countries are still battling with Covid-19 but it is apparent that the U.S and Europe is going through a tougher process. The MSCI Asia Pacific index recorded a 12% drop in the month of March, still lower than the average declines seen in Wall Street. Most of the Asian governments are currently still cooking more fiscal stimulus packages to support its deteriorating economies due to the pandemic.
Domestically, the government is currently solely focused on the containment of Covid-19 which had entered the country in the beginning in March, and has been growing exponentially since the third week. The lack of necessary equipment and accessories have been a hindrance for the doctors in our healthcare system. As Covid-19 pressure builds up, both domestically and globally, our equities market at one point dropped to low levels last seen in 2012; with government bond yields shooting up like shooting stars. However, inflation remains stable, recorded minimal decline from 2.98% to 2.96%, which is still better than expected. But foreign reserves took a hit going down from USD$130.4B to USD$120.97B, which was hugely expected due to the central bank's efforts (triple intervention done in spot market, domestic forward market, and the bond market) to stabilize the exchange rate for the Rupiah against the greenback. In addition to that, the newly minted repo agreement between Bank Indonesia and The Fed amounting to USD$60B has spurred optimism for the currency market. The government had also lowered growth expectations for this year significantly, from 5.3% all the way down to 2.3%. All in all, the month of March has punished our capital markets more than it deserved, but economic indicators show signs of resistance and resiliency.
In the month of March the JCI officially went bearish, sliding below its short-medium-long term averages to its lowest level since 2012 at 3,937.63. For the first quarter of 2020, the JCI recorded a decline of 28%, in which 16.75% came in March. It is evident that our equities market suffered a devastating blow due to the Covid-19 pandemic, both domestically and globally. As global risk appetite took a huge hit, investors are turning more and more towards safe-haven assets such as Gold and the greenback. Foreign investors recorded outflows from domestic equities market, and the same for domestic investors. As Q1 comes to an end, investors will want to see the impact of the novel virus on corporate earnings, where many would anticipate one of the bleakest earnings season since the Great Financial Crisis of 2008-2009.
With the current environment, although we don't see the JCI to be able to climb back to its glories of above the 6,000-level handle, we also do not see the JCI to dive back below 4,000 as domestic bulls will eventually take advantage of significant declines at this point as valuations become more attractive. Earnings of the current year is estimated to decline by 11%, as the domestic economy needs to recover from this pandemic. Thus, any recovery in the second semester may support JCI to hover in the range of 5,500 to 5,800.
Similar to the equities market, the bond market took a beating in March in which the 10-year benchmark yield jumped 14%, to its highest level since the first half of 2019, above 8.0%. The negative performance of the bond market is propelled by the significant depreciation of Rupiah against the US dollar, and therefore upside will remain limited as demand for the greenback is powered by the ongoing concerns relating to the Covid-19 pandemic. The central bank has exercised their "triple intervention" as mentioned earlier and has proven to be quite successful in providing a sense of stability in the bond market. As our credit market is considered a High Yield Emerging Market (HY EM), foreign investors have recorded historic outflows in the month of March, which has presented opportunities for domestic investors. However, as there are numerous ongoing uncertainties, domestic investors are more comfortable with a wait & see stance as Covid-19 cases have started to increase exponentially since the last week of March.
We believe that there is more upside to the bond market right now, with yields at 8.0%. Our year-end estimates remain the same, for the 10-year benchmark yield to be in the range of 7.0% - 7.25% with the assumption that the pandemic would peak in Q2 2020, leaving the second half of 2020 room for revitalization.
Our domestic currency, the Rupiah, is the worst performing Asian currency since the start of 2020, with a total decline of 17.6%, where 14.3% came in just the third month itself. The volatility seen in the exchange rate is mainly forced by the demand surge for the US dollar, while domestically the country is at an all-out war with the pandemic; weighing on the strength of the Rupiah itself. On the positive side, the central bank has reached an agreement with the US central bank of repurchase agreements (repo) of up to USD$60B to help stabilize the currency market. We see the exchange rate for the Rupiah against the US Dollar to be somewhere in the range of 16,000 - 17,000 by year-end.
