The world’s two most closely watched stock market bellwether indices, the Standard & Poor’s 500 and Dow Jones Industrial Average, recorded a string of all-time highs in recent weeks. This is despite rising concerns over the strength of the expected global economic recovery amid a Covid-19 resurgence, which should have a dampening effect on stocks. That said, the outperformance of US stocks was not without reason, especially if we look at the flow of funds for different countries so far this year (see Chart).
Clearly, not all stock markets are performing as well as those in the US. We have previously written about how the pandemic has underscored the gaping divide between the rich and the poor. Rich, developed countries such as the US, UK and members of the European Union are able to implement huge monetary and fiscal stimulus measures to buffer the negative impact of the pandemic. They have secured most of the vaccines available and inoculated the majority of their populations, paving the way for faster economic normalisation and recoveries. Their economies are expected to rebound strongly this year, from 2020’s steep contraction.
This divide will widen further as rich countries now move towards giving their populations the third, booster, shot, even as those from the poor nations have yet to receive their first dose.
Meanwhile, most emerging and low-income developing countries are now grappling with the worst wave of infections that is resulting in downward revisions to their GDP growth forecasts. The Delta variant is hitting Asia particularly hard, leading to the reimposition of stringent movement restrictions in many countries, including China. The latter’s strict adherence to a zero-Covid strategy will affect not just the country’s short-term economic outlook and that of its major trading partners in the region, but also the rest of the world, which will face disruptions to supply chains and logistics.
This divergence in short-term economic growth prospects between advanced and emerging-developing countries is a major reason that funds are flowing out of the latter and into the former. And this trend could persist for some months to come.
Cumulative net fund flows (since 2020) remain deep in the red for key Asean countries. The inflow of funds slowed noticeably for Indonesia in July while outflows intensified for Thailand, the Philippines and Malaysia. Taiwan, India, Japan and South Korea also saw heightened foreign fund outflows last month.
On top of this, rising and significant regulatory risks in China have spooked many foreign investors. Unsurprisingly, the Hong Kong stock market suffered the biggest foreign fund outflows in this region. The Hang Seng Index is among the worst performing of the major bellwether indices so far this year — following a massive selloff in Chinese Big Tech companies such as Alibaba Group Holding, JD.com, Baidu, Pinduoduo, Meituan and Tencent Holdings.
The Chinese government is tightening regulation across multiple sectors — including real estate, fintech, food delivery and ride hailing — for anti-trust violations, data privacy and cybersecurity. It is also targeting for-profit businesses seen to be promoting social ills and inequality, such as platorms offering private after-school tutoring and companies involved in gaming, alcohol and e-cigarettes.
Alibaba was fined a record US$2.8 billion for violating anti-monopoly rules in April 2021 — after the high-profile IPO of its associate Ant Group was scuppered last October. Food delivery giant Meituan is also said to be looking at a hefty fine for monopolistic practices. Shares in Didi Global tumbled shortly after its IPO (on June 30), when the government initiated a cybersecurity review and its app was removed from app stores. Some analysts fear that the company could be slapped with penalties more severe than that imposed on Alibaba. But the most draconian measure yet was the ban on profits for all private tutoring enterprises, in effect destroying the entire business model in one pen stroke.
At this point, no one knows which sector or business will be next in the firing line. Indeed, the Chinese government has signalled that its goal to increase regulation for key industries could last for years. The resulting unpredictability will dampen foreign investor sentiment on China-based stocks for the foreseeable future — even if valuations look attractive after the selloff and the Chinese market is still expected to grow rapidly.
The current downbeat sentiment on Chinese stocks and the broader emerging markets will change and reverse, at some point. For now, the outlook for US stocks appears far more attractive, relatively speaking.
There is a lot of talk about the US having hit peak GDP growth in 2Q2021. This is true — after all, last quarter’s 12.2% y-o-y growth was measured against the easy comparable — the lowest point in pandemic-stricken 2020. But the fact remains that the US economy is expected to register one of the most robust GDP growths in the world this year, estimated at 7% by the International Monetary Fund (IMF). The July jobs report showed strong employment gains, with the unemployment rate falling to 5.4%. Huge excess household savings are driving the recovery in consumer demand, especially for the beaten-down services sector. And domestic consumption accounts for more than two-thirds of economic activities.
Indeed, market analysts believe US GDP growth could outpace that of China’s for several quarters. The latest clutch of statistics out of China — including investments, retail sales and industrial production — suggests that recovery in the world’s second-largest economy is slowing, after having rebounded much earlier last year and against the current backdrop of Covid-19 resurgence and retightening of restrictive measures. The IMF pared its 2021 GDP forecast for the country by 0.3% in its July World Economic Outlook update, from the estimate made in April 2021.
Corporate earnings in the US are beating expectations at record rates. Corporate America is benefitting from pricing power amid the robust pent-up demand — operating margin for the S&P 500 companies is at the highest since 1993.
Monetary and fiscal conditions remain very supportive and, let us not forget, there is massive — and growing — liquidity in the world. Major central banks, including the US Federal Reserve and European Central Bank, are still pursuing extremely easy monetary policies and large-scale bond purchases. A case in point: It was recently reported that the Fed was taking in record amounts of investor spare cash, exceeding US$1 trillion, under its overnight reverse repurchase agreements facility, which pays a paltry interest of 0.05%, upped from 0% in June.
The nominal yield on the benchmark 10-year US Treasury note has fallen below 1.3% (at the point of writing), down from its recent peak of 1.74% on March 31. This means the real yield (adjusting for expected inflation) is deep in negative territory. Are bond investors that pessimistic on US economic growth over the next decade? If so, this would be an ominous signal for stocks. Or is it more the case of excessive cash competing for yields and, in the process, driving them lower and lower? As we have explained before, there are very rational reasons for investors to keep buying bonds, even if they earn negative real returns.
We know a significant portion of all that liquidity has gone into real estate and financial assets and, in the process, driven up asset prices almost across the board (including for highly speculative assets such as cryptocurrencies and meme stocks). These gains, which need to be reinvested, are further perpetuating a positive feedback loop. All that money has to find a home.
Like sentiment on Chinese and emerging market stocks, liquidity created by extreme monetary policies will reverse — the Fed has started to “talk about talking about tapering and rate hikes” and nominal yields should move higher in time. Consequently, a strategy more focused on stock-picking could outperform one that bets on a continuation of a broader market rally.
For the near term, however, and with bond yields falling anew in recent months, stocks remain one of the best games in town. And that, we think, is a big reason that US stocks have not had a significant correction in months — every pullback has been met with investors “buying the dip”.
The Global Portfolio fell 1.8% for the week ended Aug 18. Shares in Alibaba Group Holding fell sharply on news of further government regulations tightening, closing down 10.3%. Other big losers included General Motors Co (-6.3%) and Taiwan Semiconductor Manufacturing Co (-4.8%). At the other end, ServiceNow (+2.1%), Johnson & Johnson (+2%) and Microsoft (+1.3%) were some of the notable gainers last week. Total Global Portfolio returns since inception now stand at 58.9%. This portfolio is outperforming the benchmark MSCI World Net Return Index, which is up 56.1% over the same period.
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