Navigating an uncertain environment
What's driving markets?
Markets have been going through what can be described as a bad “hangover”. Supercharged monetary and fiscal stimulus unleashed by the central banks in 2020 in response to the COVID crisis fuelled bubbles across many risk assets. Investors clearly got hooked on this rather intoxicating cocktail of abundant liquidity and optimism on an economic recovery, as the world learnt to live with COVID.
However, events over the last six months have clearly demonstrated that financial markets are also subject to Newton’s third law. A combination of supply side pressures and abundant liquidity has unleashed inflation, which until recently was considered almost “extinct”.
As late as last year, market participants were writing the obituary for inflation with explanations ranging from globalisation, demographics/ageing, sharing economy, automation etc. being put forward as possible reasons for a structural demise in inflation. However, events over the last twelve months have indicated that we are far from taming the beast.
A combination of extremely accommodative monetary policies, coupled with supply side constraints, have led to inflation prints in developed markets, not seen since Freddie Mercury crooned “We will rock you”. The problem is exacerbated by the war in Ukraine which led to a sharp spike in prices of all sorts of commodities ranging from oil, coal, wheat and palm oil. The inflation trajectory will likely remain the most important driver for markets in the near-term.
Closer to home, China is the last major country still pursuing a zero-Covid policy. Investors will on one hand need to decipher the severity and duration of lockdowns following sporadic outbreaks, and on the other, the extent of stimulus measures the government may unveil to support the economy.
What is the outlook for equities?
Clearly the outlook has turned gloomy with the discussion moving away from a growth scenario to whether we are staring at a recession or worse, stagflation. Comparisons with the 1970s are not unreasonable as history clearly seems to be rhyming. We believe that inflation is likely to remain high in the short-term, which means that the Fed will continue to raise rates till at least the year-end. However, this is now widely understood, and the futures market has already priced in another 150bps of rate increases. Simultaneously, the MSCI All Country World Index has fallen 20% (in USD term) in the first half of 2022 and partially pricing in a recession, even before the recession actually hits. A shallow recession is probably already priced in by equity markets but a deeper recession or a stagflation scenario is not.
The important point to consider is that not all assets are likely to suffer the same fate. Many markets and sectors are in a rather different cycle and exhibit characteristics which allow them to generate positive returns even in the current environment.
Case in point would be China. The Chinese market has suffered a long bear market which lasted almost sixteen months before the recent rebound on policy easing by the central bank and more stimulus action announced by the government. As such the fate of the Chinese market could diverge significantly from developed markets.
Similarly, many other sectors and stocks are well placed in this climate, especially stocks which exhibit strong pricing power. Investors can also find opportunities in more defensive sectors such as telcos, energy, consumer discretionary etc.
What should investors do?
We believe that the key to generating returns in this environment is to have an unconstrained absolute return strategy to investing, backed by strong ground up fundamental research. This may potentially help investors channel capital to stocks with the highest probability of generating returns irrespective of the broader macro environment. Fullerton has been employing this approach in its key absolute return equity strategies – Asia Absolute Alpha and Global Absolute Alpha – with good results.
What’s unique about Fullerton’s Absolute Return Strategy?
Most long-only strategies are benchmarked to an index with the objective to outperform the benchmark, not to generate an absolute return. These tend to have strict risk limits measured in terms of deviation from the benchmark (i.e. tracking error), as well as limits on sectors, country, and single stock exposures.
Fullerton’s absolute return strategy seeks to generate an absolute positive return over a market cycle, which we believe could better compensate investors for the risk associated with equity investing. The measure of risk is more simplistic – do not lose money.
Apart from focusing on finding the best ideas using the unconstrained approach discussed above, our fund managers utilise cash as a “residual” asset class, i.e. the strategy can hold cash if we do not find sufficiently attractive opportunities, such as during periods of extreme market volatility.
In addition, one of our flagship absolute return strategies – Asia Absolute Alpha also redefines Asia more holistically and can invest in any company with significant exposure to Asia regardless of the country in which the company is listed or incorporated. This allows the portfolio for example to buy into some US and European consumer names which are major beneficiaries of the rise of the Asia and especially the Chinese consumers.
We believe that a robust absolute return strategy requires a certain mindset which Fullerton’s fund managers have honed over the years. This has allowed the Asia Absolute Alpha strategy to generate strong double-digit annualised returns over the past three and five years, as well as since its inception in 20151.
1Source: Fullerton and Bloomberg. Data as of 30 June 2022 in USD term, gross of fees and with dividends reinvested. Past performance is not necessarily indicative of future returns.
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