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Investors should expect more pain before relief

Khairani Afifi Noordin
Khairani Afifi Noordin • 8 min read
Investors should expect more pain before relief
Given the current market conditions, it is unlikely that investors would start seeing a recovery in the short term. Photo: Albert Chua/The Edge Singapore
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With a narrow path to a “soft landing”, investors should brace themselves for more pain before the relief of a potential bull run, say the speakers at The Edge Singapore’s Mid-Year Investment Forum — “Unmasking Opportunities”.

As the US Federal Reserve (Fed) continues its wrestle with inflation at more than four-decade-highs, the central bank has taken an increasingly hawkish stance and is likely to rate hikes more aggressively moving forward, says Mizuho Bank head of economics and strategy Vishnu Varathan during the panel discussion.

“If the interest rate hikes get to between 3% and 3.5% in the middle of next year, there is one third of a chance that a recession would take place,” he adds.

In early May, the Fed’s benchmark interest rate was raised by 0.5 percentage points to between 0.75 and 1% — the largest since 2008. More rate rises are expected, with the Economist Intelligence Unit expecting the Fed to raise rates seven times in 2022, reaching 2.9% in early 2023.

Despite this, Varathan says that there are several caveats to the assumption, which includes whether the Fed would change its path along the way or remain static throughout.

“Over the past 10 to 15 years, one of the biggest changes of the Fed is that they no longer just look at inflation by itself, they could also look at how the markets are doing.

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“If markets start tumbling really fast, they get cold feet and pull back. A very perverse outcome would be — a financial turbulence will take place but a recession is averted. There could be many permutations to this but the simple numeric answer is one in three chances,” says Varathan.

He adds that the Fed tightening should pose a bigger risk to Singapore investors compared to China’s downside pressures to growth, as the former pervades a lot of markets and asset classes whereas the latter’s economic woes are more self-contained.

China’s economy took a hit from its zero-Covid policy, which has caused constricted supply chains, dampened demand and stalled manufacturing. The world’s second largest economy has targeted full-year growth of around 5.5%, but data published in April showed that its 1Q growth slowed to 4.8%.

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Given the current market conditions, it is unlikely that investors would start seeing a recovery in the US stock market in the short term, says Paul Ho, UOB Asset Management’s senior director, Asia Pacific equities. “If [Varathan] is right and the interest rate continues to go up, with a third chance of the US going into a recession, I think investors should expect a bit more pain before the relief.”

Varathan concurs, although he expresses concerns for a bull trap, referring to a temporary reversal in an otherwise bear market that lures in long investors who then experience deeper losses. “Bear markets are very famous for episodes of correction followed by rallies. The markets are not going to make it easy for us in the next few months … If the Fed is going to trade dollar liquidity, and they’re going to step it up by Q3, I expect more volatility to persist which means things will get a bit murkier and harder to predict.”

‘Crashes are common’

Although rising inflation and rate hikes may translate to lower valuations for growth companies, Ho says that there are still long-term opportunities in Asia tech stocks. Acknowledging that the tech sector is facing a downtrend, Ho suggests value investors take a step back and see the big picture in tech investing, as crashes are common over the past decades.

Using Amazon.com to illustrate his point, Ho says that someone who invested in the stock during the pre-dotcom bubble would have experienced declines close to 60% twice before a 95% crash in the year 2000. Similarly, in 2003 and 2008, investors again saw about 60% decline each time.

“Investing in Amazon is long and painful. But even if investors did not buy at the bottom — let’s say they are late and bought it at US$10 per share — the recent peak is above US$3,000, which would have provided them with 300 times returns. Hence, for all long-term investors out there, enjoy the ride and try not to lose too much sleep,” says Ho, citing a famous quip by Charlie Munger how he had his Berkshire Hathaway stock decline by 50% three times, albeit he is only 98 years young.

In his presentation titled “Future of Asian tech stocks”, Ho highlights two promising areas of Asia tech — semiconductor and platform companies. Over the years, Asia has come to dominate the semiconductor manufacturing industry, with semiconductor contract manufacturers in Taiwan, China and South Korea commanding 52%, 17% and 12% of the global market share respectively.

