Headed into 2023, markets were rattled over global recessionary concerns. When February 2023 approached, the focus shifted to overheating and stickier-than-expected inflation. Just three weeks ago, a series of regional bank failures and takeover of Credit Suisse by UBS have had investors on edge regarding credit crunch fears and stress in the banking system. With new headwinds to growth, concerns of a steeper slowdown in global economy have resurfaced once again. We saw widening of credit spreads, rising in funding costs, ballooning of money market funds, and a rally in gold (an asset class that is commonly perceived as a recessionary hedge). In the United States (US), regulators have swiftly rolled out measures to address potential liquidity pressures in the banking sector and to restore investors’ confidence.
Central bankers are now caught between a rock and a hard place, with powerful drags and lifts between the narratives of growth and inflation, rates hiking and credit tightening. Despite the heightened market uncertainty, both the US Federal Reserve and European Central Banks raised rates by 25 basis points and 50 basis points respectively as part of ongoing efforts to bring down inflation. While downside risks have increased for the developed markets, China looks decoupled from this turmoil. Recent policy signals from the National People’s Congress (NPC) meetings are constructive with policymakers reiterating their stance to maintain medium-to-long term sustainable growth. We remain most positive on China equities which have relatively better fundamentals while still trading at attractive valuations.
BANK FAILURES LEADING TO FURTHER CREDIT TIGHTENING IN US AND EUROPE
1. The quick and decisive actions of the financial regulators in the US averted the risk of a banking crisis after the collapse of Silicon Valley Bank (SVB) and Signature Bank in early March. The implicit guarantee by the Federal Deposit Insurance Corporation (FDIC) on uninsured deposits played a role in restoring confidence and stemming further bank runs. In addition, the announcement of a new bank funding scheme helped improve liquidity at banks. We are of the view that the risk of a systemic failure in the US banking sector is low.
2. The collapse of the SVB and Signature Bank led investors to naturally wonder which could be the next shoe to drop. With a magnifying glass put on all global banks, the focus turned to Credit Suisse in Europe, with the Swiss government brokering the takeover by UBS within a short span of time. That said, the problems at Credit Suisse were not directly connected nor related to the problems in the aforementioned US banks; rather, they were on the back of a series of mismanagement in recent years and the bank suffered nearly US$8 billion of losses in 2022. The failure of Credit Suisse is therefore due to unique issues at the bank and not representative of broader issues with the financial sector in Europe.
3. Could this be the next financial crisis after 2008? We do not think so. We are of the view that the nature of the challenges today is fundamentally different (credit losses then versus duration losses now). Regulators have also built a more robust financial system and there is a clearer policy roadmap to contain contagion. While there remain tail risks, they are unlikely to be to the tune of those during 2008-09 meltdown.
4. The impact of the bank failures on the economy would likely be through tighter bank lending standards as banks become more cautious in an environment of higher funding costs. This is likely to weigh on economic growth, though the magnitude and longevity of the drag is uncertain at this point. With that said, the risk of a recession in 2H2023 for both the US and Europe has increased as compared to the beginning of the year. Consensus earnings numbers for developed markets have also come down, as growth concerns take the driving seat.
PREFER HIGH QUALITY,SHORT DURATION BONDS
5. Before the banking turmoil, central banks were battling the balance of elevated inflation against financial stability and growth. In spite of the events, as mentioned earlier, both the Federal Reserve (Fed) and European Central Banks (ECB) continued to raise rates by 25 basis points and 50 basis points respectively. The Fed’s projections for the federal funds rate implied a 25 basis points hike for the rest of 2023 and a 200 basis points rate cut for 2024 and 2025 combined.
6. Macro concerns and poor liquidity conditions have led to a spike in volatility in bond yields. With confidence fragile and uncertainty abound, we stay defensive in terms of positioning. Therefore, despite nearing the end of the interest rate hiking cycle, we prefer shorter duration, higher quality (investment grade) bonds given decent yields and resilience should we enter a recession.
CHINA’S COUNTER TREND GROWTH
7. The important annual China’s National People’s Congress (NPC) ended on 13th March with policies focused on achieving quality growth, targeting a Gross Domestic Product (GDP) growth of “around 5%”, and reinforcing the importance of consumption recovery, technology innovation and national security. With broad policies in place since November 2022, the turning point to watch out for now is a meaningful shift in investors’ sentiment and positioning as economic recovery gains traction.
8. Recent data suggests that things are starting to turn around in the all-important property and consumption sectors. Property sales by volume in February recovered above pre-Covid levels in 2019, while property completions turned positive year-on-year in January and February from a contraction in December. This is an indication that policy support to complete unfinished property projects is bearing fruit. February retail sales also saw positive year-on-year growth as compared to a decline in 4Q2022 and in January 2023.
9. Geopolitics is a long-term risk factor to bear in mind. The recent banking turmoil in the US and Europe has little direct impact on the Chinese financial system and the growth differential clearly puts China equities at an advantage on a risk-reward basis. Valuations are also undemanding with China equities trading at 10 times 2023 consensus Price-to-Earnings (PE) Ratio and consensus earnings per share (EPS) growth of 14%. As such, we are positive on China equities.
ASIA IS RELATIVELY DEFENSIVE
10. Asian banks are unlikely to be impacted by the banking turmoil in the US or Europe as Asian banks are well capitalized and have little exposure to the affected financial institutions. However, the incremental economic slowdown at the developed markets could have a greater impact on Singapore, Vietnam, Korea, Malaysia, and Taiwan.
11. Despite Singapore’s sensitivity to global growth due to its export-orientated nature, we are moderately positive on Singapore equities due to its defensive characteristics and attractive valuations.
12. We are also moderately positive on Japan equities on attractive valuations and resilient earnings from a weak Yen. However, the conviction is much lower compared to a quarter ago as the Bank of Japan (BoJ) may turn more restrictive in April 2023 under new governor Ueda.
The events over 1Q2023 have shown us how quickly tides can turn. The consequences of monetary tightening over the past year are now upon us, and more fault lines can appear as everything, everywhere, all at once. The recent banking turmoil is likely to induce further credit tightening, increasing the odds of a hard landing scenario. History has taught us not to time the market – against the volatile macro backdrop, investors should stay defensive and diversified, while considering their risk appetite and time horizon.
Figure 1: Valuation and consensus earnings forecast
Source: Thomson Reuters, 24 March 2023, Note: F – Consensus Forecast, x – excluding, P/E – Price to Earnings
All data are sourced from Lion Global Investors and Bloomberg as at 24 March 2023 unless otherwise stated.
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