We sold some stocks in the Global Portfolio last week (before the sharp selldown in the US markets on Tuesday), primarily to raise our cash holdings. Following the disposals, cash now accounts for roughly 43% of total portfolio value. To be sure, the US and global stock markets have seen more stability in recent weeks, recouping some losses from the steep selloff in 2Q2022. However, we are cautious that markets may still have more downside risks from hereon, including from weaker corporate earnings.
Although earnings expectations in the US have seen some downward revisions following the latest reporting season for 2Q, the 5.5% reduction for 3Q estimates from end—June is relatively modest. Furthermore, average net margin for S&P 500 companies, though slightly pared down, remains high at 12.3%, in part, because macroeconomic conditions in the US remain quite strong. However, the probability of a global recession is rising, especially in Europe, which is facing an energy crisis. Eventually, weaker global growth will feedback negatively into the US economy and corporate earnings and margins (according to FactSet, 40% of S&P 500 revenue are derived from overseas).
As we have previously explained, US households are, on average, in (too) good financial shape and consumers have kept spending, even as inflation rises. Plus, the labour market is still very tight, with approximately two job openings for every unemployed worker currently. Workers are demanding higher wages. Unemployment rate, at 3.7%, has barely budged and is still near 50-year lows. This is partly attributable to low labour participation rate, currently 62.4%, which remains below the pre-pandemic level of 63.4% in February 2020.
All these are, no doubt, complicating the job of the US Federal Reserve, which needs to lower demand for goods and services, and bring down inflation. The central bank may be laying the groundwork for a third consecutive 75-basis-point rate hike in its upcoming policy meeting, slated for Sept 20-21 — if only to ensure future expectations for inflation remain anchored. Indeed, we believe it will err on the side of caution — including inflicting economic pain — to prevent the possibility of a wage-price spiral, as what transpired through the 1970s. (We will write more on why we suspect the current supply-demand imbalance — in the labour market and broader economy — will lead to recession, perhaps stagflation, next week)
We think the current optimism that the US economy would emerge largely unscathed may be misplaced. Interest rate hikes take time for their impact to filter through the economy. Quantitative tightening (QT) has only just begun — in June 2022, and stepped up in September. Although the pace and quantum of QT is far more gradual and in smaller amounts than the two years of quantitative easing (QE) during the pandemic, reduction in liquidity must have some reversal effect on asset prices.
One of the stocks we disposed of was Airbnb. We like the company, as a beneficiary of reopening and recovery in travel demand. And it did deliver its most profitable 2Q results yet last month. Revenue grew 58% y-o-y and was up 73% from that in 2Q2019, driven by pent-up demand in North America and Europe. Demand from the Asia-Pacific region remained depressed. Average daily rate (ADR) for bookings was 40% higher as compared to 2Q2019, thanks to price appreciation and better sales mix. Airbnb’s operating income improved from a loss of US$51 million in 2Q2021 to a profit of US$383 million in the latest quarter — handily beating market expectations. The company guided for another record revenue for the current 3Q2022.
Despite the upbeat results, however, its share price had stayed quite flattish — likely due to prevailing negative sentiment for highgrowth stocks, even profit-making ones. Airbnb’s valuations are higher than the market average, estimated at about 40 times earnings for 2023. As mentioned above, we think the Fed will lift rates beyond current market expectations, and keep them there for longer. If so, sentiment for growth stocks could remain downbeat in the foreseeable future.
We also sold off our holdings in Bank Rakyat Indonesia, for a small loss. Its loan book in 1H2022 grew 9% y-o-y, driven by a 15% y-o-y increase in micro and ultra-micro loans. Net interest income grew at an even higher rate of 18% y-o-y, on the back of wider net interest margin. Combined with a 24% y-o-y fall in provision expenses, the bank’s net profit was up 98% y-o-y. In short, the bank is doing well so far — but we are cautious of the potential for a bigger fallout from rising US interest rates on emerging market currencies and economies.
Meanwhile, earnings for Chinese companies are hit by the country’s stringent Zero-Covid policy where new outbreaks and lockdown measures are continuing to affect tens to hundreds of millions of its population at any point in time. It is hurting consumer confidence and spending, and raising pressure on businesses, large and small. The sudden lockdowns, quarantines and mass testing are very disruptive and costly to business operations. China has since abandoned its modest 5.5% GDP growth forecast for the year.
