● Rashmi was interviewed by Yousef Gamal El-Din on a wide range of topics, included a review of the current backdrop for markets given geopolitical stress and macroeconomic concerns. This clearly points towards higher risk premium and calls for hedges.
● According to Rashmi the upcoming borrowing plan for the US Treasury to be announced on Wednesday will be an important event. The break-up between, long term and short term needs to be closely monitored, especially given the ongoing surge in long term yields. Al Dhabi Capital is focusing on long duration as they find current yield levels attractive and see upside to bond pricing in the long term. Treasuries also remain a hedge against tail risks.
● In the broader Asia Pac context we remain overweight Japan and India, our exposure to both these markets might soon may soon be increased. China may be bottoming out however property market recovery and return of foreign inflows remain key to equity market performance.
● There are several reasons for the sharp rise in U.S treasury bond yields. The BoJ's YCC tweak results in some funds gradually moving back to Japan and Japanese are the biggest overseas investors in U.S treasury bonds, recent FOMC minutes pointed towards "upside risks to inflation", which makes the market cautious about another rate hike, resulting in a bond sell off, economic data has been strong in July with strength in GDP numbers, retail sales and industrial production. This shows the resilience of the U.S economy and may indicate that fed has more work to do to cool down the economy.
● U.S stocks do not necessarily benefit from a rise in bond yields as we use the risk-free rate as a component in calculating the discount rate for stock valuation in a basic DCF model. Higher discount rate means lower valuation. Stocks which may benefit are those with cash rich balance sheets, high profitability, and strong free cash flow yields.
● Banks in the U.S are facing higher funding costs as depositors demand higher returns on their money. At the same time, their asset (bond portfolio) values are declining. This is not good for the sector, and this is partly why we have seen several credit rating downgrades for the U.S banking sector.
● Regarding the stock market correction, I believe this is seasonal in nature. We had seen a strong run up in stock markets till July. August and September are usually bad months for the market with lower liquidity. I believe the structural factors which drove the markets higher are still in place such as tailwinds from AI, innovation & resultant productivity improvements. We remain positive on the markets for the 4th quarter and believe this small correction was due.
● Markets may have been roiled by the surprise but the Yen should stabilise once Governor Kazuo Ueda explains the BOJ’s thinking.
● What we can read from the decision is that the BOJ is more open to raising rates and to tweaking the yield curve policy further, but this is something Japan needs after a long period of deflation and low growth.
● Conversely in the US, Rashmi says she expects inflation to slow enough for the Fed to pause tightening in Sept and stop by November.
● The fed has a dual mandate, first that of reaching an inflation reading in line with their long-range target of 2% and second doing that while achieving maximum possible employment in the economy. The fed is not so concerned about the stock markets in the short term and is willing to engineer a recession to achieve this dual target. ● The fed has been successful in bringing down inflation, though it is still far away from the 2% target. The job market remains very strong with 1.6 openings available per job seeker. Powell has made it clear that they are very focused on the inflation fight and rate cuts will be off the table till they are close to achieving their mandate.
● Rashmi expects the Fed's announcement to be positive for the tech sector as we do have a pause in rate hikes. However, she does not expect a bumper reaction from the stock markets. It is negative for small and medium businesses as they get more impacted by credit tightening due to higher interest rates as well as the tighter lending standards due to the ongoing turmoil in the regional banking sector.
● If we see the S&P advance this year, the breadth has been very narrow, mainly driven by 9-10 large mega cap tech stocks. The rally in these stocks has been driven by a reversion of last year’s performance, expectations of interest rates/yields peaking or coming down and some structural drivers. Nasdaq has led the rally in U.S stocks so it is fair to expect some consolidation in the near term. Going forward earnings should be the main driver and stocks which are able to outperform expectations will maintain their lead in the market. Given expectations of a recession and a slowdown later in the year, investors will focus on not only earnings but also the guidance. Given the economic backdrop, I expect managements to be cautious in their forward guidance. Here the companies with structural growth drivers are at an advantage.
● The banking sector has underperformed year to date. The U.S earnings season will start with the banks. We can divide the U.S banks into 2 buckets, the regional banks, and the large banks. Regional banks have seen deposit outflow. Larger banks have been the beneficiaries of this outflow. However overall, the banks have seen deposit outflows to money market funds which are guaranteed by the Government and offer higher rates. I would be cautious on Regional banks despite the underperformance as we do not know the exact impact on earnings, and they will be adding to their reserves. The larger banks have less risk compared to regional banks.
Nabil described the recent events as a “Lehman brothers moment” for the VC ecosystem and regional banks and emphised the need for regulators, regional banks and VC to focus on risk management.
The positive steps taken from the regulators as they step in to calm markets and attempt to control the contagion and panic.
Going forward Nabil sees positive implications for UAE and Saudi banks as some of the money will flow to the region, and also sees value in some of the larger global banks.
● Fed Chairman Jerome Powell’s testimony before the Banking Committee and its implications for interest rates and the U.S economy. Jay Powell was hawkish as we saw stronger than expected consumer spending, inflation, and unemployment numbers in January. He suggested that while monetary policy has had impact in slowing down inflation from the peak in June last year, there is still work to be done and Fed is open to increasing the pace of rate hikes if suggested by the totality of incoming data. This had a negative impact on the stock markets as a higher probability of a 50bps rate hike in the March FOMC meeting got priced in, whereas prior to his testimony consensus was leaning towards a 25bps hike in March.
● It is essential to note that we have two important incoming data points before the FOMC meeting- the payroll data on Friday and the CPI data next week. The Fed is very likely to depend on these data points to decide about the quantum of rate hike in March, if these suggest continued strength in inflation and unemployment a 50bps rate hike is very likely.
● The strong employment data in Jan was also due to some exogenous factors such as an unseasonably warm January, which pulled forward some temporary job openings and the fact that tech layoffs will take some time to reflect in numbers as employees are given 2–3-month notice periods. That said the job market remains strong and it will take some time before we can expect a reasonable slowdown.
● Currently a 5.6% terminal rate is priced in, however we cannot rule out a 6% terminal rate if the incoming data remains strong.
● Do not expect any other strong statements from Wednesday’s testimony.
Article from: Global Investor Group
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