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Within the Asian semiconductor industry, Ho says that there are huge opportunities in the “fab-less” or the integrated circuits (IC) design companies. In fact, four of the top 10 IC design companies in the world in terms of revenue are based in Asia — MediaTek, Novatek Microelectronics, Realtek Semiconductor Corp and Himax Technologies.

Even the companies that are not based in Asia have some strong Asian connection, Ho points out. Lisa Su, as CEO of Advanced Micro Devices (AMD), helped turn it from an Intel wannabe into a serious competitor. Nvidia, under Jensen Huang, was transformed from a cheap graphics card maker to the powerhouse today. Both Su and Huang are Taiwanese-Americans. Broadcom, previously known as Avago Technologies, was based in Singapore before relocating its headquarters to the US. Under Penang-born CEO Hock Tan, it has become one of the more acquisitive tech deal makers around.

As these companies mainly design the chips, they run a very high-margin business that outsources the manufacturing to companies like Taiwanese Semiconductor Manufacturing Co (TSMC), Ho explains.

“These companies have very high ROEs, generate lots of cash flow over time and pay a lot of dividends. When I started covering this industry about two decades ago, many of these Asia IC design companies were very small. Eventually, they grew much larger and only a few dominant companies are left, which means they do not face a lot of competitive challenges. In the audio devices area, for example, Realtek is a very dominant player,” says Ho.

Within the Asian platform companies, Ho cites names such as Grab Holdings, Goto Gojek Tokopedia and JD.com. Despite being hardly profitable, these companies provide a very strong network effect — referring to a concept that the value of a product or service increases when the number of people who use that product or service increases, Ho explains.

Post-pandemic opportunities

In Singapore, some counters have enjoyed the benefits of the Covid-19 restriction easing, on top of the economic and border reopening. This includes travel and tourism-related counters.

In the US, however, the “hype” surrounding the post-Covid-19 opportunities is dying down, says TD Ameritrade Singapore trade desk manager Leonard Eng in his presentation titled “What does post-pandemic US economy look like”. The US Centers for Disease Control and Prevention has allowed for fully vaccinated individuals to travel domestically in the US without pre-testing since April 2021, which led to a boom in certain stock prices.

Today, however, the rebound hype has faded. Using the TD Ameritrade’s ThinkOrSwim trading platform, Eng explains that online travel agency Booking.com saw a surge in its stock price following the pandemic restrictions easing in the US. Despite this, the counter is now back to trading at around the pre-pandemic prices.

Using the diffusion of innovation theory, Eng explains that much of the price discovery has already assimilated. “What is remaining will be the laggard that have yet to come in. That’s where you can see the sideways movement in prices.”

As for the post-pandemic world, Eng references the three sectors that flourished after the 2008 Global Financial Crisis — media, technology and telecommunications. These sectors possess the strategic dexterity and agility to reposition themselves to take on the oncoming currents.

In the media sector, the emergence of app-based media is on the rise and has been embedded into consumers’ consumption habits. Although traditional media still exists, social media is now the norm of mainstream media for maturing millennials, who are the ones with increasing consumption power.

“For example, over-the-top content is currently being pushed up, with examples including Disney+ and HBO Max. Even Mediacorp itself has its on demand service called meWATCH,” says Eng.

To look out for media companies that will evolve in the next frontier, investors should observe whether they are pushing out their own content and apps as well as whether they are driving additional distribution channels through the apps, says Eng.

He highlights that telecommunication companies such as Comcast, AT&T and Verizon are stepping into spaces of content creation and distribution via its sub brands, blurring the lines between the sectors they are operating in. “Amid the post-pandemic work location flexibility, these companies have also shifted their attention to providing better home-based solutions and applications,” says Eng.

Within the tech sector, Eng emphasizes “enablers” that help businesses with their digital transformation journey to gain digital dexterity. The enablers include household names such as IBM and Accenture, that augment their current businesses with digital divisions or undergo a digital transformation themselves before applying what they learnt for their clients.

New players gaining foothold will be the blue ocean specialists like Cognizant, whose specialty includes cloud and migration to cloud-based systems, says Eng. Among others, Cognizant has partnered with supermarket retailer NTUC Fairprice to conduct a digital transformation of the latter’s businesses.

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