Ask CIO: Investors’ burning questions answered

Here are our responses to the questions fielded
Chief Investment Office23 Oct 2020
Photo credit: AFP Photo

The following were questions received in the Q&A session of our recent 4Q20 Market Outlook webinar – On the Mend. Due to time constraint in the webinar, we were not able to address all the questions. Here are our responses to the questions fielded.

1.      US Tech sector stocks are trading at high PEG growth. Are you expecting the valuation to correct vs Value stocks? What is your assessment of Value vs Growth stocks?

Value investing is a strategy that is premised on the idea that the valuation for risk assets will eventually mean revert after sustained period of underperformance. But since the Subprime Crisis, it is evident that this strategy has not worked out for investors. In the age of global bifurcation, many traditional industries are increasingly disrupted by technology companies, and this disruption wave will not end anytime soon. The overall scarcity of growth globally will mean that investors will continue to allocate funds to Growth sectors as opposed to Value plays.

2.      Assuming the estimated arrival of vaccine either end of this year or early next year, what is your opinion on market recovery path?

Should a vaccine transpire end of this year or early next, it will provide an uplift for risk assets in general. One could assume that the biggest “victims” of this pandemic will conversely be the largest beneficiaries of a vaccine.

Industries that enquire face-to-face interactions, such as those in the hotel and leisure industries, were hard hit during the pandemic as safe distancing rules kicked in. This segment is poised for a rebound in the event of a vaccine discovery. After all, global tourism is a long-term secular trend and it is only a matter of time before people start travelling again.

3.        What is the outlook on China banks equities? Are they still good dividend investments?

China banks fit into the Income side of CIO’s Barbell Strategy, as they provide annual dividend yields of 5.5-6.0%. The relatively low payout ratio of 30% is likely to sustain the dividend distribution. China large banks should benefit from the post-COVID recovery in domestic economy.

4.        What would the impact be on China stocks if Trump wins, or conversely, if Biden wins?

Our China sector and theme in the Barbell Strategy focus mainly on domestic demand, including e-Commerce, e-Sports, and insurance. These sectors fit well in the Growth side of the Barbell, tend to have lower correlations to the external environment, and the long-term share price performances are expected to stay independent of the outcome of the US elections.

5.        What is the state of China’s economy?

China was among the first to show success in containing the virus and reopen its economy, spurring domestic consumption. The service sectors accounted for 54% of total gross domestic product (GDP) mix and will play an important role in driving the direction going forward. Retail sales recorded positive year-on-year growth in August and September, showing the resilience of domestic consumption. Notably, 2Q and 3Q GDP recorded a year-on-year growth of 3.2% and 4.9%, respectively, a clear sign of improvement after the decline in 1Q this year.

6.        China was among the first to jumpstart the economy post COVID-19, GDP has shown encouraging recovery. What can clients invest in to participate?

The main sectors that will benefit from this recovery and pent-up spending propensities will be businesses serving local consumers demand. These include e-Commerce ecosystems, New Economy sectors, large banks, insurance companies, construction services, technology components, and manufacturing. We are also constructive on discretionary luxury goods, leisure activities, and consumer services as travel restrictions, quarantine rules, the absence of accessible international travel, and the persistent large number of COVID-19 cases globally are directing China’s mammoth consumer population to spend at home instead. We maintain our conviction on China equities as they derive the majority of their revenue and earnings from domestic operations.

7.     What are your views on oil and integrated oil majors in 2021?

We believe the oil price has reached a floor of USD40.00/barrel and should gradually recover in 2021. The International Energy Agency has noted that oil demand has returned to 94% of pre-crisis level and has projected demand to rise 6% next year. Although this is still not quite back to 2019’s level, economic activities should gradually pick up and a vaccine discovery will quicken the process. On the supply side, the number of oil rigs have fallen and the Organization of the Petroleum Exporting Countries+ is expected to stick to its scheduled production cut till 2022. Moreover USD40.00 is close to production price of shale oil and should discourage its output. All these factors should protect the downside for oil price. We forecast Brent oil to trade around USD45.00-50.00 next year.

