This year so far has been tough for investors with very high volatility. Rate hikes, the Russia-Ukraine conflict, and the rising fears of a recession — the 3Rs — are gripping our attention.
What sets the macroeconomic backdrop today is record-high inflation that is hurting our finances. Meanwhile, various economies are still emerging out of Covid-induced uncertainties. The concerns over slowing growth now is clouding the markets.
Samuel Rhee (Chairman & Chief Investment Officer at Endowus) and Sin Ting So (Chief Client Officer at Endowus) shared at a recent webinar some perspectives on impact of geopolitical conflict, inflation, rate hikes, and how investors can position themselves to weather the current volatility and inflationary pressures.
A very rare year with both equity and fixed income down
Sam: It has been a difficult year for investors as almost all major asset classes have suffered losses - Equities, Fixed income, even cryptocurrencies like Bitcoin have suffered, only commodities were spared. This is an unprecedented year where we've seen massive negative returns for both bonds and equities. Equities are in the double digits and bonds are around the 10% mark as a global aggregate.
Sam: As you can see from this dot graph, this is very rare. This situation is not common. It is a very unprecedented environment that we are in. I have been in this industry for 28 years. I have seen multiple crises and cycles. But I have never seen equities and fixed income have a protracted, extended negative period like this time. A lot of this is due to the unique circumstances that we are in – Covid, Ukraine war, rising interest rates and inflation. So we need to unpack this and understand the driving factors behind markets and what is next going forward.
Sam: We hope that today's session will be helpful in gaining understanding and a better perspective of what's driving things and also why we can't give you a very simple answer to everything but we'll try to explain as much as possible. Do also remember that all of this is also coming off of a very aggressive 2021 in especially the equity markets where literally we had virtually no correction all the way up, except for one correction of five percent. But we pretty much ended the year with a double-digit return. Ever since the Covid Crisis from March 2020 where the market fell 33 percent, we have been nowhere near that. We're now down less than 20 percent, but because we had a very good year in 2021 that's why this year looks especially painful, especially after two years of positive returns.
Major asset classes down except for commodities
Sam: If you look at the breakdown, it really seems like nothing has been spared. The only thing that is up is actually commodities for obvious reasons and no one could have predicted that right because commodities were a terrible performer for the past two several years over the past decade. It did have blowouts for a couple of years but everything else is negative — From Bloomberg global aggregate, which is the broad fixed income index, to equity like the equities all country world index.
Sam: Even in Bitcoin and Crypto. Some people were saying that they can hide in crypto with 20% yield thinking that it's not correlated to traditional assets. Instead, it's perfectly correlated with very risky assets and it's actually a higher beta which means that it rises more but also falls much more. Furthermore, Bitcoin itself is also generally the best performing cryptocurrency.
Sam: Nothing has been spared in other than commodities and if you really break down commodities itself, you realise that a lot of it was just driven by a single thing. Energy which is driven by oil. Utilities are traditionally seen as a defensive dividend providing sector and everything else is negative. But even utilities are hit by energy prices so you know over the long term there's really nothing that has been spared in this downturn which is very unusual and what many could not have predicted.
Exacerbation of inflation by the Ukraine-Russia war
Sam: The Ukraine-Russia war has caused significant pressures on supply side inflation, especially for commodities; soft commodities and oil. That has really hit global markets quite hard and has led to inflation surging, reaction from central banks, and as a result, the d-rating of tech and growth in the equity markets as well. So the risk of default in credit markets is what spilled over into the fixed income market with rising interest rates, impacting bond returns.
Are Value stocks coming back in the next decade?
Sam: It looks like growth has massively underperformed value but note that this is the recent trend year to date and you can see that there's been a big difference in performance. But if you look at the long term again providing you with a long-term perspective of growth versus value, you can see back in 1999 and 2000 - I wanted to show that because that was the tech bubble and growth massively outperformed but from that moment in 2000 all the way to 2010, value outperform growth for a whole decade. But from then to 2020 and actually because covid got extended and exacerbated to 2021, at the end of 2021, growth massively outperformed for another decade plus.
Sam: So the question we're asking is if value is coming back over the next decade like it has done you know a decade at a time, or is this instead just a blip and growth is going to come back. This fundamental deep almost-philosophical question is actually really important. It's not just about tech versus non-tech, but instead it's actually value versus growth and it's a very important factor to understand. The long-term average if you break through multiple decades is actually 1.36 and we're still above that at about 1.75. If this has to normalise the long-term trends, then we have a little bit more to go in terms of value our performance growth.
How rising interest rates and inflation can impact Fixed Income allocations
Sam: Let's start with the fixed income market overall. We have to understand that interest rates have been falling for decades, and so has inflation. Therefore bonds have had a massive bull run because bond prices move directly inversely with interest rates. If interest rates go up by one percent, and the duration of the bond is one for example, then it would rise by one percent. So bonds, together with this falling interest rates, have had one of the longest bull runs in history.
Sam: This is not something new. We have actually seen this cycle play out before. In 2018, bond yields rose from virtually zero post the global financial crisis. From there, it edged up slightly to 0.5 and 0.75. Then in 2017, there was the tightening and then 2018 we had the Fed rate hikes and we went up to 3, which is where we are now. So we have had this cycle just two to four years ago now and this would have been a normal cycle but covid was the one that really really hit us.
