From left to right: OCBC economist Howie Lee, CEO of TD Ameritrade Singapore Chris Brankin, Head of economics and strategy at Mizuho Bank Vishnu Varathan
SINGAPORE (Oct 28): In the Michael Lewis book The Big Short, the central character, hedge fund manager Dr Michael Burry faced the ire of his investors for shorting the US housing market. Dr Burry, confident that his bet was correct, stuck to his guns and came under severe stress for the two years he made this bet. He won, eventually, as the US subprime housing market imploded, igniting the 2008 global financial crisis.
Yet, it was a close call. Oversea-Chinese Banking Corp economist Howie Lee wants to remind investors that not everyone can prevail, even with the right call. He quotes a by-now-famous saying among traders, reportedly first uttered by economist John Maynard Keynes: “The markets can remain irrational longer than you can remain solvent” — and Dr Burry nearly did not prevail.
Lee is not so upbeat about what is happening in the markets now. No thanks to the decade-long quantitative easing programme launched by the US to save its economy, yields have been trending down as central banks echo one another. Both investment-grade and high-risk bonds alike are affected. “People have no choice but to go over to equities and take on higher risks as they continue yield-hunting,” says Lee, who was speaking at the US Markets Investment Forum organised by The Edge Singapore and held on Oct 19.
That trend, coupled with a higher probability of a US recession in 2020, means Lee’s stance is now cautious. As investors root around looking for places to park their money, the list of viable investments is short, which, ironically, will nudge them into the US markets, simply because there is hardly anywhere else to go.
“The only question now is, how have these indices risen? Are they creating organic growth? There are a few cases of those. But, are they doing share buybacks? Are they having higher earnings because of the divestment of assets? Or are they simply laying off workers to boost the bottom line? Even if you are optimistic about the markets, just be very cautious in the next one, two years ahead. Remember to hedge your bets,” says Lee.
US telco and oil
Yet, even as many investors start to dial down their expectations, there are still stocks offering decent returns. Chris Brankin, CEO of TD Ameritrade Singapore, notes that the valuation for US markets seems “relatively sensible” now, with a fiveyear average price-to-earnings ratio of 16.6 times. He will be looking out for new drivers pushing US markets higher. Today, with negative yield investments becoming more common in Europe and Japan, money managers will not want to put their money there. The US is an easy choice. “There’s relative value, and still some relative upside,” says Brankin, speaking at the same forum.
For example, Brankin says, major US tele communications companies are “unbelievably” strong in terms of their yields. Verizon gives around 3% and AT&T’s is higher at 4%. He also sees relative value in what he calls the “wild card” sector of US markets right now: energy. Since the beginning of the year, the West Texas Intermediate crude — the benchmark for US oil prices — has gained about 20%. Yet, US oil majors such as Exxon and Chevron did not appreciate anywhere as much as the oil markets had. Yet, they are giving emerging market-level dividends of more than 4%, says Brankin.
Likewise, downstream plays in the US oil sector such as blue chips Halliburton and Schlumberger are trading at levels that give yields of 4% to 5%. “So, either you think oil is going to come back down or, at some point, some of these oil majors will catch up,” he says.
Inflammatory, yet loved
Under US President Donald Trump, US politics and economics have become more intertwined than ever. Trump famously ignited the trade war with China and has been picking fights with many other countries. Worries over a US recession seem to have faded somewhat into the background.
Brankin agrees that many people outside the US might see Trump as an inflammatory character, but he has his domestic appeal. “The Midwest loves that guy. They feel stable about their jobs, they have more money in their pockets. We see a lot of consumer strength, and I don’t think a looming recession is around the corner,” he says.
“People in the US are a lot more positive than what you see in the media, much like what you see happening in Hong Kong and China. Don’t always believe the headline news. Sensationalism sells, while boring ‘people are happy’ things don’t sell as well.”
OCBC’s Lee points out that recessions tend to blindside the market. For now, the traditional drivers of a recession — such as runaway inflation, overheated asset bubbles and runaway credit cycles — have yet to show up. “Those are actually quite lacklustre and, for that reason, we still see continued strength in the US consumer sector,” says Lee.
