The Federal Reserve became more hawkish during the September FOMC meeting as it signaled a faster pace of interest rate hike which would stay higher for longer. Similarly, central banks globally also followed by raising interest rates which would be negative for risk assets. There are however still selective investment opportunities like China, Japan and Singapore equities. The Japanese Yen has weakened to levels not seen since the 1990s, which makes Japan very competitive. We are positive on Singapore equities as Singapore emerges from Covid as the preferred financial hub in Asia. China equities lack short term catalysts, but are good long term investment opportunities, as the twin headwinds of zero-Covid policy and property slump would eventually be resolved.
Figure 1: S&P500 Index and MSCI ACWI Index
Source: Reuters 26 September 2022, Note: ACWI – All Country World Index
CENTRAL BANKS ARE HAWKISH WHICH IS BAD FOR RISK ASSETS
1.The US equities market (and global equities) rallied from the middle of June of this year on expectations that the Federal Reserve (Fed) would pivot to a more dovish monetary stance on peaking inflationary pressures. See figure 1 above. This optimism evaporated with the release of the August US Consumer Price Index (CPI). August US headline CPI rose 8.3% year-on-year and was higher than consensus expectations of 8.1%. Core CPI inflation, which excluded the volatile food and energy components, also rose to 6.2% from 5.9% year-on-year in the previous month.
2. The Federal Open Market Committee (FOMC) showed its resolve to combat inflation by raising the targeted federal funds rate by 75 basis points (bps) at the latest meeting on 21st September. And the Fed’s median dot plot of another 125 bps of rate hike for the remainder of 2022 and another 25 bps in 2023 was more hawkish than in the previous meeting.
3. It was clear from the September FOMC meeting that the Fed wanted to slow the economy further and that they would even allow unemployment rate to rise to 4.4% in 2023. This increases the risk of a recession in the US over the next 12 months, implying a need for earnings estimates in 2023 to be revised lower. This would be a headwind for US equities (and global equities given the correlation) unless inflation slows significantly over the next few months.
4. Many countries globally followed the US in raising interest rates and 17 central banks raised rates in the same week as the US in September. We expect global economic growth to slow further as central banks globally continue to tighten. The latest leading economic indicators like the September Eurozone and UK flash composite Purchasing Managers’ Indexes (PMIs) have deteriorated, pointing to weaker economic activities ahead. The risk of a global recession over the next 12 months has increased which would be a headwind for Asian equities too.
RISK OF GLOBAL RECESSION HAS ALSO RISEN
Figure 2: Dividend Yields minus Bond Yields for various markets
Source: Reuters 21 September 2022,
Note: DY – Dividend Yield, BY – 10-year Government Bond Yield for respective region
5. Bond yields have risen with interest rates and the US 10-year treasury yield reached 4%, a level not seen since 2010. The relative attractiveness of stocks (see figure 2 above) are at its lowest levels in a decade compared to bonds in the US and Europe. Our view is that bond yields are near peaking and that government bonds are relatively attractive compared to equities, which could be vulnerable to further volatility in the near term.
CHINA EQUITIES DEPRESSED AND READY TO REBOUND
6. China equities has languished on the twin headwinds of zero-Covid policy and a property slump.
7. We are of the view that China would start easing on their zero-Covid policy when they reach the necessary vaccination rate for their elderly population (aged above 60 years old). Studies have shown that Chinese vaccines with a booster shot, have almost identical efficacy to Western mRNA vaccines. As such, the only impediment to a reopening is vaccination rates and it is only a matter of time before China eases on their zero-Covid policy.
8. A recovery in the Chinese property market is also a necessary condition for Chinese economy to recover as it is of systemic importance. According to estimates by UBS dated September 2022, China’s property sector accounts for around 25% of China’s GDP, over 50% of household wealth and a third of the local government revenue. Despite two rounds of stimulus including lending rate cuts and RMB200bn of special loan quota for housing delivery in August, housing data is still weak with new home sales falling 23% year-on-year and new starts plunging 46% year-on-year in August. Given the importance of the property market, we expect Chinese policy makers to introduce new rounds of supporting policies if the property market does not show signs of recovery.
9. China equities could face short term volatility if new waves of Covid infections lead to more lockdowns across China. But China equities are attractive in the long term as valuations are depressed and the market could rally with the eventual exiting of the zero-Covid policy and stabilisation of the Chinese property sector.
JAPAN EQUITIES BENEFITS FROM HISTORICALLY WEAK YEN
Figure 3: Nikkei225 Index and Japanese Yen
Source: Reuters 26 September 2022
10. The Japanese Yen has weakened significantly this year to levels not seen since the 1990s and we expect the Yen to weaken further as long as the Bank of Japan (BoJ) continues with its yield curve control (YCC) policy. We expect the BoJ to maintain this policy till they are confident that long-term inflation stays above 2%, which may not happen in the foreseeable future. As such, our base case would be for the Yen to weaken further though we could see short periods of Yen strength from currency interventions.
11. Japan equities get a tailwind on Yen weakness. See figure 3 above. And Japanese companies could also upgrade their earnings guidance over the next few months as existing currency hedges roll over. A weak Yen would also be a major boost to tourism when Japan finally reopens to tourists in October. We are positive on Japan equities but remind investors to hedge their currency exposure.
SINGAPORE AS A QUALITY AND DEFENSIVE PLAY
12. Singapore is a small open economy vulnerable to a slowdown in the global economy. However, the Singapore economy has also become more resilient post-Covid as Singapore is now the preferred financial hub in Asia. This is reflected in the record number of family offices setting up in Singapore. Funds searching for a safe-haven are flowing into Singapore and this could offset the negative drag from a slowing global economy. Singapore equities could be considered defensive during times of volatility.
CONCLUSION
13. Current valuations (see figure 4 below) 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 would face headwinds. We have however highlighted three investment opportunities above with i) Japan equities currently enjoying the catalyst of a weak Yen, ii) China equities as a long term investment opportunity due to attractive valuations and iii) Singapore equities as a defensive play.
Figure 4: Consensus earnings forecast strong for this year and next
Source: Thomson Reuters, 23 Sep 2022,
Note: F – Consensus Forecast, x – excluding, P/E – Price to Earnings
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