The US — and global — stock market rally seems to be losing steam even as the S&P 500 index hits a fresh all-time record high. It would appear that the upbeat sentiment on the reopening of economies is almost all played out.
The economic recovery is unfolding in fits and starts with the resurgence in Covid-19 cases around the world. Case in point: The US unemployment rate has fallen to 10.2% from the peak of 14.7% in April but job gains have noticeably slowed in recent weeks. The recovery in consumer spending is also likely to slow as direct aid under emergency stimulus packages tapers off.
What then will drive the next leg of the stock market rally?
The short answer is a vaccine. An effective vaccine will mean we can all resume our pre-pandemic way of life, which will in turn set demand — and therefore, businesses and employment — on a smoother path towards economic normalcy.
Russia sparked a mini shockwave that reverberated around the world this month when it registered the world’s first Covid-19 vaccine for public use. To be sure, there is plenty of scepticism on its safety and efficacy. The country has shared little scientific data on results under Phases 1 and 2 trials and has yet to start Phase 3 testing.
Still, we think this news is a harbinger of a successful vaccine to market, sooner rather than later — especially given the massive amounts of resources being poured into the effort globally. Some companies are already preparing for the manufacturing of top candidates ahead of official approvals.
According to the World Health Organization, there are currently 29 candidate vaccines in clinical evaluation, of which seven are undergoing Phase 3 trials, the last step involving a large number of human testing before regulatory approval. There are another 138 candidates in development.
The most high-profile progress, thus far, has come from the Western world. Oxford University, working with AstraZeneca, is leading the vaccine race, having published positive results from early-stage testing.
Companies such as Moderna, BioNTechPfizer, Novavax, Inovio Pharmaceuticals and Johnson & Johnson too have created a lot of fanfare with their candidates, resulting in substantial share price gains for some.
China, on the other hand, has stayed relatively quiet on the topic. But we think the country could be very close to successfully developing a safe and effective vaccine for the mass public. It has nine candidates in various stages of clinical trials, including five (of the seven in the world) in the last stage. Last week, the Chinese government granted its first patent for a Covid-19 vaccine candidate to CanSino Biologics.
CanSino — which has just made its debut on Shanghai’s STAR market (the country’s nascent Nasdaq-style tech board) — working with the Beijing Institute of Biotechnology has been providing an approved vaccine to the Chinese military since June. Its Phase 3 trial has started in Russia while Saudi Arabia is set to begin clinical trials on at least 5,000 people. The company also signed deals for final testing with Mexico.
State-owned China National Pharmaceutical Group Co or Sinopharm has two candidates undergoing Phase 3 trials in the United Arab Emirates and Pakistan. Meanwhile, Indonesia announced that it would launch the Phase 3 trial of a vaccine being developed by Sinovac Biotech, which has already been administered to 9,000 people in Brazil. The company indicated that its vaccine could be commercially available by end-2020.
A widely available vaccine would surely boost the global economic outlook — and stock markets.
The current liquidity-driven stock market rally is being supported, primarily, by valuation expansion, with average earnings having contracted sharply. But this on its own is not sustainable. A safe resumption of economic activities, on the other hand, will translate into a quicker and sustainable earnings recovery that will better underpin stock prices in the longer term.
News of a successful vaccine is also likely to trigger a rotation into cyclicals including battered airlines and travel-related stocks as well as those in the most-affected industrials, energy and banking sectors — and out of stay-at-home proxies such as Zoom and, to a certain extent, technology stocks whose valuations are stretched, having led the rally thus far.
As such, we are taking an early position on this belief. We disposed of part of our holdings in Adobe, Alibaba Group Holding and ServiceNow — all of which have performed remarkably well — in the Global Portfolio, and reinvested all the proceeds into shares of Bank of America (BAC) and Singapore Airlines (SIA).
BAC is the second-largest bank in the US by assets. It has a well-diversified exposure to consumers, and small and large businesses across a broad swath of the economy, and a strong balance sheet. The stock is currently trading below book value. BAC is also Warren Buffett’s favourite bank stock. Berkshire Hathaway has been adding to its holdings and currently has an 11.9% stake in the bank, its second-largest investment in terms of market value after Apple.
A high percentage of population immunisation from Covid-19 is critical for the lifting of border restrictions and for returning confidence to air travel and tourism. When this happens, we believe passenger traffic will rebound sharply from current depressed levels. Though it might take some time to fully recover to pre-pandemic levels, stock markets are forward-looking.
SIA is very well-managed, with a sterling reputation and brand name, and is among the best-positioned to ride out this storm. The Asia-Pacific region, SIA’s stronghold, too is expected to generate the highest traffic growth for the foreseeable future.
The airline has an extremely strong shareholder in Temasek Holdings. Case in point — it successfully raised $8.8 billion in fresh capital from a rights issue for shares and mandatory convertible bonds (MCB) in May. The issue was fully underwritten, and the unsubscribed portion of the MCB was taken up, by Temasek. SIA has the option to raise another $6.2 billion of MCB by June 2021, should it require additional funds.
After accounting for all of the above transactions, the Global Portfolio is now near fully invested. The portfolio dipped 0.1% for the week ended Aug 20, paring total returns slightly, to 28.9% since inception. Nevertheless, this portfolio continues to outperform the benchmark MSCI World Net Return index, which is up by 19.7% over the same period.
Builders FirstSource was the biggest loser, giving back some of its recent gains. Its shares fell 5.1%. Similarly, Qualcomm succumbed to mild profit-taking, having surged to record highs in the previous week.
On the other hand, technology stocks including Alibaba (+2.1%), ServiceNow (+2.3%), Adobe (+3.7%) and Alphabet (+2.5%) were among the top gainers.
Over the past few weeks, we have cautioned investors on the irrational exuberance in glove maker stocks, which have rallied hard since the start of the pandemic. After hitting record-high levels in early August, the sector has, unsurprisingly, come under pretty heavy selling pressure. That begs the question, should investors go “bargain” hunting now?
There is no doubt that glove companies are among the biggest beneficiaries of the outbreak. The sharp spike in demand and short-term supply constraints have resulted in rising selling prices, outsized margins and supernormal profits.
It is not surprising that many want to jump onto this bandwagon. Equally, we understand why analysts and brokers would promote this theme, hard. We have read huge reports, com - plete with charts and pretentious mathematics, all to justify lofty and loftier price targets.
To set the record straight, we have nothing against glove companies, several of which are, in fact, very well run. We have invested in some of these stocks before. What we are questioning is their valuations.
The fair valuation for a stock is the sum of its future discounted cash flows. Most analysts and investors, though, favour the simpler price-to-earnings ratio (PER) method — basically, how many times the company’s profits one deems a fair value to pay. By inverting the PER, you can also derive the earnings yield, which can be used to compare against returns from other forms of investments, such as bonds or bank deposits.
Herein lies the real debate. Applying a historical average PE multiple to peak earnings as sumes that this supernormal profitability is sustainable in the long run. Considering that some estimated peak earnings are currently more than 20 times the pre-pandemic levels, a seemingly fair 15 times PER will turn into 70 times (the earnings yield will be 1.4%) if earnings normalises at five times pre-pandemic levels. Yes, that is assuming earnings can even be sustained at five times historical level over the long run.
Does anyone truly believe that glove demand and, more critically, selling prices will stay elevated in the next two or three years, especially if a Covid-19 vaccine is to be available sooner rather than later, let alone the next five to 10 years?
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.
