Listen to Stephanie Leung, Co-CIO, and Albert Kok, Deputy Country Manager, Malaysia, discuss the latest global events and their potential impact on the markets and on our investment portfolios. In this episode: What does strong US jobs data mean for interest rates and the economy? [2:00] How will China's reopening affect the global economy? [04:46] Could China's reopening cause inflation to pick up? [07:34] How StashAway's portfolios are positioned for the year ahead [10:46]
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Albert | 00:01
Welcome, everyone. We're back for our live market commentary. And this is where we talk about the latest developments in the market. And this is where we also share our thoughts about them. So I will be your host today, Albert, and I'm the deputy country manager in Malaysia. We're joined today here by Stephanie, who is our chief investment officer. Hi, Stephanie. How are you?
Stephanie | 00:22
I am good. Hi, Albert. Hi, everyone. In fact, I just returned to Hong Kong from my trip to Malaysia and Thailand. So it was great to see you in Malaysia and in person.
Albert | 00:33
Yeah. To our audience out there, if you had the chance to meet Stephanie in Malaysia or Thailand, I hope you found it was a good session last week. She shared her thoughts about markets, interacted with some of you, I'm sure. So yeah, it is interesting times now that borders have opened up. But anyway, it's been a while since we did our last market commentary back in December. January itself was a pretty jam packed month with other events, but I guess similar to before today, I would like to focus on two things. One is on US itself and the other one will be on China.
And as this is a live event, for those who are watching this from YouTube, please post your questions. There is a Slido link in the YouTube description. So just go to Slido and add your questions based on whatever thoughts that Stephanie will be sharing.
Okay, so on to the first point, which is about the US. Last week we saw a few things happen. We had a 25 basis point hike in interest rates, which was expected by the market. Jay Powell, in his press conference, didn't really push back against, you know, how exuberant the market was in terms of loosening financial conditions.
Albert | 01:57
And this led to markets being very excited. And towards the end of last week, on Friday, we also had strong economic data in terms of the non-farm payrolls. We also had average hourly earnings, all beating expectations. And lastly, yesterday night, we had Jay Powell at the Economic Club of Washington. That's where he gave his thoughts. And he mentioned that, oh, we're at the beginning of a disinflation stage and further rate hikes will be needed if we see a very strong labor market out there.
So my question to you, Stephanie, is, you know, given all that's been happening, what do you think about higher rates this year given the backdrop that we're in? That's the first part. And the second part is we have been on a year of higher interest rates, especially coming out of the US. So markets are expecting a recession. Are we then likely to see a rate cut coming in the later half of this year?
Stephanie | 03:03
Yeah, it's all a bit confusing. I think the messages that we got last week from both the Fed and also from the data released on Friday in terms of the labour market. So I mean, let's take it kind of one by one. So I think before last week, of course, the markets have rallied in terms of both bonds and equities. If you look at bond yields, I think they've come off quite significantly over the last two months or so, and that's because the market has been increasingly pricing in a soft landing scenario where inflation is coming down.
But also growth is not as bad as fear. And that's because if you look at the US CPI number, it has come off the peak. And when we last discussed this trend, I think we were in the same camp saying that inflation should come down. But also the market participants and ourselves included tend to look at a moving average. So you need a few months of data to confirm a change in trend. So I think what the market got was over the past few months, I mean, there has been a change in trend and that inflation seems to be a worry of 2022. So as we have said in our market outlook as well, we think inflation concerns would mostly be, I guess, more subdued this year.
Stephanie | 04:22
But this year the focus of the market actually returns to growth. And so the market has kind of been gyrating between, oh, are we going to get a soft landing or are we going to have a much harder recession? And this is guided by different types of data. So I think if you look at the range of growth indicators or data that we can look at, there are some leading indicators and there's some lagging indicators.
So in terms of leading indicators, for example, one of the best ones that we also like to look at a lot is PMI. The Purchasing Managers index in the US is called the ISM – Institute of Supply Management index. And that typically leads the economic cycle because it's basically a monthly survey of the purchasing managers in the industry in the supply chain. So if the economy is strengthening or weakening, they will be the first ones to feel it.
