Investing in global stocks is, undoubtedly, a winning strategy, particularly since the global financial crisis and against a backdrop of low and lower interest rates. The Covid-19 pandemic may have ended the longest US bull market in history, but stock prices rebounded very quickly and strongly. Notably, each correction has been relatively shallow and short — following which stock prices have inevitably gone on to record higher highs (see Chart).
The key driver underpinning this remarkable rally is liquidity. Major central banks have been aggressive in expanding their balance sheets for more than a decade through quantitative easing and injecting massive liquidity into the global financial system. Governments, too, have given out generous stimulus/relief monies to the people in response to the pandemic — resulting in trillions worth of excess savings worldwide.
The signs of excesses due to all this liquidity are aplenty. Prices for most asset classes have skyrocketed, some without regard to underlying financial fundamentals, economic justifications and valuations or even viable business models.
Part of the irrational exuberance is fuelled by a new breed of investors, young retail momentum traders connecting on social media (WallStreetBets) and attracted to the convenience and ease of trading with zero commission on platforms such as Robinhood. We witnessed the frenzied trading in meme stocks (such as GameStop and AMC), stocks related to cannabis and electric vehicles, special-purpose acquisition companies (SPACs), cryptocurrencies (including Dogecoin, which was created as a joke), non-fungible tokens (NFT) and so on. We bet that many who bought these assets may not even believe in the narratives about their prospects and are merely in it for quick and easy profits.
And then there are savers who are frustrated by years of low interest rates that barely offset inflation and are desperate for returns, even if it means jumping onto the more speculative bandwagons, while others are looking to hedge against future inflation and as a store of wealth. The prices of landed property in Singapore are surging — for example, the recent record-smashing deals for Good Class Bungalows on Nassim Road and Cluny Hill — on expectations that one could upgrade, downsize or cash in when the time is right.
Liquidity is not going to disappear anytime soon even if the US Federal Reserve starts tapering, currently expected to begin in November. That said, markets are currently buffeted by increased volatility, with headline narratives touting worries over the latest buzzword — stagflation, which is an environment in which inflation is high and growth flat-lines.
For sure, there are significant distortions in the global economy today due to the pandemic. We wrote about this last week, how vaccine distribution inequality and cultural differences are prolonging production and supply chain disruptions and creating a logistics nightmare for businesses worldwide. Higher costs for raw materials, commodities, oil and gas, freight as well as labour have led to shortages and rising prices for goods almost across the board. For example, Brent crude prices rose above US$83 per barrel — the highest in three years — on the back of recovering demand as well as severe gas shortage.
Inflationary pressures will not be as transient as initially expected and some of the higher costs may well be permanent (particularly wages). This means that interest rates are likely to move higher faster and sooner than originally expected. Indeed, the Fed now suggests that its first rate hike could come in 2022, as opposed to 2023 as previously indicated. Accordingly, yields on the benchmark US Treasury have rebounded higher from the recent lows of about 1.2% in July/August to around 1.6% currently.
This reset in inflationary expectations is fuelling the current stock selloff. While higher inflation will hurt bonds — the value of its future income stream is inversely correlated to interest rates, assuming no change to credit risks — the impact on stocks is less straightforward.
There will be companies that will suffer. For instance, highly leveraged companies will see earnings weighed down by higher interest expenses. Businesses with weak pricing power will have to absorb rising costs, which will eat into profits. And highgrowth stocks would be worth less today, as future earnings are discounted at a higher rate. The more their earnings are further into the future, the larger the negative impact on their share values today.
There will also be companies that do well, however, in a rising inflation interest rate environment. The mining, resources and commodities sectors, for example, will benefit from higher selling prices. Certain manufacturers with pricing power will be able to pass on the higher costs and, therefore, protect margins, especially where demand is strong. Financial stocks will benefit from a steeper yield curve. In other words, what we will see is investment rotations between sectors.
While stock prices have a tendency to overshoot in the short term — both on the upside and downside — markets are generally efficient. Excessively priced stocks do self-correct, without triggering systemic risks. For example, Tesla’s shares fell as much as 39% in May this year after hitting record highs in January. Similarly, stocks with elevated valuations such as Zoom Video Communications, Peloton Interactive, Zillow Group, Nikola Corp, Airbnb, DraftKings, Teladoc Health and Roku have suffered huge drops in share prices around the same time, as had cryptocurrencies such as Bitcoin and Ethereum. The big speculative play in SPACs too has largely petered out — all without material impact on the broader market during this period.
In summary, higher inflation will favour stocks over bonds though the composition of portfolios will shift. We are optimistic that the overall stock market will remain resilient. This is why we are keeping the Global Portfolio near fully invested, but with a slight shift in focus. We took some money off tech stocks — selling part of our holdings in Apple, Amazon.com, Microsoft Corp and Taiwan Semiconductor Manufacturing Co — and reinvested the proceeds in energy, reopening and financial stocks (Airbnb, JPMorgan Chase & Co, Wells Fargo & Co and BP) (see Table for our near-term target for portfolio reallocation by sector).
The Global Portfolio was up 1.7% for the week ended Oct 13. Shares in Alibaba Group Holding rebounded 17.6%, following its recent selloff. Other big gainers include Singapore Airlines (+9.9%), and General Motors Co (+7.1%). On the other hand, shares in Bank of America (-2.5%), The Walt Disney Co (-1.4%) and Apple (-0.8%) closed lower last week. Total returns since inception now stand at 63.5%, outperforming the benchmark MSCI World Net Return Index, which is up 54.4% 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.
Photo: Bloomberg