We sold our holdings in Chinasoft, whose profits fell in 1HFYDec2022, hit by weaker margins as a result of the difficult operating environment. The company’s key customer, Huawei, reported a 52% drop in profits in the first half of this year, and intends to scale back non-core businesses to preserve profits and cash flow. As such, Chinasoft, which provides IT outsourcing services to Huawei, would face some headwinds in the near term.
Alibaba’s revenue in 1QFYMar2023 was flattish y-o-y, while its operating profits fell 19% y-o-y — as Covid-19 restrictions affected contributions across most business segments. Profits from biggest income contributor, the China commerce segment, fell while losses from logistics outfit (Cainiao), digital media and entertainment as well as innovation initiatives and others widened in the quarter. The e-commerce business was affected by supply chain disruptions in April and May. Gross merchandise value (GMV) generated on Taobao and Tmall declined 5% during the quarter. Although there were signs of improvement beginning in June, renewed widespread lockdowns in parts of the country will prove a challenge.
Positively, losses from its local consumer services segment narrowed, from RMB4,770 million a year earlier to RMB3,044 million in 1QFY2023, due to improved unit economics per order for its food delivery business. Ele. me’s economics per order turned positive during the quarter, thanks to higher average order value, lower delivery cost per order and optimisation in user acquisition spending.
On the other hand, revenue growth for the cloud segment was affected by the loss of one of its top internet customer ByteDance’s international business as well as softening demand from customers in China’s internet and education industries. The 10% y-o-y revenue growth for the segment was mainly contributed by non-internet industries such as financial services, public services and telecommunication industries. Operating earnings fell 27% y-o-y to RMB247 million due to investments in technology, as well as increases in co-location and bandwidth costs.
We are uncertain if and when China will shift from its current hard stance on the pandemic. But Alibaba will be a main beneficiary of any government stimulus measures for consumer spending and easing of restrictions, with more than 900 million annual active customers in China. Plus, valuations are low. The company’s current enterprise value of RMB1,232 billion is only 7 times its China commerce segment’s TTM adjusted earnings of RMB175 billion.
Following the sale of Airbnb, our only remaining US stock holding is Apple. Apple’s revenue in 3QFYSep2022 grew 2% y-o-y on the back of 12% y-o-y growth in services revenue and 1% y-o-y decline in product sales. iPhone sales, which contributed around half of the company’s revenue, were resilient during the quarter, growing 3% y-o-y. Sales of Mac and tablets declined 10% and 2% respectively, due primarily to supply chain constraints caused by the Shanghai lockdown. The only notable slowdown in demand was from its wearable, home and accessories sales, which dropped 8% y-o-y.
Increases in subscription numbers drove the double-digit y-o-y growth in services revenue. Total number of paid subscriptions across Apple’s platform hit 860 million in 3QFY2022, up 160 million y-o-y and 35 million q-o-q, as the company continued to improve the breadth and quality of offerings on Apple TV+, Apple Arcade, iCloud and Apple Music. Services revenue from China also grew strongly during the lockdown as people spent more time at home. There was, however, a slowdown in digital advertising during the quarter due to the macroeconomic environment.
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Despite higher revenue, Apple’s operating income fell 4% y-o-y mainly due to a 19% y-o-y increase in research and development expenses and an 11% y-o-y increase in selling, general and administrative expenditures. CEO Tim Cook indicated that the company will continue to invest through the downturn but will be more deliberate in doing so.
Looking forward, a slowdown in the global economy and strengthening of the US dollar will hurt overseas contributions for multinational companies. Nevertheless, we think Apple’s loyal and higher-income customer base should fare better than many of its peers. This is evident in gains in iPhone sales, which bucked the broader downtrend — global smartphone shipments fell 9% during the June quarter.
With over 1 billion unique iPhone users and 1.8 billion installed devices, Apple has a large pool of potential customers for its subscription services. Contribution of services to overall revenue has been increasing, from 14% at end-2019 to 21% in the latest quarter. Increasing contributions from services can improve the company’s profitability in the long run due to its higher gross margin (71% in 3QFY2022) as compared to the products segment (35% in 3QFY2022).
The Global Portfolio declined 0.5% for the week ended Sept 14, led by losses from Guangzhou Automobile Group (-3.5%), Commercial Bank for Foreign Trade of Vietnam (-2.1%) and Apple (-0.4%). On the other hand, DBS Group Holdings (+3.3%) and Yihai International Holding (+0.6%) closed higher for the week. Total portfolio returns since inception now stand at 19.6%, trailing the MSCI World Net Return Index’s 34.9% returns over the same period.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.