Juky Mariska, Wealth Advisory Head, OCBC NISP
Though the global economy is set to sink into recession, central banks are actively injecting liquidity into financial markets to prevent the Covid-19 economic shock from turning into a financial crisis. And a rebound in activity should come quite quickly once the containment measures start to be lifted. - Eli Lee
Covid-19 has spread much faster and further over just one month. As a result, the world appears set to sink into a recession that is set to be worse than that of 2009, albeit shorter-lived.
From the macroeconomic perspective we need to consider several questions.
How deep and lengthy will be the economic contraction in developed markets due to the coronavirus and associated containment measures?
Economies in Europe and North America will be badly hit. Containment measures represent an enforced demand shock that will send some parts of consumer spending to near zero. Non-discretionary spending (such as food, housing, utilities, telco, medical care) typically represents 60-70% of consumption and this will be stable, or even firmer, but overall spending will fall sharply until the medical emergency abates. Government spending will increase rapidly, but the positive impact is likely to be more than outweighed by a collapse in private sector investment.
Conceptually, a shutdown of less than a month should contain the pandemic, but the experience in Italy and Spain suggests this could be insufficient unless rigorously enforced. However, even after draconian isolation policies are lifted, social distancing will continue to depress many areas of consumer spending, which will limit the pace of the rebound.
The assumption is that developed economies face a month of shutdown followed by a couple more months of restrictive measures before a progressive normalisation. It is impossible to know how far activity will drop, but a month where it is 10-20% below normal does not seem unrealistic and this is already suggested by China's experience. Europe is a few weeks ahead of the US, but this will make little difference in terms of the hit to full-year growth rates.
Tentatively, we have revised the growth forecast in developed economies from 1.6% last month to -2.9%, with all regions contracting sharply. Unavoidably there is a wide margin of error. Emerging markets also face a big hit, with growth forecast at 1.9% compared to 4.1% last month. That leaves global growth at zero, compared to the 3.8% average of the previous decade.
The bear case is that the containment measures are ineffective and need to be extended for several more months. In this case, the trough could extend for much longer and developed economies could see contraction of something approaching 10% for the year as a whole.
This would put a huge strain on government finances and the financial system could buckle under the weight of mass bankruptcies. It is easy to project such economic distress out to more extreme political scenarios.
Will the economic crisis lead to a financial system crisis?
Two broad policy measures give hope that the undoubted economic shock will not lead to financial system crisis.
The first is that central banks are actively injecting liquidity into financial markets wherever they see the risk of dislocation. Previous prudence has been abandoned and rule books are being re-written. This is most clearly illustrated by the Federal Reserve adopting a "whatever it takes" approach, with a rapid expansion of its balance sheet along with participation in corporate debt markets.
Secondly, loan guarantee schemes lift the cost of future non-performing loans off the balance sheets of the banks and put it onto the government. This is particularly important in Europe, where the banks are still relatively fragile, and the system is more dependent on direct lending rather than capital market financing compared to the US.
How rapid and vigorous will the rebound be once the pandemic fades?
A rebound in activity should come quite quickly once the containment measures start to be lifted, if policy action is reasonably successful in preserving jobs and supporting income, as there will be areas of pent-up demand.
However, it still seems likely to be more than two years before output returns to peak levels of 4Q2019. The recovery could be held back if the hit to growth, combined with the drop in oil prices, results in a deflationary shock that impedes the efforts of central banks to loosen monetary policy.
Similarly, if policy cannot prevent wholescale bankruptcies, then the recovery could be much delayed.
|Rest of Asia||4.9||3.2||6.3|
While volatility is likely to persist, we believe that attractive long-term value has emerged in the Chinese, Hong Kong and Singapore equity markets, and we are incrementally adding equity exposure in these markets, thereby moving our position in Asia ex-Japan and overall equities from neutral to overweight. - Eli Lee
The global selloff in equity markets has been the swiftest seen in three decades. Indiscriminate selling has also been rampant given investors' rush for liquidity.
