Helicopter View
November 2022 was one of the best months for bond markets in the past 35 years with Silverdale Funds out-performing most of the relevant indices. Positive market sentiment was driven by the trilogy of Fed’s expected slowing down of rate hikes, China’s change in policy tone, and the Ukraine issue taking back seat.
Peak Inflation & Slowing Rate Hikes
October’22 witnessed a further slowing down of Headline Inflation from peak of 9.1% (in June’22) to 7.7% (against est. of 8%) with Core Inflation at 6.3% (est. 6.5%).
The markets celebrated the positive CPI surprise with 3-year treasury yields falling by 24 bps to 4.20% and 10- year treasury down by 37 bps to 3.68%. The markets are now pricing slow the pace of rate hikes starting next month with peak Fed rate of circa 5% in 1H-2023.
Looking ahead
The largest component of Core Inflation is Shelter (c. 32% weight), which is expected to remain firm into 2023 because the way it is constructed (the sample data is collected only every 6 months) hence lags rents by about 8 months). However, stripping out Shelter, Core CPI fell 0.10% month-on-month in October 2022 (first decline since May 2020).
Figure-1 CPI’s shelter component lags housing market indicators
Further, the money supply (M2) has also slowed down significantly at levels consistent with 2% inflation, albeit with marginal increase in money velocity.
Figure-2 US Money Supply decreased 1.5% over the last 7 months
The strong dollar making imported goods ‘cheaper’ and the base effect of elevated Core CPI (almost 0.6% MOM during Oct’21 – Feb’22) will to provide headwinds to current Core CPI figures.
Labour market showing signs of cooling
Labour market is cooling down with 3-month average non-farm payroll addition dropping from 600k (Q1-2022) to 280k (Oct 2022). However, in the past 16 Fed rate hiking cycles since 1954, the average unemployment rate at the time of Fed’s last rate hike has been about 5.7% (currently, 3.7%). Hence, the ride to normalcy is likely to be longer than usually expected.
Figure-3: Job market and wages have peaked but remain elevated
Consumer & Corporate remain strong
Household debt service ratio (debt-to-disposable income) is near historic lows; read with robust corporate fundamentals (see Silverdale October 2022 Commentary), the default rates are low and are likely to be remain lower than previous rate hike peaks.
- Source: Compound Capital Advisor
- Source: Fidelity Asia
Figure-4: Household debt service ratio
China: Change in policy
On 11/11, China announced 16-point comprehensive plan to support property sector backed it by almost US$ 1 trillion of bazooka credit lines and cutting of bank reserve requirements (RRR) by 25 bps. Additionally, China started relaxing its ZCP (Zero Covid Policy) by avoiding the wholesale city-wide shutdowns while preparing for expected surge in Covid cases (targeting 10% of hospital beds to be ICU beds). The markets cheered the move with Shanghai index up circa 7% and China HY USD Bond Index up about 15% MTD.
With reopening, China reported highest ever Covid cases, while still low at cumulative rate of 0.02% as against global average of 8.1%. This is likely to be followed by a sentimentally bad surge in mortalities. Hence, China re-opening is likely to be slow and bumpy.
Figure-5: China Covid Cases
Nov’22 Performance: Out-performance
As the tides started changing, the quality and resilience of Silverdale portfolios shone. For November 2022, the Bloomberg Emerging Markets Asia USD Corporate Total Return Index was up by about 7.5% (YTD -19%) and Bloomberg Emerging Markets US Corp (1-3 years) Index appreciating by 2.16% (YTD -10.04%); while our flagship Silverdale Bond Fund NAV increased by 7.49% (YTD -22.27%) and various fixed maturity funds increased between +2.5% to 7.7%.
- Source: JPMorgan Research
- Source: Standard Chartered Research
The Takeaway: Goodbye TINA, welcome BoB
Since 2009, 91% of the time, the Fed rates were below 2%, as a result the investors has to accept TINA (There Is No Alternative) and embrace riskier assets. Currently, the bond yields are higher than S&P Equity Dividend yield???. Hence, savvy investors are calling on BOB (Bring on Bonds) resulting in one of the highest inflows into fixed income markets in 2022.
In 2023, as investors’ primary concern shifts from economics of rate hikes to politics of rate hikes (govt treasury bearing the MTM losses and interest burden) and Recession starts biting, the fixed income asset class will outshine other asset classes as SPACs, venture capital, private debt, equities, etc. (see Silverdale August Commentary).
Figure-7: Bond returns in 12 months following the peak of yields
Our flagship Silverdale Bond Fund (SBF), continues to be positioned to take advantage of high carry offered by quality bonds, with 76% high quality Investment Grade bonds, duration of 1.54 years; yet, providing leveraged YTM of 18%, 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 NOVEMBER 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.
- Source: Edward Jones Investments
- Source: Bloomberg, JPMorgan Research