3rd Quarter 2018: Thoughts on Market Outlook

I write quarterly updates for my investors and high net worth clients, in my capacity as a financial services consultant at AIA.  It is a long, technical read, but it explains how my client’s funds have been doing, and market projections for the next quarter based on where their funds are placed.

When there are changes, or challenges in the market, or when there are market opportunities, I write this to explain the issues and the opportunities.  I understand that the nature of most people in the industry, from wealth relationship managers, to brokers, to financial services consultants, is to go to ground, and hope the client does not pay too much attention to what is happening to their investments.  A professional relationship is based on trust and competency, and that can only be demonstrated through open communication and honesty.

For those of you who have been with me for a few years, you would note that the last few years, - last year, in particular – have been exceptional.  Equity markets ended 2017 on a high note, and this momentum carried into 2018, with January witnessing one of the best months in recent years, as reflected in your fund activity statements.  In fact, we fully expected this year to have record growth in the markets on the back of developments last year.

Unfortunately, no one could predict Donald Trump, and his self-destructive protectionist tendencies.  When he spoke about tariffs and threatened a trade war in January, the market slowed in February, but we still provided value.  In that time, there have been a series of new tariffs by the US, many of them specifically targeting their largest trade partner, China.  The Chinese are all about dignity – “face” – and no one who understands China, expect them to back down anytime soon.  What we have is an undeclared trade war.  The Chinese have retaliated with their own, strategic tariffs.  This market turbulence has lead to other consequences of a belligerent US policy, including the weaponising of the US dollar, emerging-markets turmoil, the bear market in Chinese stocks, and a possible oil shock.

As a result of this, and other factors, global growth has slowed.  Equity markets have corrected, bond yields have retreated and the USD has strengthened because it is the preferred reserve currency.  The global equity markets proxy, the Morgan Stanley Capital International (MSCI) World Index was virtually flat from the end 2017 to June 2018, giving up only 20 basis points in USD terms.  The US and Japanese economies, which had underperformed in 2017, were the relative outperformers with modest single-digit returns over the period.  The Asia markets, excluding Japan, suffered with a total market weighted loss of 5%, partially erasing the spectacular gains recorded last year.  The benchmark MSCI Asia Pacific Index has fallen about 5 per cent in recent weeks.  That is almost US$700 billion wiped out this year.

Within Asia, no market was unscathed.  The North Asian markets suffered considerably less compared with their South Asian counterparts.  Southeast Asia is mixed.  In many of the worst performers, losses were exacerbated by pressure on their currencies.  Countries such as Indonesia made stupid decisions such as raising tariffs instead of merely deferring payments to keep their current accounts robust.  Malaysia suffers from a lack of investor confidence because Mahathir, specifically, insists on relooking or tearing up existing contracts with major trade partners.

As the market adjusted, in the beginning of the third quarter of 2018, and improved, the bond markets became concerned with the threat of further policy normalisations by major central banks, meaning a change of interest rates.  The 10-year US Treasury yield rose by 70 basis points to a year-to-date high of 3.11% in the middle of May.  This reduced to 2.86% at end of June as the fear of additional US tariffs on China imports gathered pace, leading to investors moving their capital to safer investments.

In light of the above, investment-linked insurance policy funds registered negative returns in the last few months.  Asian-themed and emerging markets funds are the worst hit over the last six months.  None of my clients have investments in emerging market funds.  There are far too many political variables for me to consider these funds viable for you.  As such, whilst others have had losses of up to 20%, none of you have been hit as hard.  The worst performer is a 9% year to date loss.  Most of you have funds that have made slightly less, dropping from 11% to just over 1%, or making a loss of between 2% to 4%.  These are all paper losses, and are not realised.

When we consider the three-year period, every single one of your funds generated positive returns.  This is a testimony of our investment strategy over a long investment horizon since this volatility is temporary.  Not only will we ride it out, but we will be in a very good position to recoup the losses and make up on gains.  You would note that flagship funds such as AIA Acorns of Asia Fund and AIA Regional Equity Fund continue to do very well.  They have returns exceeding 8% per annum over the three-year period.  The AIA Global Technology Fund, for example, returned 15.2% over the first six months.  A combination of strong corporate guidance for 2018, along with an outperformance of 3.3% from stock selection by the fund manager have provided value in a difficult market.  Over a 3-year period, this fund returned 20.8% per annum.  It is funds like these that will lead the way in providing value to your portfolio.  Fixed income funds such as AIA Regional Fixed Income Fund returned -0.6%, as US Treasury yield rose along with widening of corporate bond spreads.  This has helped to mitigate some losses.

We are in the beginning of the third quarter of 2018.  We have weathered the very worst of this market turbulence, and it is only a matter of time before market sentiment catches up with market fundamentals.  What I want to do here is reiterate some of these market fundamentals, so that we all understand the cause of our optimism.