In our view, this creates opportunities for investors with ample cash and are underweight equities, as well as those who are looking to rebalance their portfolios, to move into higher quality long-term holdings.
For these investors, we recommend gradually averaging into bargain-priced stocks with resilient balance sheets and long-term growth outlook, as these are likely to emerge unscathed from the virus outlook, and into quality dividend-yielding stocks with healthy cash flows, such as selective Singapore REITs, that would benefit from a "reach for yield" dynamic as rates continue to fall.
The consensus 2020 earnings per share (EPS) estimate for the S&P 500 has been dropping in the last few months, but further downward revisions are highly likely. Companies are now focused on free cash flow generation and preservation, so reduced capex is to be expected. This reduction in investment activity is likely to lower revenue and earnings activity in 2020.
While lower oil prices are traditionally beneficial for consumers, concerns are mounting over the US energy sector, given that the US is now a net oil exporter following the shale revolution.
Our preferred picks in the US continue to have a tilt towards quality technology names that
The coronavirus outbreak is hitting Europe hard, and the potential impact on earnings is at the top of mind for investors. Europe's worst ever year-on-year EPS decline was -49% during the global financial crisis, while a typical earnings recession sees year-on-year EPS growth fall to -25% at its worst.
So far, from mid-February, we have only seen a ~7% reduction in EPS forecasts for 2020, and consensus is still expecting a 2% growth for EPS this year. This is clearly too high, partly because analysts need time to review their estimates.
We also note that the fall in oil price is an issue for the wider European market, as the Energy sector was supposed to be the largest contributor to 2020 EPS growth, providing over 1/6th of the total market growth. This is now lost, and whilst over the medium-term lower energy costs and lower rates should stimulate consumption, that is not the near-term focus of the market.
While the Bank of Japan's (BOJ) increase of daily ETF purchases to ~JPY100b (from ~JPY70b) has helped support the equity market near term, likely unrealized losses on its current holdings and the sustainability of this strategy (or the absence of a long-term exit strategy) remain a concern over the longer term.
Market valuations have reached undemanding levels of 0.96x price/book, nearing the previous trough multiple of 0.9 times over the past decade.
Due to the viral outbreak however, lower domestic demand and economic activities disruptions should lead to further earnings cuts in the upcoming results season, while the Olympics has been officially postponed, dampening sentiment further. With forward earnings growth still looking optimistic at ~12%, we expect earnings forecasts to be revised lower and we remain selective.
The recent focus on Covid-19 has been largely on Europe and the US. However, there are lingering concerns that the worst may not be over for Asia. For example, it is still unclear how quickly India (10% weight in the MSCI Asia ex. Japan Index) would be able to contain the spread of Covid-19 within its borders.
There were also bright spots amid the general economic malaise, as China's official PMI saw a steep rebound from 35.7 in February to 52 in March, beating consensus' expectations (44.8).
There were encouraging signs within the Chinese Property sector, as most developers reported that more than 90% of their sales offices have already re-opened (with the exception of Wuhan), while construction activities have also largely resumed above the 90% level. The major developers we track have mostly guided for positive growth in their contracted sales for 2020 by high single-digit to mid-teen levels.
The MSCI Asia ex. Japan Index is currently trading at a forward P/E ratio of 11.1x, which is 1.1 standard deviation below its 7-year mean.
The pace of activities resumption and stimulus policies will remain as the key focus with some of the high frequency indicators that we have been monitoring picking up steadily, such as daily coal consumption and inter-city traffic congestion indices.
While we expect the government will announce and implement stimulus measures that are required for a prompt and sufficient rebound, a broad-based stimulus that is similar to that in the 2008 Global Financial Crisis is highly unlikely and not necessary, in our view. That said, stronger stimulus would still be required to boost activities significantly to bring it above trend in 2H20.
