Heightened interest rate risks and tariff tensions

It is ‘Fed Week’ everyone, and investors are holding off their ammunition while strategising their next moves. The benchmark local Straits Times Index (STI) took a breather on Monday (March 19) despite Friday’s positive close for the US markets. The index ended Monday’s trading session at 3,498.29, down 13.85 points. It was a hair below the psychological 3,500 level. Still, the overall year-to-date (YTD) returns for the STI is up 2.8 per cent.

Source: Phillip Securities POEMS 2.0 Trading Platform (One-year daily chart of the Straits Times Index (STI), March 19, 2018)

Looking at the one-year daily chart of the Straits Times Index (STI), we noted that the index is still on an uptrend mode, but as seen from the chart, there are perhaps three cyclical peaks (shown by the downward sloping white channel lines) since the STI hit the high of 3,611.69 towards the end of January before volatility took back to returns.

Moreover, each peak was met with a significant trough. The first peak at 3,611.69 was corrected by about 8.2 per cent as it reaches the trough of close to 3,316. Since then, the index has rebounded and it was last close on March 21, 2018 at 3,511.13 at the close of Tuesday trading, March 21, 2018. The level of peaks and troughs have also narrowed and is on track to set another record high.

Traders pause for interest rate announcement

Source: CME Group (FedWatch Tool, March 21 2018)

Traders are virtually certain that the US Federal Reserve are expected to raise the short-term Fed Funds Rate by another 25 basis points (bps) as the day of announcement. True enough, the US Federal Reserve raised short-term interest rates by another 25 basis points to 1.50 per cent to 1.75 per cent on early Thursday morning (Singapore Time, March 22, 2018). Before the interest rate announcement, the Fed Funds Futures have already factored in for three rate hikes in 2018, followed by two in 2019.

Dot plots raised higher

Source: Phillip Securities Research, US Federal Reserve (March 22, 2018)

Looking at the dot-plot curve, we noted that the curve steepened from 2018 to 2020, but it moves downtrend following that. This might suggest that the US Fed is expecting normalisation of the interest rates to continue after it peaks at 5 per cent in 2020, followed by a gentler slope downwards post 2020, with the policy makers expecting long-run interest rates to settle at 3.5 per cent.

We shall take a look at the US 10-year Treasury yield curve to gauge the steepness:

Source: Stockcharts.com (One-year daily chart of the US 10-year Treasury yield curve)

Similarly, we noted that even though the US 10-year Treasury yield curve is upwards sloping, there appears to be some consolidation at around the 2.80 – 2.90 per cent rate range on the extreme right-end of the curve. This might suggest that the normalised level of interest rates in the long-run is expected to stay near the 2.80 – 2.90 per cent range.

Section 301 Tariffs aim at China

Apart from the short-term interest rate hike this week, a major headline grabbling news appeared to be concerns over the punitive tariffs against China. Not since the Reagan administration that there is a total of 128 trade restrictions on various goods and services being levied by the US government. Moreover, the restrictions borne out of the so-called Section 301 which seeks to circumvent the US Congress and was largely untested since the Reagan administration.

China has also taken countermeasures implementing trade restrictions worth US$3 billion in US imports. The tit-for-tat measures by both nations have spilled over to global stock markets including Singapore with the Straits Times Index (STI) trading down by 2 per cent for the day on Friday, March 24, and narrowing the year-to-date (YTD) gains to a mere 0.54 per cent rise.

Overall, the weekly decline is about 2.6 per cent with most of the STI counters or the so-called ‘Blue Chips’ in the red territory. The only exception  was ST Engineering whose stock price gone up by 2 cents to close at S$3.49 per share on a total volume of 7.46 billion shares traded. The stock also got some lift from a positive report from MayBank Kim Eng Research which rated the counter as a ‘Buy’ as the Company recently hosted an Investor Day for analysts showcasing their strategies and the overall impression was bullish according to the MayBank Kim Eng analyst.

Source: Phillip Securities POEMS Trading Platform (One-year daily chart of the Straits Times Index, March 23, 2018)

Looking closer at the STI, we noted that the index is now heading towards the ‘Oversold’ territory of 30 seen from the 14-day relative strength index (RSI). There has not been any major shift downwards since February where the index was in the ‘Overbought’ levels of 70 and above. However, this past week’s events, including the announcement of the tariffs on China caused many markets to be sold off heavily.