And every month,the ISM asks these purchasing managers, these are participants in the supply chain – how do you feel about the current economic situation and how do you think about the future situation? Do you see inventories rising? Do you see prices rising, coming off, etc., etc.? So this actually gives a pretty good leading indicator of where the economy is going.
Stephanie | 05:45
And when we look at this indicator in the US, it has been going down in the past few months and recently in December, it actually crossed the 50 line, i.e. when this ISM number is below 50, it means that the economy is actually in a contraction, whereas when it goes above 50 it means that the economy is expanding.
So then, I mean, we all know that the economy is actually slowing down. And if you look at the US manufacturing ISM it actually slowed down to a level which is quite alarming. So compared to the last time when we had such a big slowdown, that was actually back in 2020 when we had COVID, I guess like stopping the economy and preventing people from going to work.
So on the one hand, this data has been quite alarming. On the other hand, on Friday, we got the payroll data right. Payrolls actually were a blowout. The consensus or the market was looking for around 300,000 increase in non-farm payrolls. The actual number actually came out to be 510,000. So that actually beat the consensus quite a lot. And the unemployment rate is actually at an all time low. So you ask why is there such a big difference? Right.
Stephanie | 07:01
One piece of data is telling us the economy is actually contracting. The other piece is telling us it is quite strong. So when we look at the different types of data, some are leading, some are lagging. And from our analysis, actually the payrolls data is quite lagging. I.e., if you think about companies, people tend to be the last thing, the last cost item that you cut. You try to keep your employees as long as possible as your business can still sustain. So that explains why payroll is so, so strong, WWhile we're already seeing the leading parts of the economy falling into a contraction.
So that's kind of on the growth side. And I mean, the market reacts quite nicely to it. One more reason is because of Powell's more dovish comment. I think if you I think the market going into the Fed was actually looking for Powell to be quite hawkish. Actually, if you look at Powell's actual comment. It didn't say much. He didn't say, Oh, we're going to stop hiking rates. In fact, I mean, yesterday he said we may have to take interest rates a bit higher than what we're already penciled in. So if you look at the Fed's own projection, they are projecting to sort of a 50 basis points more rate hike at 5.1%.
Stephanie | 08:25
And then basically they project to stay at 5.1% for quite some time. The market is actually saying that the Fed will raise interest rates, but not as high as the Fed projects, and then they will actually start cutting interest rates in the second half of 2023. So quite soon. And that explains why I guess we see equities and bonds rallying. If we look at this scenario, it's actually quite an optimistic scenario in our view because of the lagging nature of the payrolls data. So I think we're looking at some lagging indicators. It's not that useful for putting together portfolios or indicating kind of forward asset price performance. And we're seeing different parts of the economy already slowing down.
So I think net net again, Powell being a bit more dovish, means that high inflation may stay for a bit longer, even though it has peaked. But also if interest rate stays a bit longer, then the risk of a deeper contraction also increases. So I guess that last week a lot of things happened, but net net, we think that doesn't kind of change our view that still a much lower growth scenario remains the biggest risk in 2023.
Albert | 09:56
All right. So that's for the US economy aside, but also I guess on the back of it all, there's another interesting thing happening on the other side of the world, which is China itself. So that's been a lot of, I guess, people happy about China reopening in terms of economic numbers. We have also seen the many manufacturing and services PMI, which went from below 50 to above 50, signifying an expansion. We are also coming out of the lunar New Year from China. So that's where the economy kind of pretty much restarts again. So given this whole reopening from them, the positive spillover to trade partners like in Southeast Asia or even Europe, could we avoid a recession or even a soft landing that you talked about earlier and instead things won't be as bad as feared?
Stephanie | 10:57
Yeah, I think if again, we like to look at the data and China also has its own PMI. So if you look at the PMI, indeed, as Albert mentioned, it has climbed above 50. So it means that the economy is actually starting to expand. However, it's also quite a bit choppy in the last few months. So if you look at a kind of three month average, it's still below 50. I mean, we don't have a clear signal that the trend has changed.
