Five insights in five minutes
Asia small caps
Here’s an algorithm for you. IF vaccine = stronger recovery THEN small caps ≥ large caps. Why is that? First of all, investors tend to reverse back out of ‘safe’ larger cap names once recessions seem to be over. Like now. Second, smaller company shares are more sensitive to growth revisions due to their higher market beta. Third, cap-challenged stocks have underperformed their larger cousins globally by ten per cent over the past two years and remain unloved. The stronger the economy, the better small caps tend to do – and nowhere is zippier than Asia according to the IMF, which forecasts the region to grow seven per cent next year. What is more, Asia small caps are currently trading at a quarter of the price-to-book value of Asia large caps, compared with a ten-year average discount of 16 per cent. On mean reversion grounds alone Asian small caps look attractive.
Themes: Asia equities, small caps
For illustrative purpose only.
Steeper yield curve
Unless you’re a bond expert, remembering your bull steepeners from your bear flatteners is head spinning. And sometimes they make no sense. For example, today long-term rates are rising faster than near term ones – a supposed bear steepening – yet it’s been bullish for most asset classes since October, when the yield curve tilted sharply. We wrote last week that rates don’t matter for stocks, but they obviously do for bonds, whose coupons are fixed. So what to make, say, of the 80-odd basis point steepening in the US since the pandemic struck? It has barely half begun if history is anything to go by. In the first nine months of each recession over the past six decades, the spread between ten-year and three-month US rates has widened a median 160 basis points, as can be eye-balled below. But rates are lower in absolute terms now, so that would be pushing it this time.
Themes: global fixed income
For illustrative purpose only.
With nightmares of shuttered high-streets, empty malls and darkened office towers, investors must be careful not to awaken too scared of commercial property. Needless to say, the efficacy and timing of any vaccine is key to many segments. Listed real estate equities have already jumped nine per cent since the Pfizer news. To be sure, some weaker shopping centres may never fully recover, but much retail is holding up well, such as supermarkets and DIY stores. Online spending needs warehouse space and rental growth here is strong. Meanwhile, demand for office space is changing rather than disappearing – hybrid working models require safe, environmentally-friendly buildings, probably with lower densities. So what are markets discounting now? Assuming investors want a 500 basis point premium over risk-free government bonds, our property team reckons current prices imply another one third drop in dividends over the next two years. That is unlikely, which make an investment in commercial real estate worth sleeping on.
Themes: listed real estate, credit
For illustrative purpose only.
Asia’s trade union
The Regional Comprehensive Economic Partnership (RCEP) is a free trade agreement nine years in the making. It was finally sealed by participating Asia Pacific nations last weekend. The signatories make up a third of the world’s population and a smidgeon less of its output. Every major economic power in the region is involved except India. Aside from the Ricardian benefits of free trade, the agreement signifies a new growth model for Asian developing countries. In the 21st century, exporting to the West need not be the only road to prosperity – aspiring Asian nations can and should export to their richer neighbours in the region as well. Even before the RCEP, some members have already been adopting this strategy, as shown in the chart below. If yet to be convinced, this new partnership is yet another reminder to international investors that the long-run Asia growth story cannot be overlooked.
Themes: Asia equities, Asia credit
For illustrative purpose only.
Monday’s news that Tesla will soon steer itself into the S&P 500 – driving its shares nine per cent higher – is a good chance to address a popular myth around index inclusions: that passive funds ‘forced to own Tesla’ will cause its share price to rise. In reality, buyers are always matched by sellers at a price determined by active investors – irrespective of the relative weight of active and passive money. If this were not true, given a vertical demand curve for passive funds, Tesla’s share price would have immediately gone to infinity. And how would shares ever leave an index? No, inclusion trades only make sense if joining a benchmark results in new information about a company’s prospects. Here it gets tricky. Some academics argue this is impossible – everything is already in the price. But most research shows a definite performance boost, suggesting new information is revealed (although the effect is not so clear in reverse, when stocks leave an index). Enjoy the ride anyway!
Themes: global equities, ETFs, passive funds
For illustrative purpose only.
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