SINGAPORE (Apr 24): While opportunities exist for savvy bargain-hunters amid the doom and gloom of the Covid-19 pandemic, investors must prepare for the risk of further market volatility. Some of this volatility could be accentuated as the US “weaponises” the greenback to secure its political and economic interests.

Amid gloomy forecasts of a recession, Chris Brankin, CEO of TD Ameritrade Singapore, is looking at a V-shaped economic recovery. His reasoning: pent-up demand and trillions of dollars in government stimulus will repair the economy. After all, the S&P 500 has rebounded by more than 29% since its low on March 23 this year.

Brankin’s prognosis comes after the Federal Reserve Bank of New York forecast a 31% chance of recession in the coming year. The International Monetary Fund (IMF) expects a global recession, starting in 2020 and concluding in 2021, while the Monetary Authority of Singapore (MAS) predicts a potential economic contraction of –1% to –4%.

Investors seem to be brushing aside those gloomy forecasts. “Last week was the best week for US stocks since 1974. Think about that: according to many economists and financial pundits, we are most likely headed for a global recession,” said Brankin at the Virus, Oil and Politics: A Volatile Mix webinar held on April 19.

Organised by The Edge Singapore and sponsored by TD Ameritrade Singapore, the event featured three panellists – Brankin; Vishnu Varathan, head of macroeconomics and strategy atMizuho Bank; and Nirgunan Tiruchelvam, head of consumer equity research at Tellimer.

The market weakness artificially caused by the outbreak has been met with countermeasures from policymakers. But are they enough to stave off a deep recession and support a recovery?

Varathan is not as upbeat. He believes that the recovery is likely to be more tentative — with
firms remaining in cash-preservation mode as the global economy gradually eases back to full production, the rebound in the real economy will instead resemble a U-shaped curve (though asset markets could rebound more quickly).

“Unlike the [Global Financial Crisis] where it was about freeing up liquidity and rebuilding confidence, this time is slightly different as it has to do with things like social distancing [where] there will be a lot of interruption,” he predicts.

A study by Harvard’s T H Chan School of Public Health notes that intermittent social distancing may persist into 2022, thereby crimping normal consumer behaviour and spending.

The big short
Nevertheless, the panellists see the downturn as an opportunity for value investors to pick up
undervalued counters in resilient sectors. The fact that the bear market now is caused by external shocks rather than weak fundamentals means there is a growing list of solid counters at bargain valuations.

Tiruchelvam highlights three broad categories of stocks to look out for. First, he encourages investors to buy “stay at home stocks” suchas home entertainment, social media and e-commerce. Second, they may want to short-sell stocks in vulnerable categories like hotels and airlines,and finally, be aware of “blow ups” — fraudulent firms whose unethical behaviour may be exposed by the financial pressures of the pandemic.

“The iconic home entertainment stock right now is Netflix. The levels of downloads and usage have increased three or fourfold in the last six weeks,” said Tiruchelvam. “Netflix, Facebook, Amazon and other stay-at-home businesses have outperformed the sell-offs. That shows that these businesses have some merit in a market of this nature.” 

Emerging market e-commerce has also outperformed the market in light of tighter lockdown measures. Smaller e-commerce firms could, however, face liquidity challenges as a result of burning cash flow to increase revenues, making cash-rich established players like Alibaba — with its stronger balance sheet — safer bets than younger firms like Sea, the internet company that owns gaming platform Garena and online shopping portal Shopee. 

Tiruchelvam further warns investors to stay clear of businesses that have no inventory (e.g. airlines), since this would lead to difficulty postponing sales as they cannot stockpile their products for future sale. Firms that have high fixed costs (e.g. cinemas) or are heavily leveraged may also quickly run into cash flow problems as the pandemic carries on. 

“In such a scenario, investors need to display a Michael Burry-type insight,” says Tiruchelvam, referring to the protagonist of the 2015 movie, The Big Short, who famously persevered with shorting the US housing market in the face of criticisms from his own investors. “They need to delve into the details of companies to identify the sort of companies that are going to be vulnerable in a situation of this nature.” 

Meanwhile, although the Singapore REIT asset class is likely to perform promisingly, following the MAS raising its gearing ratio to 50%, Tiruchelvam warns that certain REIT types such as commercial and mall REITs will face pressure from severely diminished consumer spending. Data centre REITs, however, are likely to do well owing to the rise in internet usage due to lockdown measures. 

