This article first appeared in Capital, The Edge Malaysia Weekly on May 9, 2022 - May 15, 2022
WITH economies reopening, as many parts of the world began their transition to Covid-19 endemicity, investors were expecting 2022 to be a lot better than the previous two tumultuous years.
But with the Russian invasion of Ukraine and surging commodity prices that are driving aggressive quantitative tightening across the world — which, in turn, have stoked fears of a global recession — this year is shaping up to be very different from what many initially anticipated or are comfortable with.
The worries about an economic slowdown sent the S&P 500 and Nasdaq Composite to new 2022 lows in the last week of April before staging a comeback. In fact, the Dow Jones Industrial Average and S&P 500 had their worst month since March 2020, while the Nasdaq saw its rockiest month since 2008.
In a May 2 commentary, BlackRock Investment Institute — the research unit of the world’s largest asset manager BlackRock Inc — remains “overweight” on equities amid an inflationary backdrop that saw the US Federal Reserve hike interest rates by 50 basis points last week to rein in surging prices, although it acknowledges mounting challenges such as the energy shock and China’s growth slowdown.
In particular, it is overweight on stocks in developed markets (DMs) for their supportive fundamentals, robust earnings and low real yields. “We see many companies in DMs well positioned in the inflationary backdrop, thanks to their pricing power. We prefer those in the US and Japan over Europe,” it says.
While BlackRock Investment Institute sees Chinese equities as being more risky, improved valuations leave it moderately overweight on them. “China’s ties to Russia have created a new geopolitical concern that requires more compensation for holding Chinese assets, we think,” it adds.
The research unit is “neutral” on emerging market equities, given the more challenging restart dynamics, higher inflation pressures and tighter monetary policies in these markets.
The Edge asked several fund managers about their investment strategy in this climate and the sectors they are focusing on. Some of them also shared what they did right, or wished they had done differently, last year.
Co-chairman and co-chief investment officer
Value Partners Group Ltd
(Assets under management [AUM]: US$8.3 billion as at March 31)
Most energy and commodity stocks already reflect the rising commodity prices, and I wouldn’t recommend chasing them. The biggest challenge for long-term investors is how to keep ahead of inflation, with sharply rising prices having become a global problem.
For Malaysian investors looking to diversify, Chinese stocks could be attractive. Despite the country’s recent struggles with the Omicron variant, China has not resorted to a “whatever it takes” approach. Rather, it still exercises tight social and financial discipline. China still has room to cut its domestic interest rates, while countries like the US are forced to raise rates to fight inflation.
Chinese stocks fell after the government’s recent campaign to regulate businesses. But now, the government has changed its emphasis to stimulating economic growth. The China market (MSCI China) is currently trading at historical lows, with a price-earnings ratio (PER) of 10 times. This represents a significant discount to its historical PER of 16 times.
On a base case, should the China market rerate to just 12 times earnings, investors could be rewarded with an upside of 25% to 30%. A more bullish case could even see a rerating to 16 times earnings, which will present an upside of 50%. Given the current lows, the downside for investors is capped at about 2% to 5%.
With current valuations, I think investors are facing an asymmetric valuation risk/reward trade-off in Chinese stocks. It is a matter of being willing to accept short-term volatility. Even as economic forecasts are slashed, China is expected to grow about 5% this year. The long-term growth potential of the country remains intact.
CEO
Areca Capital Sdn Bhd
(AUM: RM2.8 billion)
We are holding on to our long-term strategy and staying about 70% to 80% invested in equities.
With the negative sentiment on the US Federal Reserve rate hike, China lockdown, Russia-Ukraine war and inverted US Treasury yield curve priced in, we see opportunities in some fundamental stocks for long-term holdings. We may deploy cash if prices weaken further.
We like the innovative electrical and electronics sector for long-term growth. We have also positioned for a pandemic recovery and economic reopening in selected financial and consumer-related sectors. With high commodity prices and a weaker currency, we may have [further] exposure to some exporters and industrial players.
