Overview
US Federal Bank rate hikes result in economic slowdown in about 18 months and in increase in unemployment in about 24 months from the first-rate hike, that is, by June 2023 and Dec 2023. In case of slowdown, the best performing asset class is fixed income.
Inflation reaches valley
US headline YoY CPI fell from 9.1% (Jun’22) to 4% (May ’23) and is further expected to drop below 3.5% in Jun’23. In the absence of erstwhile base effect, thereinafter, the rate drop is unlikely to be material. The YoY Core inflation continues to be stickier at 5.3% in May’23. Hence, as project in Figure-1, the 2% inflation target is unlikely to be achieved in next 12 months. Hence, the comment of Fed Chair Powell that rate cuts should be expected only in 2025.
Figure-: After Jun’23 YoY comparison becomes less extreme so the headline inflation path may not move one way
Labor: strong but fractured
A decline in job openings from very high levels, the slowdown in resignations, and lower hours worked per week pointed to slower job growth.
Due to ageing population, the labor market normalization will be gradual. The 50+ age group workers that left the workforce during Covid are unlikely to return. Given uncertainty of economic growth, businesses prefer plug-and-play experienced workers reducing the demand for 19-29 age group rookies. Also, the women participation is unlikely to increase. Further, the drop in immigration during Covid and Trump era, has aggravated the situation. Nevertheless, cracks in market are seen with marginal decline in job openings, drop-in hours per week worked, and inching-up of unemployment rate to 3.7% in May’23 (from 3.4% in April’23).
Central banks signal the market
The core function of a country’s central bank is to signal the market to (re)act in the desired fashion. Hence, while the dot-plot provided 16 of 18 FOMC members saw further tightening necessary and provided for two more rate hikes this year, the rate hike was put on a pause to allow the rate hike impact to work through the economy, to reduce inflation expectations and signal the market not to front-run interest rate cuts. Hence, the dot-plots are likely to be inaccurate in the magnitude and timing of rate hikes, as seen in Figure-2.
Figure-: Actual Fed Fund Rates vs Historical Dot Plot
For record, in December 2021, the Fed dot-plot projected December 2023 interest rate to be 1.6% (as against actual interest rate of 4.75%???)
Economy cooling down
We mentioned in our May month’s commentary, as per Fed’s Senior Loan Officer Survey, about 46% of banks have tightened lending standards with 62.3% increasing their loan spreads. The Year-To-Date number of defaults spiked to xxxx (2022: ???; 2021:???), yet the default percentage of high yield is 2.3%?? below long-term average default rate of 4.4%, and is likely to peak around 5.1%??. This is the reasons detailed in earlier Monthly Commentaries, in particular strong corporate, consumers and bank balance-sheets.
Figure-???: Since 1972, the bonds have historically performed well during recession
Fed study postulates Equity is over-valued
As per Fed’s research discussion paper: End of an Era: The Coming Long-Run Slowdown in Corporate Profit Growth and Stock Returns: “Lower interest expenses and corporate tax rates mechanically explain over 40 percent of the real growth in corporate profits from 1989 to 2019. In addition, the decline in risk-free rates alone accounts for all of the expansion in price-to-earnings multiples. I argue, however, that the boost to profits and valuations from ever-declining interest and corporate tax rates is unlikely to continue, indicating significantly lower profit growth and stock returns in the future.” Hence, the coming era, fixed income is likely to relatively other asset classes.
China: Calls for stimulus intensify
The target for China GDP growth at 5% is far higher than 2%?? for US and 1%?? for Europe. However, its tepid post-Covid recovery fueled by weak consumer confidence, geopolitical tensions, and unwillingness among corporates to invest, is crying for Govt stimuli.
High current yields 🡪 higher investor returns
As mentioned in our xx Monthly Commentary, the current high starting yields offered by high-quality bonds imply high potential future returns, with significantly less volatility and good downside protection compared to equities.
Figure-: Higher starting yields have led to better returns for investment-grade bonds
Borrowing cost: 3-year < 1-year
Savvy investors can not only lock-in high yields provided by quality bonds but also further enhance the returns by leveraging it. For relatively conservative investors, they could consider fixed tenure funds which provided enhanced returns using embedded leverage.
Silverdale Positioning: Rainbow Ahead
Silverdale Funds are optimally positioned to benefit from the high carry offered by quality bonds enhanced by use of prudential amount of leverage, without recourse to the fund investors. In Silverdale Bond Fund we are steadily and selectively increasing our duration to generate higher return without material impact due to rates widening.
Silverdale Bond Fund (79% high-quality Investment Grade bonds with leveraged YTM of xxx%) as well as our several Fixed Maturity Funds, have out-performed the indices and peer group.
In view of strong investor interest, we have launched: Silverdale Fixed Maturity Fund Oct 2026.
We are grateful for your confidence in us.
DISCLAIMER
THIS COMMENTARY IS AN INTEGRAL PART OF AND SHOULD BE READ ALONG WITH THE FUND FACTSHEET FOR MAY 2023. This document is written for the benefit of and is being communicated exclusively to Accredited Investors or Institutional Investors as defined under the Securities and Futures Act (Cap. 289) of Singapore. The above commentary does not provide a complete analysis of every material fact regarding the market, industry, security, portfolio, or any Silverdale fund. It is not a recommendation to buy or sell any security nor an investment advice. The portfolio holdings, opinions and information may change without notice and the actual results may differ from the said opinions and estimates. The contents of this document, including any narrative, does not constitute an offer to sell or a solicitation of any offer to buy the units or any Sub-Fund or class of the Silverdale Fund VCC (the “Fund”) or any of the funds managed or advised by Silverdale Capital Pte Ltd., and is strictly for educational purpose only. The distribution of the shares of the Fund may be restricted in certain jurisdictions. It is the responsibility of the person or persons in possession of this communication to inform themselves of, and to observe all such restrictions, all applicable laws, and regulations of the relevant jurisdiction, including of any applicable legal requirements, exchange control regulations and taxes in the countries of their respective citizenship, residence, and domicile. Any subscription for units or shares must be made solely based on the Fund’s private placement memorandum, applicable class supplement) and Subscription Documents (together “the Offering Documents”). Past performance is not an indicator of future performance. The Fund uses leverage and invests in financial derivative instruments. Please refer to the Offering Documents for Risk Factors. Nothing in this document is intended to constitute legal, tax, securities or investment advice or opinion regarding the appropriateness of any investment, or a solicitation for any product or service. Please seek opinion from an independent professional adviser before taking any decision based on this document.