Looking ahead, it will be important to monitor the above data points that may suggest cyclical policy is stronger or weaker when compared to our expectations.
On a relative basis, we do see favourable factors to support Chinese equities to outperform, namely
However, in the event of a prolonged structural downturn or global recession (which is not our base case), China's growth will not be immune. A prolonged period of weaker global growth will hurt Chinese exports.
|Total Returns %||12-months||YTD||March|
When the levee breaks
Given our belief that spreads will not revisit 2008/2009 levels, we think that it makes sense for longer-term investors to sensibly reengage with the high yield credit space. As such, we are maintaining our overweight stance on emerging market high yield and neutral stance on EM investment grade. - Vasu Menon
Credit markets globally staged a historically epic collapse beginning in late February and extending through the month of March. Over the past month Emerging Market (EM) is down 10.1%, with Investment Grade down 7.1% and High Yield falling 14.9%. March was the worst month for Credit since October 2008, even though in the last week or so the market recouped some of its earlier losses.
High Yield (HY) spreads widened out as much as 500 basis points during March to reach the highest level post the Global Financial Crisis (GFC) before rallying back more than 105 bps at the end of the month. Investment Grade (IG) spreads widened a more modest 180 basis points at the widest during the month before re-tracing 10 bps at the end of the month.
Further downside in EM Credit possible, but we do not foresee 2008/2009 levels
The ultimate impact, scope and duration of Covid-19 is still largely an unknown.
Hence, despite all the money thrown at the problem by global policymakers and governments, further volatility and downside may persist until there is widespread consensus that the virus is a spent force (or a vaccine is developed).
However, within EM credit, we do not expect spreads to revisit the lows achieved during the GFC.
The composition of this market is far superior today from a credit quality perspective. China is the largest component and almost 10% is from the Gulf Cooperation Council countries (Abu Dhabi and Saudi in particular). Many of the largest names from these countries are systemically important, with significant government ownership.
We would expect that these countries will provide these strategically important entities with support during times of severe stress.
Maintain medium-term preference for Asian High Yield
Asian dollar bonds have also suffered during March as a result of the global market volatility but held up relatively well.
Our overweight on Asia high yield bonds, in particular Chinese property, remains current. Two main factors support our view.
Firstly, China experienced the Covid-19 earlier, and it is slowly resuming economic activities. Officially, 90% of businesses have reopened in China. We still expect to see a weaker year-on-year March in the Chinese property sector, but we expect a more significant recovery during April.
Secondly and importantly, while the US Dollar bond market has been closed to Chinese issuers in the second half of March, the onshore bond market is still operating. We have observed many of the developers under our research coverage issued onshore corporate bonds, supporting their liquidity position during 2020.
Maintain neutral duration position
The US Treasury (UST) market has exhibited extreme volatility and even bouts of illiquidity in recent weeks. The 2-10 year UST curve "bull steepened" in the wake of Fed rate cuts (and subsequently flattened 25 basis points) while the 3-month UST bills went negative in the signs of a potential liquidity trap.
In this market environment where significant policy actions are ongoing, we would recommend a neutral portfolio duration position until some measure of stability and continuity returns to the interest rate market.
Maintain overweight rating on High Yield and stay neutral on Investment Grade
We are maintaining our overweight stance on EM HY and neutral stance on EM IG.
Within the EM credit space, HY has understandably borne the brunt of risk reduction.
However, given our belief that spreads will not revisit 2008/2009 levels, we think that at current levels, it makes sense for longer-term investors to start reengaging with the asset class.
FX & COMMODITIES
Gold surges on pandemic fears
We cut the 12-month oil price forecast to USD40/bbl for WTI and USD45/bbl for Brent on the back of downside pressure from the pandemic shock and the Saudi/Russia oil price war. Meanwhile, gold could continue to take a breather over the next few months before continuing its journey higher. - Vasu Menon
Crude oil has been hit by double whammy from the pandemic and the Saudi/Russia oil war. We cut the 12-month oil price forecast to USD40/bbl for WTI and USD45/bbl for Brent. A fading of the Covid-19 shock to oil demand and US oil supply cutbacks should still allow oil prices to rebound in the medium-term.