2021 was a challenging year due to the adverse pandemic situation and rate hike rumours. We were right about some sectors, such as financial. We were too careful on commodities, such as plantation and oil and gas, which we were underweight on in our portfolio. As long-term investors, we decided to stay put with our strategy — which is forgoing short-term opportunities for long-term growth — instead of employing short-term tactical plays.
CEO
Fortress Capital Asset Management Sdn Bhd
(AUM: RM1 billion)
We are cautiously optimistic about the equity markets at the moment. We expect Southeast Asian economies to register higher growth in the immediate term, compared with North Asian and other advanced economies. A large part of this growth — although from a low base — will be from the recovery after Covid restrictions and disruptions.
In line with this, corporate earnings will improve. We believe domestic recovery will be led by the services sector, while the Malaysian manufacturing sector still faces headwinds from supply disruptions, labour shortages and logistical issues.
Sectors such as those related to tourism, food and beverage and retail are expected to be key beneficiaries. As raw material prices rise, we prefer businesses that can pass on these cost pressures, particularly those with pricing power that benefit from lower price-sensitive consumer behaviour.
We have a moderate outlook on domestic monetary policy and expect a gradual pace of tightening. We are adopting a balanced stance in our investment strategy but prefer equities over fixed income at the moment.
From a macro perspective, we favour the financial sector. Banks are typical beneficiaries in a moderately rising interest rate environment, as net interest margins recover. Concerns about asset quality will ease in line with an expected improving economic outlook, and we expect loan growth to improve. Banking stocks are offering decent dividend yields.
For lower-risk-profile portfolios, positioning in some defensive stocks that offer decent dividend yields, such as blue chips with good track records that can provide a stable income stream, is typical in a volatile environment.
Despite having a moderate growth outlook, we still like certain stocks in the technology sector due to the secular growth trends in areas such as renewable energy, 5G, electric vehicles and artificial intelligence. Having said that, short-term volatility in stock prices will remain.
In the previous year, we positioned well in stocks that would benefit from reopening and recovery plays. Although the performance of these counters was affected by frequent movement restrictions, we held on to the view that as vaccination rates improve, economic activities would recover.
Our investment in banks provided decent capital appreciation and dividend yield. In the later part of last year, we laid a good foundation for future portfolio performances as we trimmed our positions in technology stocks when valuations moved beyond our comfort level.
In hindsight, to maximise portfolio returns, we could have entered the technology space earlier, while our exposure to certain commodity stocks, such as those in the oil and gas sector, could have been higher.
Founder and chief strategist
Pheim Asset Management Sdn Bhd
(AUM: About RM1 billion)
With increased volatility in developed markets, we believe an active asset allocation strategy will add value, rather than being fully invested at all times. We seek to trim our equity exposure near market peaks to preserve capital, and only to be fully invested near market troughs. We will continue to seek companies with focused management, that enjoy high margins and earnings growth, that have low debt equity gearing and whose shares are trading at low price-earnings ratios and/or low price-to-book ratios.
Domestically, we are looking for opportunities in banking, plantation, oil and gas (O&G), technology, mining and retail. Regionally, we are looking at e-commerce, e-learning, software, cybersecurity, automation, digitalisation, artificial intelligence, commodities, furniture making, renewable energy, property development, construction, technology, electronic vehicle (EV) and EV batteries, 5G and healthcare.
In the past year, many investors had high hopes for China’s equity market, with many allocating a sizeable portion of their investment to the region. However, 2021 saw a slew of regulatory policy changes in industries related to education, technology, gaming and internet platforms, which led to a major selldown of Chinese stocks.
As early as late 2020 until the third quarter of 2021, we decided to reduce Pheim Asia Ex-Japan Fund’s (PAXJ) equity exposure to Hong Kong/China from 41.27% as at Nov 30, 2020, to 22.87% as at September 2021. That enabled PAXJ to avoid the worst of the decline in China stocks. Now that Chinese stocks have declined substantially, we are looking at undervalued sectors.
We also decided to increase our exposure to O&G and palm oil stocks last year. Given the subsequent strong run-up in these sectors, we should have increased our exposure by a greater margin.
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