(Apr 5): More words of caution from the US Federal Reserve on the US economy as well as weak manufacturing data from around the world triggered yet another bout of investor panic over recession fears in March, albeit a relatively short-lived one, as it turns out. That said, we could very well see a repeat of similar volatility in the coming weeks and months.
The sharp selloff in equities also sent global bond prices broadly higher as investors sought out less risky havens. Yields, which move in opposite direction to prices, fell across the board. According to Bloomberg, roughly one-fifth of the world’s bond market is now back in negative yield territory. For a brief period, another segment of the US Treasury yield curve inverted — this time, the 10-year versus three-month bills.
I had articulated on the shape of the yield curve in February. The Fed sets the short-term interest rate while investors determine yields on the long-dated bonds via market prices.
The steepness of the yield curve reflects investor expectations for inflation and economic growth and, by association, policy rates. The latest drop in long-dated yields is driven mainly by renewed recession fears. In addition, rates were already low to start with, following years of quantitative easing.
But, as we have witnessed time and again, expectations can change direction very quickly and may or may not come to pass.
No doubt, there is a slowdown in global economic activities — in China, Asia and Europe — borne out by weakness in underlying data. And the US is certainly not immune to the negative feedback.
For starters, the global economic slowdown will affect US corporate earnings, especially those of MNCs. Case in point: Recent sales numbers for companies such as Apple and Tiffany & Co fell short of market expectations, attributed to weaker Chinese spending. US corporate earnings for 1Q2019 are forecast to contract 3.9% y-o-y, which will be the first decline since 2Q2016.
The US economy will slow with the waning effects of last year’s fiscal spending boost and tax cuts. Economic cycle is a fact of life — the economy is either growing or slowing at one point or other.
But I believe fears of an imminent recession are overblown and that this upcycle still has legs. Why? Because consumer spending accounts for over two-thirds of economic activities in the US. And the average US household is in pretty good shape.
US household debt made headlines after hitting a record US$13.6 trillion ($18.4 trillion) at end-2018. But the economy has been in a decade-long recovery — and household debt to GDP has actually been falling steadily. It peaked at 98.6% in 2007, just before the US Great Recession, and has been trending lower since then. It is currently at 71.3% (see Chart 1).
More importantly, debt servicing as a percentage of disposable income has dropped to the lowest levels in decades — to 9.8% in 2018 compared with a high of 13% in 2007. In fact, it is now hovering well below levels that prevailed in the past four recessions (see Chart 2).
Gains in per capita disposable incomes and wages have gathered steam as the labour market tightened. Per capita disposable income grew at an annual compound rate of 3.7% from 2014 to 2018, compared with 1.9% from 2009 to 2013. Unemployment has been falling steadily since hitting 10% in October 2009 and now stands at 3.8% (see Chart 3).
Debt servicing is also falling, owing to historic low interest rates. Yields on the 10-year bonds — a key reference rate for bank loans — are now hovering around 2.5% (see Chart 4).
Thirty-year fixed-rate mortgage in the US is currently barely above the 4% level, which should bode well for future home sales. Consumers have been actively refinancing mortgages, given low interest costs.
The most noticeable drivers behind the increase in total household debt in the past 10 years are student loans (compound annual growth rate of 8.6%) and car loans (CAGR of 4.9%). Total mortgages outstanding, on the other hand, have yet to return to the peak levels in 2008.
The rise in student loans could suggest workers going back to school/acquiring new skill sets during the high unemployment years. A better-skilled employee base bodes well for future productivity gains.
In any case, as the portion of disposable income required to service borrowings drops, it leaves more for US consumers to spend and/or save. Incidentally, personal savings rate has rebounded from the lows in the run-up to and during the global financial crisis years (see Chart 5).
The Global Portfolio gained 3.2% last week, mirroring the rebound in global markets. Some of the notable gainers include Malayan Flour Mills, Apple and Ausnutria Dairy.
Shares in recently acquired Hartalega Holdings, one of the biggest and most profitable glove makers in the world, performed well too. Its share prices have corrected quite a bit in the past few months as the market factored in expected short-term pricing pressure (owing to industry capacity expansions) and reversal of the ringgit-USD rates from 4Q2018.
With most of the negatives priced in, the sector could be ripe for a turn in sentiment. In particular, I expect the sharp drop in liquefied natural gas (LNG) prices to soon lead to cheaper gas and electricity prices.
The non-power sector is paying nearly RM33 per mmbtu for natural gas while Asian LNG spot prices are hovering around US$4.50 per mmbtu. Even after factoring in regasification and distribution costs, we should be looking at cheaper energy costs. Glove makers are among the biggest consumers of gas in the country.
The drop in Asian LNG prices, compared with this time last year, is driven by excess supply with new facilities coming onstream and warmer-than-expected winter demand. But I think the price downturn will be more enduring beyond short-term demand-supply mismatch.
The US has an abundance of low-cost shale gas (currently trading well under US$3 per mmbtu) that has only recently started to enter the global market. And it is disrupting the staid gas market dynamics, typically based on long-term contracts linked to oil prices.
US LNG export terminal capacity is expected to double in 2H2019-1H2020 as ongoing projects are progressively completed and more are expected to be completed over the next few years. Significantly increased purchase of LNG could be part of the trade deal between the US and China, which could displace current suppliers. We should see prevailing price disparity between the US and the rest of the world narrow.
Last week’s gains are significant, lifting total portfolio returns (since inception) back into positive territory. By comparison, the benchmark MSCI World Net Return Index is up 4.4% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
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.
This story appears in The Edge Singapore (Issue 876, week of Aug 8) which is on sale now. Or subscribe to The Edge now