Sam: The underperformance in fixed income markets this year has been unprecedented and mainly driven by current and future Fed rate hikes. Due to the hike in interest rates, losses that are normally recovered because of coupons and other interest rates have been neutralised and all of it is marked to market losses on bond pricing, driving the fixed income underperformance. Market yields have factored in most of the “future” Fed rate hikes – US 10 Year Treasury have surpassed 3%. Current market pricing sees the Fed increasing interest rates to 2.5% - 2.75% by the end of the year. If the Fed’s increase outstrips this expectation, fixed income markets would be hurt again.
Sam: However, framing these short term losses in a long term macro view of bond prices, we still see that the long term performance trend is still intact. Bonds historically have never lost money on a 2-3 year rolling basis. They have also outperformed as an asset class significantly, in any recessionary scenario and when interest rates are cut to stimulate growth. Bonds thus still play an important role as a diversifier of risk during high market volatility.
Sam: Long-term yields have recently seen the sharpest rise in decades. If inflation stays high, it’s not unusual to see yields remain high. However, the bulk of the loss that would have normally been slowed by coupons would already be realised due to the sharp rise of interest rates, and markets have already factored this into the pricing of bonds.
Is there an impending recession? Or worse, stagflation?
Sam: According to the Bloomberg’s MLIV survey, the chances of recession this year is still low (15%). Growth is slowing, and that’s definitely clear because 2021 was a special year. Due to Covid, 2020 was a massive negative year and due to the base effect, we had a high number in 2021. Naturally, we are bound to see growth slow. Though the US has just published a negative quarter, it is unlikely that we’ll see two consecutive quarters of negative growth. So most people are expecting a recession next year in 2023.
Sam: Consumer confidence is at its cyclical lows, being comparable to that of the 2008 Global Financial Crisis and the lows of the 1970s-1980, but this seems to be a mismatch with our balance sheets. The consumer balance sheet is at the healthiest it's ever been. Even in Singapore, consumer deposits and balance sheets are at a historical high. So while we’re concerned about consumer sentiment, the reality of our balance sheets and our job security in terms of employment is actually solid. Earnings have also been surprisingly good and have beat expectations for 7 consecutive quarters now. Admittedly, expectations would have been lowered progressively and earnings are beating lower expectations, but nevertheless it's still something that is positive for the markets.
Sam: Stagflation is usually accompanied with 3 indices: slow economic growth, rising prices (high inflation) and high unemployment. While growth is slowing and inflation is present, unemployment still remains low. Views on the likelihood of stagflation are thus mixed.
What can investors invest in to weather current market volatility & inflationary pressures?
Sam: We’re always searching for the next best thing and sometimes our emotions get in the way. That’s why passive investing is important and this is why people understand the benefits of diversification. Having a clear defined plan and sticking to it is essential.
Sam: Assets like REITS are highly leveraged to economic growth and negatively correlated to inflation, so it is not a good space to be in when inflation goes up. U.S equities in general have done poorly. It’s highly leveraged on growth; so if growth is great and inflation is high, equities do really well. Conversely, the inverse would yield negative returns for equity investors.
Sam: Gold, commodities and even EM bonds and EM currencies have positive correlation with inflation and negative correlation with interest rates. So, emerging markets in general might be something that we can start looking at again. Places where valuations are cheaper and below long-term averages are Japan, Europe and recently China, so these are areas that could be looked into.
Sam: But I would say that fundamentally, diversification is still the only free lunch in finance. The benefits of diversification are still relevant. It is very rare for fixed income and equities to both do badly, so diversifying your portfolio is important because it’s impossible to predict the best asset class every year.
About the speakers
Samuel Rhee is Chairman of Endowus, a leading digital wealth platform in Asia. He is the former CEO and CIO of Morgan Stanley Investment Management in Asia, with 27 years of institutional investing experience in Singapore, Hong Kong and London.
As Endowus’ Chief Investment Officer, Sam heads the Investment Office and ensures holistic portfolios for every investor, including the Endowus ESG Portfolios — the first of its kind in Asia. He is also responsible for the company’s asset allocation and investment selection across all offerings.
He is a firm believer that individuals should have access to the same knowledge and resources that are made available to institutional investors. With this vision, Sam passionately advocates digital adoption in wealth services by creating an interactive and seamless user experience, and making investing and smart financial planning easy and painless.
Endowus solves the biggest problems of wealth and investing, and retirement adequacy, leading to the firm becoming the first and only digital advisor for CPF investing in Singapore.
So Sin Ting is the Chief Client Officer of Endowus, a leading digital wealth platform in Asia.
Prior to Endowus, Sin Ting had spent close to a decade in the wealth management industry at leading banks in Hong Kong and Singapore, including Morgan Stanley and Nomura.
In her current role, Sin Ting aims to make investing accessible and bring best-in-class investment products and solutions to retail and accredited investors at scale. She leverages her extensive wealth management experience to deliver the best digital customer experience for all investors by building a seamless onboarding process and efficient multi-channel customer support. By combining an intuitive, customer-centric platform with an advisory fee-only model, she believes that Endowus truly places the customers’ needs at heart.
Despite her experience in wealth management, Sin Ting found it challenging to manage her personal wealth in a holistic manner. She hopes to spread financial literacy and enable investors to make informed decisions about their own financial future.
Click here to get started with Endowus and know more.
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