For the better part of the past decade, globally, economic growth and challenges were more or less in sync. All countries, by and large, benefited from globalisation, in terms of relative free flow of trade, capital and technological innovation, which drove down prices for goods and services. Inflation was modest or in decline, liquidity was more than ample — thanks to extreme monetary policies by major central banks — and interest rates were in a multi-year broad downtrend.
Aside from the effects of globalisation, we discussed some of the other key factors behind falling inflation last week. Capital investments were in decline across the developed world, due in part to excess capacity and less capital-intensive requirements for tech investments. The trends of slowing population growth and ageing population were observed across both developed and developing countries, including China. Rapid technological advancements and rising income-wealth inequality are also disinflationary.
Even the impact from, and initial responses to, the Covid-19 pandemic were largely similar around the world, in terms of restrictive movements, work from home, fiscal and monetary policies — the socialisation of private debts, near-zero interest rates and QE (quantitative easing) — as well as vaccine rollouts.
Liquidity and cheap money underpinned a massive global rally in bonds and stocks. Excessive liquidity-fuelled speculative activities, creating bubbles in pockets of assets — for instance, in driving up valuations for non-profitable, cash-burn companies, justified on unsustainable price-to-sales multiples. It bred a generation of Robinhood traders who gamified investing, pushing up prices for meme stocks with little underlying fundamentals and cryptocurrencies of no practical, real world utility — simply because it was fun.
In some sense, this is understandable. When money is cheap (near-zero interest cost) or free (pandemic cash handouts by the government), there is very little cost to excessive risk-taking and failure. Liquidity was driving the broad market rally and a rising tide lifts all boats. For many of these traders, “investing is easy” because “stocks always go up”. But this, we think, is no longer the case.
Some of the most powerful secular trends may be stalling or reversing, at least for the foreseeable future. Global inflation has reversed sharply higher — inflation in the US is now at a 40-year high — and bond yields have mirrored this rise, precipitating the worst rout in the bond market since the early 1980s. Central banks are under pressure to tighten monetary policies and withdraw liquidity with inflationary pressures expected to mount (see Chart 1).
The world is moving out of sync
The global investing landscape has changed very quickly. Temporary supply disruptions due to pandemic lockdowns are turning out to be more long-drawn-out than expected, and made worse by the Russia-Ukraine war. Commodity prices have surged, feeding into across-the-board price escalations.
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The thing is, while the fallout from the war and high commodity prices will impact every country and household, it will be to different degrees. For instance, Europe, which is highly dependent on Russian energy, will be more affected than the US. As a result, we have seen huge outflows of funds from European stock markets and inflows into the US since the invasion. (Refer to our article, “Does anyone gain from the Russian-Ukrainian war?” last week).
Economies that are big importers of oil and gas will be hurt more while commodity exporting economies will be net gainers. Poorer emerging countries will be the most severely impacted by rising food costs, hurting domestic consumption and further delaying their economic recoveries from the pandemic.
Additionally, the speed of reopening also differs, depending on the pace of vaccination rollouts and strategy of choice. In particular, China’s economic growth is expected to slow from previous estimates — the country has steadfastly maintained a zero-Covid strategy that has led to stringent movement restrictions including a lengthy, near-complete lockdown in the country’s most populous city and major economic-financial hub, Shanghai.
All these translate into differences in economic growth prospects across countries. In other words, GDP growth is now far less likely to move in lockstep, as it had in the past few years. As a result, fiscal and monetary policies are also starting to diverge.
Case in point, the post-pandemic economic recovery in the developed world is moving far ahead of most emerging countries, thanks to faster vaccination rollouts and reopening as well as massive fiscal aid packages. Jobs recovery has been exceptionally strong. For instance, unemployment rates in the US, UK and Germany have fallen well below levels from a year ago and indeed, lower than pre-pandemic levels. By comparison, unemployment rates in Singapore and Malaysia are still above levels from five years back.
The tight labour market is pushing wages higher while robust consumer demand coupled with prolonged shortages and supply chain disruptions are driving up prices of goods and services. As a result, the change in inflation rates, compared with a year ago, is also running higher in the developed world — forcing central banks to tighten more quickly.
The US and the UK have started raising interest rates. Notably, the US Federal Reserve had taken a decisively aggressive stance — suggesting a series of rate hikes as well as a rapid shrinking of its balance sheet or QT (quantitative tightening). The Fed appears set to reduce its bond holdings by as much as US$95 billion (S$129.7 billion) a month starting May — nearly double the maximum roll-off of US$50 billion set in its previous QT phase in 2017-2019.
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In contrast, China cut both short- and medium-term lending rates in January — and is expected to ease further in the coming weeks. The recent resurgence in Covid-19 cases and strict lockdowns are weighing on consumers and the economy, which is already grappling with a slowdown in the property sector. Meanwhile, many emerging countries, including Malaysia, have yet to start tightening, as their economic recoveries are still at the nascent stage (see Chart 2).
Beginning of the end for unfettered globalisation and time out for Big Tech?