How should investors react to the potential outright ‘Trade War’

We think that there is no cause for panic or alarm as the US tariffs on 128 goods and services forms about 0.2 per cent of China’s total imports, and 2 per cent of China’s imports from the United States. Many analysts think that the tensions are not expected to escalate to a full blown-out trade war. We think that both nations would find a compromise in the coming months as both countries and global economies will suffer if both of the largest economies were to turn against each other.

The Chinese government has also worked hard to resolve any trade tensions by agreeing to crack down on intellectual property (IP) theft and not insisting on technology transfers for American multinational firms  (MNCs). The Chinese administration hope that with more discussions, a compromise solution can be found. However, if tensions escalate further, the world’s second largest economy will undertake serious countermeasures that do not benefit each other, and globally.

With this hindsight, we think that investors should not wait for any favourable outcomes, but more focused on picking the correct, yet less expensive stocks that have now turned south. If investors were to focus on bargains, yet value accretive stocks, you will reap the benefits in the future. It is not the time to avoid stock picking and retreat out of confusion and fear.

How did the China stock markets react

Source: Stockcharts.com (One-year daily chart of the Shanghai Composite Index (SSEC), March 23 2018)

One of the leading stock indices, the Shanghai Composite Index (SSEC) exhibited a knee jerk reaction following the announcement of the punitive tariffs by the US government. The SSEC closed the week on a negative note after hovering around the 200-day moving average (MA) line of 3,306.95. The index ended up correcting by about 4.7 per cent from the 3,300 level to close Friday’s trading session at 3,152.76. It was one of the steepest decline since the February 2018 down surge.

Looking at the index, there is still some room for a potential technical rebound if the index were to turn lower towards the early February 2018 lows. However, investors should not place any misplaced notion that if there is a ‘W’ type of chart pattern, it means a so-called ‘Double Bottom’ signalling a potential technical rebound shortly. We think that investors should continue to observe the chart movements before making any investment moves on Chinese stocks. We think that the correction might continue, but looking the SSSE chart, we think that the overall selling is perhaps ‘Overdone’ as the index is falling towards the 14-day RSI chart of 30, possibly signalling a deep correction.

Tencent shares corrected sharply

Source: Phillip Securities POEMS 2.0 Trading Platform (One-year daily chart of Tencent (0700.HK) shares, March 23, 2018)

Following the release of the quarterly earnings report ending December 31, 2018, Tencent’s share price fell hard to close at HK 420 per share after scoring an all-time high of HK476.6 per share on January 29, 2018.

The company reported net profits for the quarter ending December 31, 2017 at RMB 20.8 billion (S$4.4 billion). This was up 98 per cent from one-year ago as the company embarked on various mobile and technology developments.

However, it was noted by CNBC.com that Tencent’s 51 per cent jump in revenue was weaker than expected after mobile gaming revenue growth slowed from the previous quarter. Management continues to reiterate that overall revenue is still supported by payment-related services, advertising and digital content subscriptions and sales.

Despite the various issues from the latest financials being addressed by management, along with reassurance with the investor community, the stock price continues to be trending sharply on the downside on Friday, March 23, and is now below the 100-day MA line.

Tencent’s Hong Kong-listed shares have risen 14 per cent so far for the year, and this outpaced the 5 per cent rise in the benchmark Hang Seng Index.

US shares fell into deep correction territory

US stocks reacted violently to the latest announcement of punitive trade tariffs on China with the major stock indices falling into deep correction territories. A summary of the closing US market indices is shown below:

Source: CNBC.com (March 24, 2018)

The knee jerk reaction to the latest tariffs was sharp and causing major setbacks to the year-to-date (YTD) returns on the indices. It appeared that investors are not prepared to hold stocks over the weekend as the so-called ‘tariff wars’ begin to escalate. There were also risks if both US and China were to disengage with each other, and this will be the worst possible scenario. The stock market sell-off is likely to be risk-off strategy undertaken by investors.

