SINGAPORE (Feb 28): Global stocks traded sharply lower last week as the second wave of Covid-19 outbreak, this time outside of China, triggered heightened uncertainties. US stocks, which had demonstrated remarkable resilience thus far, even hitting fresh record highs, succumbed to heavy selling pressure. The Dow Jones Industrial Average, the most closely watched bellwether index in the world, fell 2,035 points or 7%, in the first three days of the week.
Positively, stock prices in China, the initial epicentre of the viral outbreak, have rebounded quickly from the initial steep selloff, even though volatility persists. The Shanghai Composite index fell 7.7% on Feb 3, the first trading day after the Lunar New Year break, in reaction to the worsening viral outbreak in China. Since then, however, the bellwether index has closed higher on 12 of the 18 trading days. As at Feb 26, the index was up 0.4% from before the holiday break. An obvious explanation is that, unlike a financial crisis, history has shown that economic recoveries from health scares tend to be quick and sharp. And data out of China suggests that the outbreak is being contained. The People’s Bank of China has injected massive liquidity into the system and cut interest rates and plans to buy short-term securities; the government also unveiled a slew of fiscal stimulus measures, including tax cuts and support for the worst affected businesses. Investors are expecting more to come.
This underscores our belief that governments and central banks of the world will do everything possible to sustain the longevity of this current economic upcycle.
Singapore has just announced the most expansionary budget and biggest deficit since the global financial crisis, to counter the negative impact of the viral outbreak. And the reality is that financial assets are being driven higher by excess savings and liquidity on a global scale. US stocks were the outperformers this year, before the latest bout of profit-taking. The selloff, we believe, reflects the downward share price adjustment to account for the short-term impact on earnings, owing to the viral outbreak. The global economic cost is expected to be high — though far too early to ascertain at this point.
Last week, I wrote about how governments will always step in to guarantee liquidity when faced with systemic risks, in order to remove panics and eliminate economic and financial crashes. Indeed, this is what the US Federal Reserve has done in response to every sign of concern and/or panic in the market since the global financial crisis. Investors are betting that the Fed and the Trump administration will actively support any weakness in the economy and, by association, prices for financial asset (stocks and bonds).
President Donald Trump, who faces re-election in November, has sought to reassure that the risk to the American public “remains very low” and that “I think the stock market will recover. The economy is very strong. The consumer is the strongest it’s ever been”, This comes after Centers for Disease Control and Prevention officials issued warnings that it was just a matter of time before the outbreak starts to spread in the country. His National Economic Council director Larry Kudlow went a step further to say, “I would suggest very seriously taking a look at the market, the stock market, that is a lot cheaper than it was a week or two ago.”
It is the strength of this belief that is underpinning the US stock and bond market rally — even as PE valuations rise and bond yields collapse. Traditionally, bond and stock prices tend to be inversely correlated. Forward PE valuations for the Standard & Poor’s 500 index rose as high as 19 times, the highest level save for the period after the bursting of the dotcom bubble in the early 2000s (see Chart 1).
Yet, there are few signs of investor panic and mass exodus, the latest selloff notwithstanding. Every pullback has been shallow and brief as investors bought the dips. Sure, there are always those calling for imminent recession, doom and gloom. But the majority of investors remain sanguine. Just look at the stock and bond market rallies. The US housing market too is showing underlying strength. Buying a house is a long-term commitment, which goes to underscore prevailing conviction in consumer confidence. In fact, consumer confidence ticked slightly higher in the latest February survey. We will elaborate more on this next week.
We tracked the relative share price performances for two baskets of stocks, growth (defined as companies with three-year sales growth above 10%) and value (defined as companies giving at least 3% yields above treasury rates) over the past two decades (see Charts 2 and 3).
The data suggests that growth stocks have, by and large, outperformed value stocks in the last 20 years. This is not unexpected. During good times, investors would naturally favour companies with strong growth (and returns) prospects. And in bad times, there would be less interest in stocks anyway, growth or value. That said, investors are more inclined to switch to value and defensive, high-yielding stocks when the broader market falls — for instance, when perceived risks of a downturn rise as the economic cycle matures — and vice versa.