In August 2018, Singtel issued USD$500 million in corporate bonds, at 3.875%.  Singtel is not in need of that money.  However, they are viewed as a proxy for Singapore incorporated.  This is the Singapore government sending a message to institutional investors and fund managers that they are aware of the pressure on regional currencies and the capital flight.  This bond issue just locked in USD$500 million for the next decade, which helps both liquidity and the shores up the SGD.  This is also why the Singapore currency has appreciated as much against regional currencies such as the MYR.  This translates well for the AIA Regional Equity Fund and AIA Regional Fixed Income Fund.

China has suffered in the short term because of the tariffs.  However, this does not change the fact that they are still the factory of the world, and have other markets to pivot to, whether in Europe, South America and Asia.  China is also making huge inroads into Africa, and positioning themselves for the next half a century.  They are playing the long game, and so should we.

This downward valuation of Asian equities will eventually lead to a correction.  Their valuations will become attractive.  Funds will circle picking up the best bargains, and the best bargains are found in East Asia and Southeast Asia.  ASEAN, South Korea, and the Greater China Region are still growth regions.  Growth has slowed, not stopped.  The market, as usual, has over-reacted, and that is what short-sellers and short-term investors do.

None of you are short term investors.  The average investment horizon is from 7 to 15 years.  Now that stocks are due for a rebound, the correct action to take is to actually invest more into the correct funds, and take larger positions so that greater gains can be made on the rebound.  This will see funds such as the Greater China Equity Fund, Greater China Balanced Fund, and technology and manufacturing counters grow.

For those among you who are more adventurous, you might consider greater weightage into AIA Global Technology Fund.  The MSCI Asia excluding Japan Index is dominated by the big technology names such as Tencent, Alibaba, Samsung and Taiwan Semiconductor.  Almost 32% of the index is weighted to just one sector: information technology, and Chinese companies make up seven out of the top ten holdings.  The index has a higher allocation to two tech stocks: Tencent and Alibaba, at nearly 11 percent.  People are not going to stop buying new handphones or stop using social media anytime soon.  This slowdown affected manufacturing and traditional industries.  Technology has been virtually unscathed.

We must understand that individual country indices track large-capitalisation stocks, which tend to be the big, state-owned players.  These include Temasek Holdings, the Government of Singapore Investment Corporation, and their subsidiaries and special-purpose vehicles.  Economies are distinct from their stock markets, particularly for East Asia.  When investors want to capitalise on fast-moving industries in the region, they are unlikely to be able to access them through established indices.

Beyond the current belligerence of the Trump presidency, the trade cold war and the emerging markets turmoil, there are major structural shifts transforming Asia underlying all this.  There is the migration from traditional retail to online, which has led to the dominance of e-commerce giant Alibaba.  There is a growing middle class that is changing its shopping habits and moving up the value chain.  The future market is the millions of new middle class in places like China, India and Indonesia.  An American slowdown in consumer purchase will eventually be irrelevant.  There has also been a surge in entrepreneurship, from fintech and online retail to innovative enterprises in the gig economy, all piggybacking China’s growth.  What this means is that a current slowdown on indices and stock markets does not reflect the economic reality.  These smaller, nimble businesses will eventually have an impact on the market indices within the next five to ten years.

The funds that I have recommended for you are involved in some of these growth areas.  As I have mentioned before, to many of you, in the California Gold Rush, it was the people who sold the shovels and pans who made the most money.  None of the funds I recommend are “sexy”.  I recommend shovels, not panning for gold.

For example, the companies on some of the funds are involved in the manufacture and sale of smartphones.  China is the world’s largest market for smartphones.  Every quarter, over 100 million units are shipped.  This has been so in the last few years.  Chinese smartphone manufacturers now account for nearly a quarter of the global smartphone market and they continue to grow rapidly.  Smartphone camera component makers, such as Sunny Optical Technology which recently reported a pick-up in handset-camera module shipments, reflects the considerable growth opportunities in China’s smartphone market.

Another areas is banking.  This is solely due to underpenetrated markets.  In 2008, for instance, India and Indonesia had nine and seven commercial bank branches per 100,000 adults respectively. By 2016, the number had increased to 14 in India and 17 in Indonesia and we expect this growth to continue.  Private banks with strong and experienced management teams will benefit as financial service penetration continues to increase.  And with the growth of local banking to service a wealthier, more sophisticated clientele, services will also grow exponentially.

Yet another area is infrastructure.  The logistics industry in India is worth around US$160 billion and is projected to rise to US$215 billion by 2020.  This means it is projected to grow at a compound annual growth rate of 10.5 percent.  Indonesia, the Philippines, Vietnam, and Myanmar are countries that are investing heavily in infrastructure growth, funded by export credit.

In summary, this trade war is not going to last simply because the US cannot afford it.  When Trump attempted to weaponize the USD in his crusade against Iran, it shook investor confidence in the status of the US as the preferred reserve currency.  Whilst there have been attempts to walk that back, funds are already moving to alternatives, primarily the Euro and the Renminbi.  Capital is flowing back into the region, and once funds start picking bargains, the value of funds will rise again.  Those who persevered in this market will be rewarded.  This is the value of long-term investing.

I understand that this is a long, and technical read.  However, I hope that I have adequately summarised the market cycle, and explained why your money is in good hands, and that long-term growth is assured.