S&P 500 index fell to just outside correction territory

Source: Stockcharts.com (One-year daily chart of the S&P 500 index, March 23, 2018)

As shown in the one-year daily chart of the S&P 500 index, the long red-coloured candlestick just touched above the 200-day MA and at 2,588.26, the index is now corrected by about 9 – 10 per cent from a high of 2,870 – 2,875 in January 2018.

Moreover, it was dramatic reversal from the deeply ‘Overbought’ territory with the 14-day RSI closing at above 80 for many weeks in a row in late December 2017 and January 2018. The index is now in the ‘Oversold’ territory of below 30.

Likewise, the Volatility Index (VIX) has turned up, but it was half of where it was in early February 2018 when the first sell down of the year took place.

Source: Stockcharts.com (One-year daily chart of the Volatility Index (VIX), March 23, 2018)

Commodity Prices have yet to catch up the pace of decline in US Dollar

Despite the higher interest environment, followed by risk-off investor reactions to the tariff news, and the declining US Dollar due to the sharp government deficits, the so-called ‘Commodity Boom’ remains quite subdued as shown by the Bloomberg Commodity Index.

Source: Stockcharts.com (One-year daily chart of The Bloomberg Commodity Index, March 23, 2018)

As shown in the above one-year chart of the Bloomberg Commodity Index, there has not been any major investor buys towards commodities as a whole despite the sell down of the US Dollar. We think that the buy move might be hampered by the rising interest rate environment which does not make commodities a valid buying proposition during such times.

In summary, with the knee-jerk reactions to this week’s economic events, along with Facebook controversy with Cambridge Analytica over possible data breaches, and the continuing revolving door at the White House with former National Security Director HR McMaster being the latest official to be fired and former US Ambassador John Bolton taking his place, US investors are mired in confusion and increased uncertainties. This might explain the extreme roller coaster style of ups and downs shown in the major US stock indices.

How did our model investment portfolio perform

Note: Model equity portfolio performance as of March 23, 2018. For illustration purposes only, and information is not verified by third party. Past performance is not necessarily indicative of future performance. Please seek the advice of your qualified licensed financial adviser before any investments are undertaken.

Since the inception of the model equity portfolio at the end of November 2016, the latest portfolio return this week has shown a major outperformance of 85.18 per cent, inclusive of capital returns, dividends earned, and realised returns earned during the last rebalancing round on December 31, 2017. This compares to the total return of 17.77 per cent for the Straits Times Index (STI) during the same time period.

The top three holdings in total return terms (dividends plus capital gains) include Nordic (up 47.4 per cent since end June 2017); followed by Ascendas Reit (up 11.1 per cent since November 2016), and SATS Ltd (up 6.2 per cent since December 2016).

The model equity portfolio did experience a shortfall coming from Singtel (down 10.3 per cent since December 2016); followed by Straits Trading (down 8.2 per cent since end June 2017), and Sheng Siong (6 .6 per cent since end June 2017).

For now, we are not planning to make any changes or do any rebalancing for the portfolio. We shall actively monitor the model portfolio till end of March 2018.

Upcoming Earnings News next week

No major earnings announcement next week

Major economy reports to look out for next week

Singapore

Source: Tradingeconomics.com

One of the key economic events to look out for as we enter into the end of the first quarter of 2018 is the industrial production data which is scheduled to be released on Monday, March 28. There could be some one-offs in the data trends due to the Chinese New Year effects.

China

Source: Tradingeconomics.com

An important economic data to watch out for is China’s March 2018 purchasing managers’ index (PMI) which is scheduled to be released on March 31. It will be keenly watched by many investors to gauge the state of manufacturing landscape in China.

United States

Some of the key economic data releases in the US where investors will be closely monitor include the final revision estimates of the Gross Domestic Product (GDP) figures for 4Q2017, personal income, personal spending, and the University of Michigan Consumer Expectations for the month of March.

Have a good trading session next week. See all of you soon.

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About Peak Hour 86 Articles
Hock Meng has 12 years of financial industry experience, including three years working as a research associate for a hedge fund company in Wall Street, US, with assets under management (AUM) close to US$400 million during its peak in 2008. Hock Meng is a Chartered Alternative Investment Analyst (CAIA) holder and passed his Level I Chartered Financial Analyst examinations. Hock Meng is licensed to provide investment advisory services in the area of unit trusts, dividend portfolio construction, securities wrap services, and life insurance planning