Scraping the bottom of the barrel 
Brankin also highlights consumer staples as a popular sector to invest in during the pandemic, as people tend to cook at home rather than go out for meals due to lockdown measures. In addition, healthcare stocks (e.g. biotech, pharmaceuticals) are in high demand as a result of a global scarcity of medical supplies and efforts to develop a Covid-19 vaccine, though Brankin warns investors against falling into “irrational exuberance”. 

“When you see stocks [that] are not wellknown healthcare or pharmaceutical-type companies, I would take a closer look at them before I put a large portion of my investment into any of these companies that I do not know much about,” he warns, drawing parallels with the damaging ramifications of the dotcom bubble in the early 2000s, when new, unknown internet companies were chased after indiscriminately simply because they have a “dot com” in their names. 

Investors are also recommended industrial, financial and energy stocks. Brankin observes that industrials will be “coming off the bottom” as global manufacturing slowly recommences, while well-capitalised and government-backed financial institutions like Bank of America and JPMorgan have begun to recuperate from a mass sell-off (40% of US banks counters) when the US Federal Reserve slashed interest rates to nearly zero in March. 

Energy stocks have, however, been “the bog of the S&P 500” as a result of the RussiaOpec price war and a global drop in demand, which has led to low oil prices falling into unprecedented negative levels on April 20. With Russia and Opec having now agreed on cutting oil production and businesses slowly resuming operations, energy stocks like ExxonMobil and Chevron, and firms servicing the energy sector like Halliburton and Slumberger could find themselves making a comeback. 

Though Varathan did not provide any specific sector recommendations, he urges investors to consider long-term consumer behaviour changes after Covid-19. Sectors where behaviours caused by the pandemic prove “sticky” could experience extended post-Covid valuation differences. 

“[For] behaviour post-Covid, I think it will be a function of three things,” he says. “How well will balance sheets hold up? ... How confident are we even as we come through the recovery… and finally it is also about preferences — which behaviours have changed.” 

“Decisions made out of fear or greed typically don’t turn out so well for many in the long run,” says Brankin. “Not staying invested means missing out on most of the long-term market upsides.” 

Debauching the US dollar? 

Meanwhile, Varathan warns investors to prepare for greater foreign exchange volatility ahead. With the Fed implementing “QE infinity”, strengthening network effects could see the greenback being “weaponised” to advance Washington’s political and economic interests. 

With the US dollar serving as the world’s reserve currency, it is used in most global economic transactions, and a measure of value. This creates network effects that make it difficult for the global economy to move away from the dollar, allowing US regulatory sanctions and monetary policy to be used as leverage against global economic actors. 

At the height of Covid-19, investors fled traditional safe haven assets such as the Japanese yen, US Treasury bonds and even gold, in order to hold greenbacks, highlighting its status as the world’s ultimate safe haven currency. “When people say cash is king, what they really mean is that the US dollar is king,” quips Varathan. 

“What’s perverse is that because there are a lot more US dollars printed [because of QE infinity], there will be a lot more US dollar-assets also created, and the world buys into this. As the world buys into this, the network effect of the dollar increases and the dollar’s grip increases, [which] lowers the costs of weaponising the dollar.” 

While countries like China would ideally like to challenge the dollar’s hegemony, Varathan notes that such attempts are unlikely to succeed due to China’s existing capital controls and the Chinese yuan’s lack of network effects. He points out that despite Beijing’s attempts to strengthen the global influence of the yuan by starting the Asia Infrastructure Investment Bank and obtaining reserve currency status in 2016, the US dollar remains strongly hegemonic in global markets. 

As global geopolitical tensions pour more fuel on economic nationalism, it is very likely that the US may resort to dollar weaponisation within an increasingly competitive geoeconomic order. This could potentially create significant foreign exchange volatility for investors going forward, especially considering Washington’s track record of “weaponising the dollar” at the Plaza and Louvre Accords. 

Entrenched path dependencies and high switching costs renders the international community unable to dislodge the hegemony of the greenback, while the potential political gains of weaponisation will likely prove irresistible for US politicians. “We cannot de-weaponise a weapon…we need to be price takers and brace ourselves for the realities of the dollar being weaponised to varying degrees,” says Varathan.

Investors must therefore prepare for not only elevated dollar volatility, but also significant capital market volatility in the emerging market and high yield space. Consequently, there will likely be a rise in demand for hedges against fiat currencies like gold, bitcoin, hard currency and assets as the market loses confidence in paper currency. Investors must also better anticipate potential geopolitical risks arising from dollar weaponisation. 

“Right now, markets are between chasing liquidity and then wanting to hunker down to protect against certain extreme risks. This is going to challenge the view on assets,” Varathan concludes.