In line with our expectations that oil price should gradually recover as the global economy rebounds from 2020’s low, we believe the risk-reward for the Europe oil majors is favourable. Oil price is a strong vaccine discovery play. Should a vaccine transpire in the coming months, it will provide an uplift for risk assets in general, including oil and energy stocks, as confidence in a global recovery starts to pick up.

Despite the cuts in dividends, Europe oil majors are still one of the sectors with the highest dividend yields and is too attractive to be ignored when compared to Eurozone bond yields, which had fallen further to -0.6%. An acceleration in restructuring plans by way of cost cutting, deleveraging, asset sales, or M&A activities should see stronger balance sheets for these companies going forward and the ability to add returns-accretive projects through the cycle. Longer term, the Europe oil majors’ shift to lower carbon emission targets and renewable energy platforms should place them in a sustainable growth path.

8.     I understand you have been positive on Singapore REITs and they have performed very well. What are the catalysts to invest in Singapore REITs?

Investors can look for the following catalysts in Singapore REITs (S-REITS):

a)      Economic recovery and vaccine discovery

As S-REITS have priced in a high degree of economic recession, as reflected in dividend cuts, a gradual pick up in the economy would imply a return of dividends and thus, they would re-rate. We expect Singapore’s GDP growth to record -6.5% in 2020 before rebounding 5.5% next year. 

The recovery will be uneven across the sub-industries which we expect retail and office REITs to recover first before hospitality REITs, while Industrials REITs are almost unaffected by the recession. Having said that, hospitality REITs are the worst hit due to the fallout in tourism and thus, should react positively to a vaccine find.

b)      Sector bifurcation benefiting the Industrials REITs

Sector bifurcation can also be seen among the S-REITs where Industrial REITs are benefiting from the accelerated digitalisation trend brought about by the pandemic. Furthermore, many international companies are setting up regional centres in Singapore as part of their China+ strategy, giving a boost to logistics spaces and data centres. We continue to see demand for industrial space rising next year.

c)       Acquisitions and restructuring

REIT managers are also making use of the crisis and a low interest rate environment to restructure and acquire properties to improve yields and reduce costs. We should see many acquisitions or asset injection from the sponsors.

9.        How do you position in credit? Long or short duration?

With recovery expectations in play, along with the new “flexible average inflation targeting” approach adopted by the US Federal Reserve, the most likely shift in the US Treasury curve is a bear steepening as the market builds expectations of upward global growth and inflation trajectories in the long-end. Indeed, such a move was observed through much of 3Q20. Correspondingly, long duration Investment Grade (IG) credit is likely to see demand weakness with this backdrop of low absolute yields; a risk that we had highlighted previously. In this regard, we think that investors are better rewarded with additional yield by taking credit risk (via shorter duration, High Yield credit) than extending duration in IG while the recovery remains intact.

10.  Gold has done well after your recommendations. How important is gold in an investment strategy?

Gold acts as a risk diversifier in our Barbell Strategy. Its uncorrelated relationship with equities and bonds helps lower portfolio volatility. In addition, gold has no credit risk and has low volatility.  These factors can help improve the risk-return characteristics of a portfolio.

Investment demand for gold is rising as interest rates are almost zero, even negative in some countries. There is thus no opportunity cost of investing in gold. Central banks are also looking to diversify their reserves into gold as unrelentless money printing questions the value of fiat currencies while the amount of negative debt builds up, pushing central banks to look into alternatives.

11.  Gold and silver have taken a beating over the past month. Is it just consolidation? Any further consolidation before resuming the uptrend?

Our proprietary gold pricing model suggests that gold price is sensitive to the US Dollar Index (DXY) and interest rates. DXY has strengthened in the past month after weakening to 92 in the prior six months. We view that DXY is consolidating currently, as uncertainties over the US elections is driving safe-haven flows to the dollar. We expect the dollar to resume its weakening trend next year when global recovery gains traction, risk assets become well bid, and dollar safe-haven trades are unwound.

As far as interest rates are concerned, we expect them to stay low. The current ascent of yields should stop at 0.9% this year, and 1.35% next year. With rising inflation (and hence rising yields), negative real rates should enhance the appeal of gold.

We thus believe it is a good time to accumulate gold and silver for more upside next year.

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