Having said that, however, of course, we've seen a lot of policy coming out from China, including the reopening. And also, I think more importantly, we've seen a sort of relaxation in some of the tightening policies, for example, for the property sector. And then also they injected quite a lot of liquidity into the whole system. So this is in contrast to the US. And I mean, that was one major reason why we kind of upgraded our view on emerging markets, including China in our December reoptimisation of the portfolio. So to bring it kind of more market weight. I think if you look at the implication of China's recent policies and reopening, I think it's quite likely that we've seen a trough in terms of China's economic growth.
Stephanie | 12:17
However, to have a sustained kind of uptrend, we need stronger kinds of, I guess, growth drivers from different industries and from a growth perspective, if we think about China, the past two decades or so, property actually contributed 30% to GDP every year.
And then obviously in the past few years, the Internet was also a big growth driver and they employ a lot of people. The structural change is that China cannot afford to stimulate property again. And also, given the policy focus on the Internet sector, it is very, very hard for us to envision that the Internet sector will grow as it has been in the past decade. So, I mean, with these two kinds of growth drivers kind of more muted going forward, we need to see some other growth drivers emerging from China.
So far, there are a few potential ones, but we haven't seen some very, very strong support for any particular kind of sector that could replace these two. So I think all in all, we think the trend is positive. We may see some PMIs climbing further up in the next few months, but is it strong enough to support the global economy or even prevent US from going into a contraction?
Stephanie | 13:53
I think that's not very likely unless, China goes on a bazooka – unless they just kind of stimulate the property market like how they did in 2009. So I think it is very, very hard to see that happening again. China is trying to focus on risk mitigation. They don't want sectors like property, for example, to go into systemic risk because, I mean, then it touches upon the banking system, which creates a much, much bigger systemic problem for China.
But they're not going to just stimulate blindly because they know the price that they will have to pay in future. So I think, yes, relative to the US, it is in a better place. But also just bear in mind that the equity prices in China-related sectors have rallied quite significantly. For example, you look at the Hang Seng, it's rallied 50% from its low. So in terms of valuation, it has rebounded quite a lot and I think that incorporates the hope that reopening would bring an economic recovery.
Albert | 15:07
On that point, actually, before that, if any of you have questions, I see some questions streaming in already on Slido, but if you aren't aware there is a link to Slido in the YouTube description. So please feel free to post your questions and we'll get back to it in a few moments. But yeah, on the whole reopening of China itself – Stephanie do you foresee any risks from that, i.e. if inflation picks up again, are we going to be back on a path of rate hikes going forward?
Stephanie | 15:38
Yeah. So if you look at more recent data like jet fuel consumption in China, it has been going up. And I think this is to be expected because of revenge travel. If you're locked up for a whole year and suddenly you're free, then of course, I mean, you take the plane, you take the train, you go to places, you visit relatives, etc., etc.. So I think you need to take the recent spike with a grain of salt.
But, having said that, China reopening has positive implications for commodities, for oil, for others like gas, copper, etc.. So I think that sort of gives more support to these commodities. And if you think about the net-net effect of US contraction versus China reopening, some of that would balance out. So I think it lends support to commodities.
However, when we look at inflation, it's a year on year change, right? So if you think about commodities like oil prices, last year, it went up to $120. And I mean, it's hard for me to see that a China reopening would actually push oil prices up there. So in terms of the year on year change, we're going to see much more subdued year on year change this year compared to last year when we had the Ukraine war. So are we going to see oil prices going down a lot? I think the China reopening story will support that, but also probably not that much upside. So I think commodity prices may be more range bound over the coming months. And the year on year effect means that the impact of inflation will actually go down.
Albert | 17:35
Hmm. And I'm just taking some questions from the audience here on the topic of China. Someone's asking who are the biggest beneficiaries from China reopening? Is it the emerging markets?