We think these divergences could last longer and deeper, even after commodity prices and inflation stabilise and supply disruptions are resolved.
For starters, the costs of complicated and long global supply-chain disruptions are fuelling the trend for manufacturing localisation and regionalisation. Geopolitics is further driving polarisation in the world, which would result in the realignment of strategic allies and trading partners. The Western world has effectively weaponised the global financial system, the US dollar and trade while Russia is weaponising energy in the fallout from the Ukrainian war.
Concerns over long-term supply security are leading to the reshoring of investments, especially for key industries such as semiconductors, rare earth minerals, medical supplies, renewable energy equipment and battery production. Plus, we suspect more than a few countries are now actively exploring alternatives to the greenback as the reserve and trade currency.
In short, the fallout from the Covid-19 pandemic and Russia-Ukraine war will hasten the end of unfettered globalisation — and its benefits of ever-falling costs. But in fact, the cracks to globalisation were already evident well before either event, starting with the rise in populism and nationalism around the world and critically, the US-China tech war.
China’s rapid technological advancements and the US’ aggressive pushback to protect its interests and dominance in core technologies such as 5G, quantum computing and artificial intelligence is fragmenting the global technology space — potentially creating competing standards and technologies that would complicate interoperability and connectivity for the rest of the world. This bifurcation will have implications across the world, from data flows, future innovation and immigration to cross-border investments and growth prospects, for economies and capital markets.
Furthermore, increasing regulatory oversight for technology companies appears inevitable, sooner rather than later. Big Tech has, in the past, grown very rapidly in a regulatory vacuum that fostered innovation but also allowed them a free hand in disrupting traditional industries, often through uneven playing fields and leveraging on massive data collection. This is changing. Increasing scrutiny and regulations — on data privacy and security, anti-monopolistic practices, fintech, consumer and gig worker rights and so on — will quite likely crimp future growth potential, perhaps innovation, and raise operating costs for tech companies.
The Chinese government has gone the furthest in reining in the sprawling operations and influence of its home-grown tech giants, the likes of Alibaba-Ant Group, Tencent Holdings, Meituan, DiDi Chuxing and Baidu. Europe is catching up, although the US is somewhat lagging. Just last month, the European Union struck an agreement on a landmark legislation — the Digital Markets Act — to regulate digital gatekeeper platforms, including Alphabet, Meta, Apple and Amazon.
Investing has to be more discerning, focus on stocks
As we said earlier, the investing landscape has changed. Inflation is no longer falling, at least not in the short to medium term, with some secular trends stalling. And interest rates are heading higher. In this environment, stocks will fare comparatively better than bonds.
That said, the reversal of liquidity and cheap money means that instead of a broad market rally — where all stocks rise in tandem — investors now need to be much more discerning. In other words, there should be greater focus on relative sector performances — for instance, tech companies focused on cost savings and labour savings will likely outperform — and individual stocks. It means back to basics — balance sheets and cash flows, pricing power (price elasticity of demand) and economic moat (proprietary tech, brand value, competition, barriers to entry, availability of substitutes, strength of network effects and switching costs, etc) for individual companies.
A major strategic shift for the Global Portfolio
Against this backdrop, we have taken a major strategic change for the Global Portfolio. We have cut our basket of stocks to just 10, and pared back our exposure to the US market.
We have raised our stock holdings in mega caps and index heavyweights, Apple, Amazon.com and Microsoft. We have also upped our investments in smaller-cap high-growth stocks, CrowdStrike Holdings and Airbnb, while retaining our exposure to the financial sector through Bank of America.
We disposed of all the remaining stocks in our portfolio. The proceeds were reinvested into four China-based companies listed on the Hong Kong Stock Exchange — Alibaba Group Holding, Guangzhou Automobile Group Corp, Postal Savings Bank of China Co and Yihai International Holding.
We concede that this switch may well result in the portfolio underperforming the benchmark MSCI Index in the short term. Current heightened uncertainties will favour the US dollar as the relative safe haven and raise the liquidity premium. As such, the US market, which is the most liquid in the world, and larger caps will likely outperform. The fact is, we cannot beat the market by following the market and sticking largely to index stocks. As Warren Buffett advises, we would be better off buying the S&P 500 index fund.
It is time to take a different approach. We are raising the stakes in our highest-conviction stocks, at the expense of greater diversification. We believe that the four Chinese-based companies offer very good risk-reward propositions over the longer term. All are trading at significant discounts to their US counterparts and have strong underlying fundamentals.
Our strategic shift is off to a positive start. The Global Portfolio was down by 1.7% for the week ended April 12, lesser than the MSCI World Net Return Index’s 2.9% drop. CrowdStrike Holdings (+5.8%), Guangzhou Automobile Group (+1.2%) and Yihai International (+0.9%) bucked the broader market selloff to finish higher last week. On the other hand, Alibaba Group Holding (-8%), Microsoft (-5.8%) and Amazon.com (-5.0%) fell sharply. Total portfolio returns now stand at 42.7% since inception. The benchmark index is up 51.4% over the same period.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
Cover photo: Bloomberg