In the past 10 years, however, growth stocks clearly had the upper hand (rising and sustained outperformance over value stocks as shown in Chart 2) as the S&P 500 index chalked up strong returns. This current economic expansion is officially the longest in US history. Yet, the market is telling us that the perceived recession risks must be low if high-growth (tech) stocks are still leading the rally. What gives? Are investors irrationally exuberant or rationally complacent? We believe it is the latter. Why?
We said it in the title: The Fed and Trump are underwriting this US bull market. Interest rates will stay lower for longer and both monetary and fiscal policies will remain accommodative and expansionary, and supportive of continued economic growth. To underscore our conviction, we are keeping the Global Portfolio fully invested.
Apple
Apple issued an earnings guidance update on Feb 17 that reverberated around the world. The company said that it would miss revenue forecast — made a little over two weeks back, at end-January — for the current quarter and offered no additional guidance. This highlights how even the companies themselves are highly uncertain of how the coronavirus outbreak will affect sales and profits.
Apple has had to temporarily shutter its retail stores in China — the country accounted for 17% of total revenue in FY2019 — some of which have since reopened but on shorter operating hours and to low foot traffic.
Apple also foresees disruptions to the iPhone production as factories begin slower-than-expected ramp-up after the extended Lunar New Year break. Any resulting supply shortage would hurt sales worldwide. Some news reports suggest the supply and production disruptions could hurt launch dates for several products slated for later this year.
Its share price has held up comparatively well, however, underscoring our belief that investors are, by and large, looking beyond any near-term impact from the viral outbreak. After all, supply disruptions are to likely have little impact on underlying demand and, therefore, sales will recover quickly.
Apple handily beat market expectations in its most recent earnings results for the quarter ended December 2019. Revenue was up 8.9% y-o-y, bolstered by the 7.6% resurgence in iPhone sales as well as robust 37% growth in wearables and 17% increase in services. Gross margin improved to 38.4%, compared with 37.8% in FY2019.
Alibaba
Apple is certainly not alone in issuing profit warnings. Chinese e-commerce giant Alibaba Group Holding too has warned that supply and logistics disruptions are affecting sales for merchants on its platform as well as food delivery and that its businesses that rely on physical goods (such as its Hema supermarkets) will see revenue decline.
Like Apple shares, losses have been relatively limited. It is quite likely that the negative earnings impact has yet to be priced into the share price simply because neither the company itself nor investors can quantify the impact.
But even taking into account the eventual knock on sales and earnings, Alibaba remains one of the cheapest priced highgrowth, tech companies — at forward PE of around 25 times. Its longer-term outlook is intact. As such, we are hanging on to our holdings.
The company’s latest earnings results for the last quarter of 2019 beat market expectations for the fifth straight quarter. Core commerce and cloud — the two largest business segments — grew 38% and 62% respectively, boosting total revenue growth to 38% y-o-y.
Margins were fairly stable with adjusted earnings before interest, taxes, depreciation and amortisation (Ebitda) up 37% y-o-y. Singles Day — Alibaba’s biggest annual shopping event on Nov 11 — saw a record US$38.4 billion worth of merchandise value transacted, up 26% y-o-y. The company’s cash-generating ability remains robust, with net cash rising to more than US$33 billion.
Alibaba is holding its own against the competition. The number of annual active consumers totalled 711 million (+18 million for the quarter) while mobile monthly active users stood at 824 million (+39 million), or roughly 57% of China’s population.
Looking ahead, key growth levers include strategic focus on user engagement, enhancing product variety and, crucially, penetration into less developed areas, where 60% of new annual active customers came from. For example, its “live broadcast” on Taobao — hosted by merchants, key opinion leaders and celebrities — is one of the fastest-growing and most effective selling formats, with a high level of consumer interactions and engagement with the brands.
Alibaba is still one of the best proxies to tap China’s growing consumption power, as more and more of its nearly 1.5 billion population join the ranks of the middle class on the back of rising per capita income.
The Global Portfolio fell 8.5% for the week ended Thursday, mirroring the broader market selloff. All of the stocks in our portfolio ended in the red. Some of the big losers were Builders FirstSource (-16.8%), Qualcomm (-12%) and The Walt Disney Co (-12.7%). Last week’s losses pared total returns for the Global Portfolio to 17.2% since inception. Nevertheless, this portfolio is still outperforming the MSCI World Net Return Index, which is up 11.8% over the same period.
Tong Kooi Ong is the chairman of The Edge Media Group, which owns The Edge Singapore.
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.
