Helicopter View: Strong start
2023 started on a strong note with the Bloomberg Emerging Markets Asia Total Return Index up by 4.3%, Bloomberg Emerging Markets USD 1-3 years Corp & Quasi Index up by 1.7%, and Silverdale Fixed Maturity Funds up between 0.50% to 4.50%, with Silverdale Bond Fund appreciating by 4.8% for January 2023.
A record US$ 650 billion was invested in fixed income securities (excluding money markets) in January 2023.
Inflation continues to glide down
US headline inflation slowed for the sixth straight month to 6.5% in Dec’22, the lowest since Oct’21, from its peak of 9.1% in Jun’22. Core inflation rate came down to 5.7% in Dec’-22, down from the peak of 6.6% in Sep’22, while still at elevated levels. Core services inflation continues to be sticky, mainly due to Shelter.
Figure-1: Core CPI excluding shelter and shelter CPI
As we discussed in Dec’22 Monthly Commentary, Shelter inflation, which has circa 40% weight in core inflation, lags prevailing rents by 6-8 months, and is expected to moderate in the current quarter onwards.
- Source: JPMorgan
Figure-2: Timely measures of rent inflation have likely peaked
Drop in inflation 🡪 higher bond returns
Bloomberg consensus expects headline and core CPI to decline to below 3% YoY by the end of 2023. Over 1976-2022 when CPI decreased more than 1% YoY, Bloomberg US Aggregate Bond Index provided an average return of 6.1% (as detailed in December 2022 Commentary).
Labour market slowing down, yet strong
The labour demand has peaked but the unemployment rate remains, though very low around 3.5%. Historically, Fed pivots when the unemployment rate is near 5.7%.
US economy slowing down, yet robust
It is one of the rare times that the US is entering into a slowdown / recession on such a strong footing: (a) US consumers have circa$0.8 trillion of excess savings from US Covid largesse; (b) Corporates have very low debt to EBIDTA ratio, with Investment Grade corporate Net Debt to EBITDA ratio of just 2.1 times, and High Yield corporate Net Debt to EBITDA ratio of 3.6 times; and (c) Banks have the strongest balance-sheets since 2008. Hence, the default rates are likely to be relatively lower.
Low maturities 🡪 low defaults
US High Yields’ maturities in 2023 ($69 bn) and 2024 ($194 bn) is very low aggregating to circa 8% of the total HY market. Also, Emerging Markets’ bonds maturities in 2023 at circa $248 bn is less than 10% of the emerging economies debt market. This should also keep default level lower than the previous economic downturns.
- Source: Principal Fixed Income
Figure-3: US HY maturity schedule very low for 2 years
High Liquidity
Despite quantitative tightening by the Fed, the liquidity in the markets remains high with (a) US money market fund assets hitting an all-time high of $4.8 trillion, (b) $550 bn of quantitative easing by BoJ, in the past 6 months, and (c) $133 bn of additional liquidity, in the past 3 weeks, caused by US Treasury drawing cash from TGA (Treasury General Account) due to debt ceiling.
Figure-4 Cash Levels at All-Time Highs
Yields peak before the last hike
Historically, fixed income yields have always peaked just before the last Fed rate hike, and investing in bonds for a year, starting six months before the last Fed rate hike, has provided a 5-year annualized total return of 6% to 16% (for details refer to December 2022 Commentary).
- Source: JPMorgan
- Source: BofA Research
Figure-5: Treasury yields tend to peak before the ‘last hike’
Central banks efforts to tame inflation have reached a critical point after the sharpest rate hikes in the history. Bank of Canada (BoC) has become the first G10 central bank to state that it would likely hold off further hikes. Fed is near the peak of its tightening cycle.
As a results, yields across global fixed income have come down with a strong recovery in the fixed income market, in the month of January 2023, as follows:
Figure-6: Bonds have appreciated across asset classes
China turbocharging
The Chinese government is getting back to business with focus on growth, with (a) abandoning of zero COVID policy; (b) support for property developers; and (c) removal of regulatory headwind for the tech sector. The high-frequency data from several cities is already pointing to a strong rebound with metro-traffic, traffic congestion, sale of luxury goods, etc. close to 2019 levels.
Takeaway: The return of “Yield”
Fixed income continues to offer attractive investment opportunity, and relatively higher (risk-adjusted) returns as compared to most other asset classes’ returns. In case of economic slowdown, the increase in credit spreads would be partially compensated by drop in treasury yields; in the interim, the elevated yields would cushion market volatility.
- Source: Vontobel
- Source: Bloomberg, JPM Indices
Figure-7: Higher yields provide a cushion for unexpected moves
Our flagship Silverdale Bond Fund (SBF) continues to be positioned to take advantage of the high carry offered by quality bonds, with 75% high quality Investment Grade bonds and a duration of 1.67 years; yet, having high leveraged YTM of 12%, pointing towards higher potential returns to investors. Currently, a 4-year Fixed Maturity Fund could provide circa 9% p.a. returns.
We thank you for your trust in Team Silverdale.
DISCLAIMER
THIS COMMENTARY IS AN INTEGRAL PART OF AND SHOULD BE READ ALONG WITH THE FUND FACTSHEET FOR JANUARY 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 independent professional adviser before taking any decision based on this document.
- Source: Blackrock