Gold has outperformed during the recent sharp equity market downturn, though it is not exempt from volatility in the rush to liquidate positions for cash amid intensifying US Dollar funding pressure. While US Dollar funding pressure has since eased, gold could continue to take a breather over the next few months before continuing its journey higher. Helicopter money and successful Fed action to boost inflation breakeven and push down real rates should ultimately bolster the bullish gold trade in the medium-term.
Compared to March, the broad US Dollar is likely to be more stable heading into April as implied volatility eases across the foreign exchange space.
The series of central bank and government rescue packages have alleviated some immediate financial stress and calmed risk sentiment, indirectly keeping a lid on broad US Dollar strength.
So far, actual macro data concerns have largely been overlooked as the market's focus was set on the financial markets. This may change in April. The pipeline for positive news may be thinning, whereas the potential for negative developments - virus spread, economic concerns, credit issues - may still actualise. Thus, we would not rule out another bout of risk-off moves in the near future. This should re-ignite US Dollar safe haven flows.
Overall, we see some range-bound action in the major pairs early in April, as positive drivers run their course. Heading further into April may see renewed US Dollar strength, as the macroeconomic hit becomes even more apparent.
On a multi-week horizon, we prefer to back the US Dollar against cyclical currencies. Reserve currencies, like the EUR and JPY, may also come under negative pressure against the US Dollar, but are expected to remain more resilient.
In Asia, the pattern of near-term consolidation and US Dollar strength further out is also expected to play out. The ability of the CFETS RMB Index to track broad US Dollar movement in March should provide an anchor of stability to Asian currencies, and ward off outsized moves in the USD-Asia pairs on either side.
Fundamentally, Asian currencies continue to face downside pressure on unprecedented portfolio outflows. South Asian currencies are particularly vulnerable, with heavy outflows both on the bond and equity fronts.
On the growth front, Thailand and Singapore have forecast contraction for their economies. The scale of the growth downgrade is large and will set the tone for the rest of the Asian economies. This should also weigh heavily on Asian currencies in the structural horizon.
With the environment negative for Asian currencies, we expect the USD/SGD to search higher on a multi-week horizon. However, despite the easing actions by the Monetary Authority of Singapore, the message of stable monetary policy also came across strongly. We think this will ward off excessive upside expectations for the USD/SGD for now.
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Warga Negara Indonesia, 56 tahun
Domisili: Jakarta, Indonesia
Presiden Komisaris Bank OCBC NISP sejak 16 Desember 2008.
1987–1989: Executive Trainee Daiwa Bank (sekarang Resona Bank) New York, London dan Tokyo.
1989-1997: Direktur Bank NISP
1997–2000: Komisaris Bank OCBC Indonesia.
1997–2008: Presiden Direktur Bank NISP.
2005–sekarang: Non-executive and Non-independent Director OCBC Bank Singapura
Saat ini menjabat berbagai posisi senior di asosiasi bisnis, universitas dan badan sosial pendidikan.
Mengikuti Program di berbagai universitas terkemuka, SESPIBI XVI (Sekolah Staff Pimpinan Bank Indonesia), dan program beasiswa bidang International Relations di International University of Japan, Jepang. Memperoleh gelar MBA di bidang Perbankan dari Golden Gate University, USA (1987) dan Bachelor di bidang Perbankan dan Keuangan dari San Francisco State University, USA (1985).
Best CEO Award 2004 – Majalah SWA.
Best CEO Award 2006 – Majalah Business Review.
Most Prominent banker Award 2006 – Majalah Investor.
Outstanding Entrepreneur Awards 2008 – Asia Pasific Entrepreneurship.
Penunjukan pertama kali: 2008.
Penunjukan kembali: 2011, 2014 dan 2017.