Helicopter View: 3Rs of 2022 to big R of 2023
2022 was a story of 3Rs – shot-at by Russian invasion of Ukraine: sending energy shocks to the world; brutalized by Rate hikes: shooting up of 1-year US Treasury rate from 39 bps to 473 bps (1113% increase!) resulting in the worst G-sec returns in 238 years! and resurrected by Re-opening of China with tailwinds from inflation downticks.
Today, the bond yields are highest since 2008 with xxxx index yield at x.xx% as against xxx index dividend yield of x.xx%.
Figure-7: Attratrive??? yield across asset classes
Historically, higher bond yield at the start of investment results in higher investor returns
As seen over past 20 years, the bond yield is by far the most stable and reliable component of total return from bond portfolios, as follows:
- Source: Bloomberg, Schwab Research
Figure-2: Fixed income returns broken down by price and yield over the past 20 years
Inflation glides down, Unemployment still low
The headline inflation has dropped from peak of 9.1% (in Jun’22) to 7.1% (in Nov’22) but the core inflation continues to be elevated and sticky around 6%. The largest component of core inflation is “Shelter” (c. 40% weight) sample data is collated only twice a year, hence lags prevailing rents by about 8 months. The sharp rise in mortgage rates (c. 7%) has induced the sharpest fall in property prices in 11 years, which in turn is feeding into sharp drops in property rents. The impact of this will be seen US CPI from late Q1 2023 onwards.
Figure-3: US Inflation
While the labour demand peaked in the spring of 2022, it is still elevated with 1.7 job openings for every person unemployed, forcing companies to raise wages to attract workers. Historically, Fed has stopped rate hikes when the unemployment rate has been around xx%.
- Source: UBS Research
- Source: Bloomberg
Figure-4: Job market and wages have peaked but remain elevated
Interest Rates peaked?
The markets have already priced-in peak Fed interest rate of nearly 5%. Hence, unless the peak Fed rate expectation changes, the impact of Fed rate increases would be minimal. However, Fed balance sheet reduction (QT of $95bn per month), and normalization of monetary policy by ECB and BOJ will back-stop any sharp drop in yields.
Investing prior to the final rate hike has provided strong returns
Historically, the fixed income yields have always peaked just before the last Fed rate hike, and investing in bonds for a year starting six months prior to the last Fed rate hike has provided a 5-year annualized total return of 5.9% to 15.6%.
Figure-5: Five-year annualized total return for that first 12 months plus four more years
Relatively lower risk
It is one of the rare times that US is entering into slowdown / recession on such a strong footing:
US Consumers have about US$ 1 trillion of excess savings from US Covid largesse;
Corporates: The Investment Grade companies have very low Net Debt to EBITDA ratio of 2.1 times, even High Yield corporate have Net Debt to EBITDA of just 3.6 times;
Banks’ balance-sheets are one of the strongest since the 2008 GFC.
As a result, the corporate defaults are below 0.84% as against long term average of 1.5% . Mathematically, fixed income investors are being paid two-to-three times more than that attributable to the risks they are taking.
- Source: JPMorgan
Japanese investors own $2.4 tn of foreign investments ($1.2 tn US Treasuries). Increase is effective yen yields will induce inwards flow of these investments.
- Source: Capitalgroup
China again a global growth engine?
In past 50-days, China has removed most Covid restrictions and the Chinese population is learning to live with Covid like rest of the world, which underpins the Politburo’s 5% economic target for 2023.
The CNY 1 trillion ? economic stimulus, primarily targeting the real estate sector, support to technology sector, and removing hang-over over Macau gaming sector, provide further boost to Chinese credits.
While reopening is a process, and not an event, but given very attractive valuation, Chinese assets have high alpha generation opportunities.
Nov’22 Performance: Out-performance
As the tides started turning, the quality and resilience of Silverdale portfolios shone. For December 2022, the Bloomberg Emerging Markets Asia USD Corporate Total Return Index was up by about XXX% (YTD -XXX%); while our flagship Silverdale Bond Fund NAV increased by XXX% (YTD -XXX%) and various fixed maturity funds increased between +XX% to XX%.
Takeaway: 2023 – The Year of the Bonds
Today’s elevated bond yields offer an attractive entry point and provide huge cushion to handle price volatility. The uneven growth rates provide compelling opportunities for active managers to uncover via bottom-up research and security selection.
Inflation has moderated, and Fed rate hikes are likely to peak in the not-too-distant future. Given the inevitable slowing of the economy with looming big “R” of recession, the bonds would provide relative stability and income.
Our flagship Silverdale Bond Fund (SBF), continues to be positioned to take advantage of high carry offered by quality bonds, with XX% high quality Investment Grade bonds, duration of XX years; yet, providing leveraged YTM of XX%, pointing to higher potential returns to investors. FMP2026 points to low double-digit net leveraged returns, and FMP August2024 targeting high single digit net leveraged returns.
DISCLAIMER
THIS COMMENTARY IS AN INTEGRAL PART OF AND SHOULD BE READ ALONG WITH THE FUND FACTSHEET FOR DECEMBER 2022. 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 on the basis of 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 independent professional adviser before taking any decision based on this document