Helicopter View
With UK’s U-turn on mini budget, the markets started on a positive note; however, China’s XX National Congress meet conferring absolute power to Xi Jinping led to purge of Chinese equities and bonds, with its contagion impact on entire Asian bond universe. However better than feared corporate earnings (outside of US tech), and dovish rate hikes by developed markets central banks, provided strong tailwind to the markets.
Inflation and Rates
The headline inflation has declined from 9.1% to 8.2%. However, the core inflation continues to wobble around 6.6%, led by sticky inflation in shelter and services.
US Mortgage rate of c.7% have led to over 40% drop in mortgage application, which is the highest drop ever in mortgage applications since 1997. It triggered one of the fastest drop in US house prices, resulting in sharp drop in month-on-month rentals; which will result in broader lower shelter inflation in about 8 months.
Figure-1: MOM Change in in National Rent Index (2018 – Present)
The labor market which topped at c.2 jobs per person in July 2022 dropped to c.1.7 jobs per person; led by one of the sharpest drop in number of job openings. Normalization of global supply chains, cooling of energy prices, and base effect is adding headwind to inflation.
As a result, the central banks are downshifting their tightening pace amidst “two-sided risks” (growth downside versus inflation upside risks) and “lagged-effects” (the fact monetary policy works with a lag, hence can’t be tightened right up to the point when inflation collapses).
So, while another outsized 0.75% rate hike is expected from Fed next week, Fed is widely expected to lay grounds for shifting to smaller rate hikes (as done by Bank of Canada (hike of 50 bps vs est. 75 bps) and Royal Bank of Australia (hike of 25 bps vs est. 50 bps).
- Source: Apartment List Rent Estimates, Apartment List
Figure-2: Interest Rate Cycle Positioning
It should be noted that given the trade-offs and the painful lessons from pre-Volcker era, the interest rates are likely to stay higher for longer. Traditionally, the Fed rate hikes peaks around unemployment rate of circa 5.7% (currently, 3.5%).
Robust Balance Sheet: Household, Corporate, and Banks
US households still have around $1.7 trillion in ‘excess’ savings accumulated during pandemic, out of which, around $350 billion are held by the lower half of the income distribution.
- Source: Illustrative interest rate cycle, T. Rowe Price
- Source: BofA Global, Haver
- Source: Federal Reserve, WSJ
Figure-3: Stock of Excess US Household savings by Income quartile
US household, nonfinancial corporate and small-business sectors ran a surplus of total income over total spending equal to 1.1% of gross domestic product in the quarter of April to June 2022.
Even the global high yield corporate fundamentals remain strong with interest coverage of 6x as against median of 4.5x (2011-2022), with longer debt maturities (less than 3% of Global HY matures in 2023 and only 20% matures till 2025).
Figure-4: Gross / Net Leverage Ratio and Interest Coverage Ratio
China: under microscope, but still on petri dish
Xi’s tightening grip on power and the risk of additional market unfriendly policies, let to stampede of investors fleeing Chinese markets as a result Hang Seng dropped by c. 14% and China Bond Index fell by c. 7.7% in Oct’22.
While China continues suffer from ZCP (Zero Covid Policy), widening rift with the US, growing tensions around Taiwan, and slowing GDP; the Chinese assets are cheapest they have been in decades. There is value in Chinese bonds, and we continue to monitor the situation closely (including recent roll-out of vaccination) but do not intend to increase China exposure in the immediate short term.
- Source: WSJ; Using a three-year average, the measure is healthier than on the eve of any U.S. recession since the 1950s.
- Source: Bloomberg Global High Yield Index
Oct’22 Performance: In-line with indices
For the month of October 2022, the Bloomberg Emerging Markets Asia USD Corporate Total Return Index was down by 5.63% (YTD -24.26%) led by Bloomberg Emerging Markets Asia High Yield Index dropping by 9.06% (YTD -34.41%); while our flagship Silverdale Bond Fund was down 5.39% (YTD: -27.69%) and various fixed maturity funds returned between +1% to -2.5%.
The Takeaway
Given (a) the downtick in headline inflation, (b) the politics of interest rate hikes (paying 10%-40% of national revenue collections to plug hole in securities held by treasury/central bank) and (d) central banks (including RBA, BOC and ECB) telegraphing slowing of interest rate hikes, the investors should consider locking in the current attractive bond yields.
Historically, in the 12 months after a peak in yields, bond-market returns have been positive by about 16% on an average (ref: Figure-5).
Figure-5: Bond returns in 12 months following the peak of yields
Our flagship Silverdale Bond Fund (SBF), continues to be positioned defensively, with 77% high quality Investment Grade bonds and short duration of 1.49 years yet has leveraged YTM of 21.5% providing higher potential returns to investors. Our fixed term funds (FMPs), continue to maintain adequate headroom, IRS, and be actively managed for the target returns.
DISCLAIMER
THIS COMMENTARY IS AN INTEGRAL PART OF AND SHOULD BE READ ALONG WITH THE FUND FACTSHEET FOR SEPTEMBER 2022. This document is written for the benefit of and 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 of Silverdale Fund VCC (the “Fund”) or any of the funds managed or advised by Silverdale Capital Pte Ltd., and is strictly for educational 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: Bloomberg
- Source: FactSet, EdwardJones