Our 2022 outlook piece at the beginning of the year was titled “Road Bumps Ahead” and markets have corrected since. Our view is that there is more volatility ahead for global equities as global recessionary risks are rising in 2023. On the other hand, we are more positive on Chinese equities. Economic growth in China has indeed slowed from lockdowns to maintain zero Covid-19 but we expect significant policy supports later this year to defend the 5.5% GDP growth target for 2022.
Figure 1: MSCI Indices Percentage Returns in USD (%)
Note: ACWI – All Country World Index, 2022* as at 2 June 2022
Source: Bloomberg, 2 June 2022
INFLATION VERSUS GROWTH
1. Equities and bond markets globally continued to sell off into the second quarter of the year and equities are lower across most major economies (see Figure 1 above). The main worry was whether central banks needed to continue to tighten further to weaken demand to combat inflation. The change in priority at the US Federal Reserve, for example, to focus on fighting inflation has raised the odds of a recession in the US and globally in 2023.
2. The recent correction (13.8% decline from January till the end of April of 2022) in the US equities market was from multiple compression as consensus earnings growth expectations remain positive for 2022 and 2023 and investors are anxious to buy the dip as valuations are now more attractive compared to historical mean. (See Figure 4 for current valuations of the major markets compared to historical mean.)
Figure 2: Real Gross Domestic Production (GDP)
Note: F – Consensus Forecast, Source: Bloomberg 2 June 2022, *Consensus Forecast at 28 December 2021, **Consensus Forecast at 2 June 2022
3. We think the current sell-off, at least in the US, has not adequately reflected weaker economic growth outlook ahead as earnings growth has yet to be revised lower. We are already seeing global GDP estimates being revised lower and the drop in the Purchasing Managers’ Index (PMI) in many economies suggest that economic activities could slow further. Cost structures of many companies are also higher than pre-Covid-19 levels and a decline in revenues could quickly lead to deterioration in margins and earnings.
4. Markets with central banks focused on dampening demand to rein in inflation would face significant headwinds and we are negative on such markets like the US and European equities. There are also certain parts of Asia facing hawkish policies, like Korea, which has been hiking interest rates aggressively.
GOODBYE TINA AND GROWTH TO VALUE STOCKS
5. On a bigger picture, the investment climate for the last decade had been one of low economic growth with stubbornly low inflation which allowed central banks to continuously cut interest rates. This environment was particularly favorable for valuations of growth stocks due to lower discount rates used for future earnings. Low yields offered by bonds also drove investors towards equities, as “there is no alternatives” (TINA), thus driving equities valuations higher.
6. The investment climate may have changed since the onset of Covid-19 as baseline inflation could now be significantly higher than that in the past decade and central banks are also now forced to hike interest rates to combat higher inflation. This would be a headwind for valuations of growth stocks, especially for profitless or early stage companies, with potential earnings only in the far future. Value stocks, like financials and commodity plays, would be preferred in this investment climate.
7. The direction of US government bond yields affect prices of bonds globally. We are of the view that the US 10-year yield would move marginally higher into 2023. This is due to mixed factors affect US government bond yields like interest rate hikes, reduction in the Federal Reserve’s balance sheet, lower US government’s financing needs and higher recessionary risks in 2023.
CHINA COMMITED TO ITS ECONOMIC GROWTH TARGETS
8. The Chinese economy slowed significantly with the widespread lockdowns across China as they continue to pursue a zero-Covid-19 policy. Industrial production declined by 2.9% year-on-year in April and unemployment rate in 31 major cities rose to 6.7% in April. Property sales also remained weak with sales value declining by 47% year-on-year in April. This contrasts starkly with the positive economic data coming out from the US. The MSCI China index declined 17.7% this year ending 29 April 2022, reflecting the weaker economic data from China.
9. However, we remain positive on Chinese equities provided that the Chinese government remains committed to delivering “economic stability” in 2022. The Chinese market tends to do well in years when the national agenda is to support growth and badly for years targeting tightening. (See Figure 3 below). It is reasonable to believe that the Chinese government would do what it takes to contain Covid-19 infections and stabilize the economy (with policy supports) before the important Communist Party Congress scheduled in November. We expect China to reopen after raising the vaccination rates of the elderly and vulnerable and more policy supports to follow after that.
10. The 33 comprehensive measures announced by the Chinese State Council included support for small companies, infrastructure investment, investment and consumption. There could be more measures if economic growth continues to slow further. We expect investor sentiments towards Chinese equities to drastically improve with this combination of supportive policies and reopening later this year.
Figure 3: Keywords / Phrases used during Central Economic Work Conference
Source: Lion Global Investors, December 2021
11. Current valuations (see Figure 4) are attractive relative to historical averages and the bearish sentiments allows for a rebound on positive news. However, as explained above, earnings could be revised lower as economic growth slows. Markets with hawkish central banks like the US, Europe and parts of Asia like Korea would face headwinds.
12. Certain Asian markets which are commodity exporters like Indonesia and Australia would see tailwind on potential earnings upgrades. We are also positive on the Singapore equities market on the reopening theme and for having a value bias. We are positive on Japan equities as exporters there benefits from historically weaker Japanese Yen. We are very positive on Chinese equities on reopening and policy supports later this year.
Figure 4: Consensus earnings forecast strong for this year and next
Source: Thomson Reuters, 20 May 2022, Note: F – Consensus Forecast, x – excluding, P/E – Price to Earnings
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