Navigating Volatility : Strategic Positioning Amidst Mixed Sentiments
Feb 7 , 2024 | 3min read
2024 started off well for US Equities as S&P 500 Index reaches all-time high. US economic indicators released in January, showed a resilient US economy admittedly with inflationary pressure seemly under control and abating. On the flip side, we have China, the 2nd largest economy in the world, reeling as the scepticism over China assets is spreading beyond stocks, with investors expecting the yuan and government bonds to underperform in a year when the Federal Reserve’s dovish pivot is set to buoy emerging markets. This force China’s authority to cut banks’ reserve requirement ratio (RRR) by 50bps aimed at boosting market sentiment.[1] However, this lasted barely a day or two as HK and China’s equities markets continues to show weakness.
Meanwhile, concerns about geopolitical risks in the Red Sea have left investors anxious about the potential escalation of conflicts in the Middle East. Global markets are also closely monitoring elections worldwide, and so far, the outcomes have generally aligned with market expectations. Notably, Taiwan experienced some turbulence but thankfully without any major incidents. In January 2024, U.S. Treasury yields rebounded from the sell-off in December 2023, with the benchmark 10-year rate rising from 3.79% on 27 December 2023, to 4.18% on 24 January 2024[2]. However, they later edged lower towards the end of January 2024 following an unexpected reduction in the US Treasury's quarterly estimate for federal borrowing in the current quarter to $760 billion[3].
Views on Fixed Income
The United States is currently witnessing a noticeable downward trend in inflation, and the labour market still appears consistent with a soft landing. Looking at where the futures are trading, there is still a market expectation for the Fed to implement aggressive rate cuts in the upcoming year, with the initial cut likely occurring in June 2024.[4] As base rates are believed to have reached their peaks and the Fed leans towards easing, the appeal of cash as an asset class is waning. The prevailing belief is that fixed income has the potential to deliver strong returns through possible capital appreciation in this easing environment.
However, we hold the view that market is currently pricing in rate cuts too aggressively. We urge investors to stay cautious and we continue to favour short-duration investment-grade bonds. Amidst the recovery of China, we expect beneficial effects arising from the adoption of the "China Plus One" supply chain model, as multi-national companies continue to explore ASEAN as an alternative manufacturing source.[5] Sector wise, we favour financials which include banks and utilities while focusing on high quality issuers that may perform well in a slowing economy.[6]
Views on Equities
Investors may expect improved returns from China equities in 2024 . After experiencing a downward trend three times consecutively, the China stock markets appears poised for a reversal. This is attributed to extremely low foreign investor positioning and various tailwind factors that support the potential for upward movement. David Lai, Partner & Co-CIO of Premia Partners, highlights crucial considerations for seizing opportunities in China's future prospects. He also references Charlie Munger's concluding remarks, emphasising the positive outlook for the China’s economy is more promising than that of nearly any other major economy and China’s top companies are stronger and better than any other countries’ leading companies at a much attractive valuation.[7]
Sentiments in global markets have reached extremes, characterised by extreme optimism towards the US and Japan and extreme pessimism surrounding China. This sentiment is, to some extent, shaped by straightforward projections of the economic cycle, envisioning the US continuing its current path known as the "Goldilocks" scenario, and Japan sustaining earnings growth driven by currency depreciation. This dynamic aligns with the metaphorical concept of the cycles of "fire and ice".[8] Investors may want to secure some of their profits and retain a portion of available funds, anticipating increased volatility in the coming months.
Views on Currency
A strong start for the dollar as we saw the U.S. Dollar Index (DXY) recovered from the low of 100.91 (27 December 2023) back to 104 (23 January 2024) as traders rushed back into the dollars after a string of stronger data[9] as traders took dollar higher as yields started to spike further and remained well supported with an eye on the conflicts in the middle east. However, towards the end of January, DXY eased somewhat to 103.55 (30 January 2024) as the FED FOMC (31 January 2024/1 February 2024) comes into play even though market consensus is for the FED to hold rates, FED Chair Powell statements will be an important one which could set the tone for the dollar direction in the short term. Market is still pricing in a 46.6% chance that the U.S. central bank will begin cutting in March 2024, dropping from 73.4% a month ago, according to the CME Group’s FedWatch Tool.[10]
It's noteworthy that volatility has dropped significantly since December 2023 with the stronger dollar. Funding currencies had mixed performances, the Swiss Franc (CHF) strengthen on risk aversion associated with the “Red Sea” debacle and the poor EUR performance relative to CHF. The Chinese Yuan (CNH) was back to the weaker side while Japanese Yen (JPY) remains weak after BOJ retained their policy rates unchanged while there seems to be a disagreement on the timing of on possible normalising of the rates. Here is our perspective:
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Japanese Yen (JPY): No significant change, and given the yield difference, it's unlikely the JPY will appreciate much. Meanwhile Japan's jobless rate fell to 2.4% in December 2023 from the previous month, government data showed on (30 January 2024), just under economists' median forecast of 2.5% in a Reuters poll given bullish JPY some hope.[11] Potential range is expected to be between 145 and 150.
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British Pound (GBP): BOE starts Feb with a policy meeting (2 February 2024), but market feels they are likely to adopt a wait and see attitude with a slightly hawkish bias. More consolidation ahead and potential range of 1.25-1.30 with some biasness on the downside.
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Euro (EUR): Policymakers seem to be in disagreements on the exact timing of a cut or the trigger for action, although that hasn't stopped traders from fully pricing a move in April 2024. Nothing new here as Euro continues to trade on the weaker side in a lower sideways pattern. Potential range is 1.06-1.10.
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Swiss Franc (CHF): The currency is likely to consolidate around the 0.85-0.88 range.
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Australian Dollar (AUD): We think AUD may have seen a bottom despite China’s issues. Possible range 0.6450-0.6850.
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Chinese Yuan (CNH/CNY): Both the offshore and onshore Chinese Yuan are likely to consolidate on the weaker side, with agents banks holding the weakness in check. Potential range 7.15-7.25.
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Singapore Dollar (SGD): Given Singapore Dollar Nominee Effective Rate (S$NEER) is currently positioned at top quartile of its +-2% band, we see SGD’s valuation as still rich, and look for a partial pare back. Potential range 1.3250-1.3600.
Source:
[1] China’s RRR Cut Doesn’t Solve Long-Term Economic Concerns (msn.com)
[2] 10 Year Treasury Rate (ycharts.com)
[3] 10-year Treasury yield ends lower as traders await jobs data, Fed decision this week (msn.com)
[4] Fed to cut in Q2, probably June; economists less dovish than markets - Reuters poll | Reuters
[5] Focus on ASEAN-s longer-term potential (eastspring.com)
[6] J.P. Morgan Asset Management. Data as of end-Dec 2023
[7] Final Thoughts From Charlie Munger on Warren... | Morningstar
[9] DXY history — Timeline of major events — TradingView
[10]Dollar keeps tight ranges ahead of Fed, jobs data | Reuters
[11]Japan December jobless rate falls to 2.4% | Reuters
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