Stephanie | 17:50
Yeah, I think there are. Obviously the service industries in China are the biggest beneficiaries because people can then go out and spend, go eat, go travel. And if you think about the playbook it is basically quite similar to when we reopen leisure, like hotels or airlines, I mean, all these sectors kind of benefit. Also, of course, if you think about where the Chinese would travel, Southeast Asia is a popular destination.
I was actually in Thailand last week. And on the ground, we're seeing a lot of Chinese tourists returning. And then the other sector could be European luxury brands or European leisure stocks. So, these are obvious sectors that would benefit from a China reopening.
Then, from a secondary perspective, it will mean that some of the sectors from China will have capacity to start going back to work and developing, etc., etc.. So I think initially in the first few months, I mean, those are the sectors that we’re paying attention to.
Albert | 19:16
All right. Okay. And then I guess switching gears a little bit more focused on our product offerings, because they have quite a few questions on that. This is a bit more general, but this question says it seems like economists are divided about whether there will be a recession or not. Are our portfolios positioned in a way to stay resilient for the uncertainties?
Stephanie | 19:40
Yes, actually, I mean, that's a great question. And so thank you very much for that. At StashAway, we actually manage or I guess put together our portfolios according to something called the StashAway Risk Index, which is the maximum 99% draw down under different macro scenarios. So we actually reposition our portfolios whenever we see a new macro scenario or new risk emerging.
So when we were in December, we actually reoptimised our portfolios because throughout the second half of 2021 and also to June 22, inflation was the biggest risk. And so we added inflation protection to all our portfolios back then, and that actually helped our portfolios to outperform benchmarks by around on average, 5%, 6% throughout 2022 to go into 2023.
As I mentioned before, we think that now actually growth becomes the market's biggest risk because inflation is rolling over, people expect inflation to be on a path to coming off. The question is how fast. But on the growth side, there's much more uncertainty. If we are heading into recession, are we going to go into a soft landing? So when we optimise our portfolios, we make sure that when we put together different asset classes and this kind of growth slows down, inflation is still high, but it's a rolling off scenario, that the worst case draw down would not exceed our SRI level. And with 99% confidence. So that's how we manage our portfolio. So for people concerned about drawdowns, I think this is what we've done to make sure that the downside is protected.
Albert | 21:36
Great. And I guess on that point, I got a question here. It was asking about interest rates. Do you expect interest rates to rise much more? And because of that? which is one of our offerings?
Stephanie | 21:56
Yeah. So I think in terms of US interest rates, there will be two more meetings, I guess where the Fed will hike 25 basis points. Given what we're seeing now in the data and everything. So the Fed is expected to hike 25 basis points in March and then afterwards in May, there's going to be a second meeting. And if the Fed hikes another 25 basis points, I mean, that takes the fed funds rate to 5.1%, which is the Fed's target. We think it is quite likely that they will do the two interest rate hikes and just stay there for a while and observe the data.
In that scenario, I think if you look at Simple, Simple Plus or fixed income products right now, the yield on these products are actually quite attractive. The reason is because when we think about valuation for bonds, you need to compare it with inflation. So of course, today's inflation is still fairly high. It's around 5 or 6%. But inflation, given the Fed's tightening, should come off.
Stephanie | 23:20
And long term, if you think about longer term inflation of around 3% or even lower, and an interest rate of 4% to 5%, it's actually quite attractive because you're earning like 1% or 2%, so called real interest rate. And also, secondly, in terms of this year's environment, given all the uncertainty and potential volatility in equities, bonds tend to be a lot more stable.
When we talk about bonds, it always sounds very boring because, I mean, bonds are boring. Bonds are typically not the most colorful guys. And I guess on Wall Street that is exactly what bonds provide. They provide stability. So I think if you look into your own asset allocation, if there's more allocation to equities or more risky assets, then this year it's more thinking about, oh, should I add some more bonds to balance out the risky assets and just build a more diversified portfolio?
