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Five insights in five minutes

Five in Five: Jackson Hole, China internet, Ultra short-term credit, India small caps, Covid and markets
27 August 2021

    Jackson Hole

    The biggest news in finance this week is the Wyoming Economic Symposium on Friday. And that’s saying something – the event is virtual and no one expects Fed chair Powell to reveal much. (That said, regular attendees are probably delighted not to be going. Jackson Lake Lodge has no spa, gym or salon, and everyone, central bankers and journalists alike, pays to attend.) Still, investors are advised to keep note. Over the past decade, US stocks have risen by an average of 1.1 per cent in the five days after the chair’s speech. And the topic of when the Fed will begin tapering its USD120 billion per month of bond purchases is relevant beyond fixed income, as the chart below plotting the size of the Fed’s balance sheet alongside the MSCI World index makes clear. In periods where reported holdings rose, the average annualised returns for global shares was 15 per cent. Returns are similarly robust when the Fed balance sheet doesn’t change. Shrinkage, however, coincides with periods of flat returns. A bore-fest, in other words, may be a good result for equities.

    Investment relevance: global equities, emerging market equities, fixed income

    Jackson Hole 

    China internet

    The Hang Seng Tech Index is down a quarter year to date. Ouch. That’s almost double the 13 per cent decline for MSCI China – and removing internet companies from that index reduces its loss to only a little north of three per cent. Of course, Beijing’s whole new approach to the sector has rapidly been factored into estimates of future earnings. Regulation has and always will be a risk when it comes to powerful companies – even in America. Eventually risks are discounted though, often overly so. Indeed, some Chinese tech valuations are starting to appear mightily compelling. For example, the two largest names in the internet sector now have an average price-to-earnings ratio of 23 times, not much higher than the 17 times for the overall market. Yet the duo is still expanding revenues by an incredible 40 per cent per annum, leaps and bounds above the three per cent growth of MSCI China. Such discrepancies tend not to last long, as the ten to 20 per cent rebound in many stocks over the past week reminds us.

    Investment relevance: China equities, Asia equities

    China internet 

    Ultra short-term credit

    Who doesn’t want it all: liquidity, security and yield? But gone are the days when money markets offered mid-single-digit returns. Despite the rise in longer-dated US rates, money market yields remain at historical lows. Alternatively, short duration funds offer more yield but come with a one to three-year duration, incurring additional rate and credit risks. Thus investors looking for higher returns than cash, with a modest increase in risk, should consider the middle ground, occupied by ultra short-term securities. Owning corporate bonds with a duration of less than one year, ultra short-term funds aim to remain liquid and mildly sensitive to interest rate changes. The trick is that since the decline in global interest rates, government yields now only contribute to less than half of the overall yield, against 85 per cent prior to the pandemic – as can be seen in the chart below. With credit spreads now representing the majority of the overall yield, ultra short-term performance will primarily rely on asset managers’ credit expertise.

    Investment relevance: ultra short-term credit, money market funds, global fixed income

    Ultra short-term credit 

    India small caps

    Indian equities doubling themselves since the March 2020 low is an amazing feat. But small caps outperforming large caps by another 40 per cent during the same period is just eye popping. Some attribute this superior performance to a retail buying frenzy and worry that when fevers cool, a reversal is certain. But if small caps are indeed overbought relative to larger Indian stocks, we should observe a widening valuation premium of the former versus the latter. Ever since November of last year, however, the spread between the forward price/earnings multiples of small and large caps has been dropping precipitously, as can be seen in the chart. All the while, small cap share prices are reaching ever loftier heights. In fact, the premium is now just 16 per cent, below the five-year average of 21 per cent. If it is retail investors who are responsible for the surge in small caps, at least they seem to be keeping their heads about them this time.

    Investment relevance: India equities

    India small caps 

    Covid and markets

    Events impact (and reveal) the way people think, which consequently feed into markets. Covid-19 is no exception, with studies of investor behaviour in America, China, Japan and Finland during the past two years showing that asset prices have been negatively affected by biases such as herding mentality and hindsight bias. Despite this, over-confidence now abounds. Recent surveys have investors pencilling in double digit annual returns for the next five years. Vaccinations have been a key driver of optimism in markets since January, especially developed ones. Doses have increased globally by almost 70 per cent in the past two months, according to Bloomberg data. That’s helped investors. Our strategists plotted in the chart beneath how US equities relative to bonds have moved broadly in line with vaccination rates this year.

    Investment relevance: equities, fixed income, real assets

    Covid and markets 


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