In any case, the US Federal Reserve’s estimates for a US recession in 2020 should not be ignored: The probability is 30% to 40% — the highest level since 2008. “This rings some alarm bells, that’s for sure,” says Lee.
L-, U- or V-shaped recovery?
Vishnu Varathan, head of economics and strategy at Mizuho Bank and a panellist at the forum, notes that it has become more difficult to predict economic cycles, as geopolitics and economics have become so entangled.
With geopolitics a bigger wild card today than before, there is plenty to worry about — and less that can be calculated. Varathan says: “They tell you, all’s fair in love and war. If you change the spelling to ‘L-U-V’ instead, then the question is, with the war going on, in what metaphorical sense do you want your recovery? L-, Uor V-shaped? I don’t know. My sense is that V looks very unlikely, U looks like an optimistic scenario and L looks like one scenario we cannot discount. And that’s my bigger concern, that we don’t come out of this stagnation.”
The International Monetary Fund has recently said it expects most Asian economies to bottom out this year and grow a little bit in 2020. Varathan does not share this optimistic outlook. “There’s very, very little certainty about that. It could very well be that it is prolonged, and then you get the recovery coming back in 2021 instead,” he says.
Varathan has done some modelling on the impact of the US tariffs. Based on the tariffs implemented so far — excluding the new ones that the US has threatened to place — the negative impact on exports to the US is going to be the sharpest only in the middle of next year. “There’s a high correlation between negative impact on Chinese exports and Asian exports. So, Asian exports are going to be hardest hit going into 2020,” he warns.
He notes that many other market commentators have been telling this “sexy story” of how infrastructure spending and consumption in Asia will help offset possible drops in exports, but he begs to differ. “If you are to plot nominal GDP against exports for all of Asia, you can’t tell one line from the other. Exports drive Asia’s economies,” he says.
Can fiscal policy help?
If the dire predictions are indeed coming true, can Asian economies extricate themselves in time? Do central banks and governments have the “levers” to do so?
According to Varathan, some have them more than others. As Lee also pointed out, massive quantitative easing measures have been put in place. So, even if there is more to spend, liquidity traps might be formed.
“You don’t know whether you will [gain] any benefit. So, the question now is, can fiscal policy do enough? In many parts of Asia, fiscal positions are stretched, the ability to spend entails a huge compromise. Either you see a currency stand-off, because markets grow concerned about debt level and fiscal deficits, or you get the government taking money from elsewhere,” says Varathan.
While, technically, there are levers at the disposal of central bankers, they may not be as well oiled and therefore as effective as they were meant to be, warns Varathan.
“Sometimes, you can spend the fiscal money but, for it to hit the ground, it is a different thing. Economists here worry about leakage. Whatever you spend stays; it doesn’t get recycled into the economy. Whatever stimulus, whatever you do, depends very much on the multiplier effect. If I put money in your pocket, I trust you will go out and spend, and put the money in someone else’s pocket, so on and so forth,” says Varathan.
“In the current situation, however, confidence is low, you don’t get the multiplier effect — no one really spends, businesses are holding back, especially on large expenditure, capital expenditure and so on, and that impedes the ability to recover. The lever is there, but I’m not sure whether every part of the mechanism is well oiled, and that’s my problem.”
The positive among the negative
Despite the gloom and uncertainty, there are still some positive notes. Brankin thinks the markets have started to price in progress in the Brexit negotiations. Similarly, the US and China are seen to be establishing a framework on which progress can be made in resolving their trade war, which has gone on for more than a year. “If we get some clarity around that, I do truly believe we could see the next leg higher in the markets,” says Brankin.
Varathan believes that none of the global powers are eager to dive into any form of conflict. If a conflict does occur, it would have to be an accident or a miscalculation.
Lee, who previously worked at the Mone tary Authority of Singapore, says governments and central banks have been more responsive in their policy shifts, “engineering soft landings more quickly than before, for better or for worse”.
For these reasons, he does not expect a sharp slowdown like the one in 2008. “The real difficulty is, after giving out all these stimuli, fiscal and monetary, how do you retract them in the next couple of years to rebalance the excesses we’ve been giving out in this downturn?”