Albert | 24:39
Yeah, maybe for for those of you who are listening, but aren't sure what Simple or Simple Plus is. It's a cash management fund that we offer. Essentially, it's a way to earn a little bit of interest rather than just keeping in the bank and not making your excess cash work for you. So that's how you can benefit from it. And if you need to withdraw it at any point in time, there's always that flexibility. So there is no lock in period.
All right. Next question is, by this person, he says, I have a Flexible Portfolio and I have added more exposure to China and emerging markets. However, despite the gains, I guess from the past few months, the weakening dollar has negated growth. So what are your strategies on this, Stephanie?
Stephanie | 25:30
Yes, depending on your home currency, the dollar impact could be big or small. So I'll just say a few things. Number one, renminbi also strengthened against the US dollar, and that also contributed to the increase in the allocation to China in the flex portfolio. Because if you think about your portfolio, the underlying equities or underlying companies actually operate in renminbi.
So I think for that, you need look at it from a China currency versus your home currency basis. That may not have changed that much because a lot of the Asian currencies’ move was driven by dollar weakness or renminbi strength. So it kind of moved in tandem. So you need to take that into account. When you take that into account it actually occurs to you, it's not that big.
Secondly, I would say that if you have a portfolio that is predominantly home currency, maybe it includes your house, includes your other investments locally, then having some kind of exposure to US dollar can actually help you diversify your risk so currencies tends to be a kind of zero sum game.
Stephanie | 27:04
So if you look at long term charts of the US dollar, it fluctuates up and down every cycle, whenever it's an upcycle, it goes up like 25%, whereas downside comes back like 25%. So net-net over a long term basis, the currency fluctuation actually cancels out each other.
And because currency is actually quite different from equities and bonds, equities and bonds tend to go up over time because for equities you're actually earning the economic growth or the earnings growth of the company. For bonds, you're actually earning interest rates. However, FX is basically a zero sum game, it's one currency versus the other. So over time it doesn't tend to go up and it just stays flat. So of course within that there are some big cycles, but I would encourage everyone to think about their home bias, their home currency exposure versus maybe getting some US dollar.
Albert | 27:59
So that's Stephanie's view in terms of currency. And I guess the last question because we're kind of running out of time, which is a little bit more on StashAway as a company itself. So the question is, it seems like we are in everything right now. When I, I presume when this person asks and says that we're in, everything means we have different offerings out there from general investing portfolios to flexible portfolios. So, Stephanie, what is kind of the direction of the company or StashAway this year?
Stephanie | 28:30
Yeah, I certainly hope we have everything, but I guess we don't have everything. And if I look at the suite of products that we have, there's still a lot of gaps that we can still fill. And of course when we first started out in Singapore like six, seven years ago, we only had the general investing portfolios. We only had a few products. As the company grew, as our client base grew, I think we have different client needs that we're trying to serve.
So that's why we've launched Simple, Simple Plus, which has been very successful over the years for very, very ultra low risk investors. We have thematics for high risk investors now flex for people who like to just do a bit more customisation on their own. We also have BlackRock for investors looking for an alternative to the StashAway managed portfolios.
And so if I think about all the different portfolios that cater to different risk needs and different kind of investor type needs, but I think central to StashAway is still our managed portfolios and that's why we're paying so much attention to what's happening in the macro world, in different asset classes, in different regimes and data and how to enhance your managed portfolio performance as well.
So I mean, there is not a move away from being very, very diligent on our portfolio management. And in fact, we've expanded our investment team quite a lot by hiring people or hiring senior macro analysts and quantitative analysts to take care of the portfolios for everyone. So, I think it's a good change or a good kind of evolution for the company to have more products on our platform. But I think we're also increasing our resources so we can actually look after all the products.
Albert | 30:36
All right. So that's a little bit of insight into our company, Stashaway. But anyway, our time's up. And thank you so much to everybody for tuning in. Thank you for your questions. Thank you, Stephanie, for sharing your thoughts. This is the live market commentary event for February. We will be doing another one next month. So we'll see you all in the meantime. Thank you again. Do stay safe and take care, everybody.
Stephanie | 31:08
All right. Thank you. And we'll talk again soon.