We expect long-dated bonds to outperform equities in the near term

Notably, we have boosted our bond holdings to about 34% of total portfolio value, comprising 26% in long-dated US Treasury bonds and 8% in Singapore government bonds. As we have explained in our previous article (“Understanding interest rates, stocks and bond prices” in Issue 1446, Nov 7), we believe bond prices will recover faster than stock prices as interest rates near their peaks.

Bonds, with fixed future cash flows, have historically outperformed stocks in recessions. Indeed, the TLT has outperformed all three key bellwether indices — the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite — this month thus far. With expectations of US interest rate peaking, the US dollar strength has also started to reverse in recent weeks. This is why we added Singapore government bonds to the mix, in anticipation of a stronger Singapore dollar going forward.

Although stock investors cheered nascent signs of moderation in inflation, there are reasons to believe that a recession may be inevitable. Consumer spending remains stubbornly resilient — supported by the still-massive pile of household excess savings during the pandemic — and the labour market is simply too tight. The US Federal Reserve appears to be having limited success at dampening both consumption and the labour market so far, although we must bear in mind that the effects of higher interest rates are necessarily lagging. That said, it most likely means rates have to move even higher in the short term — perhaps beyond the 5% or so that markets currently expect — raising the odds of recession, and worse to come for earnings.

In fact, a recession scenario is already being reflected in the bond markets. Yields for the 10-year Treasuries have fallen sharply relative to short-term interest rates (the reason why TLT has outperformed — bond prices rise when yields fall). The yield curve inversion deepened after the release of stronger-than-expected retail sales report for October — with the spread between the 10-year and 3-month notes widening as much as -0.65%. This is a larger gap than that just prior to the global financial crisis and Great Recession. Historically, yield curve inversion usually precedes recession. In particular, the gap between the 10-year and 3-month Treasuries has, without fail, turned negative before every recession in the last 40 years.

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This being the case, we will continue to stay away from US stocks, at least until there is greater clarity on the economic outlook. Prevailing valuations, we think, are still too optimistic. On the other hand, we think the Chinese economy may rebound faster over the next year or so, with recent baby steps to relax its zero-Covid policy and support for the struggling property sector. Yes, Chinese stocks were again beaten down after the latest flare-up in cases in Beijing, and the market will probably remain volatile.

We understand that our bet on Chinese stocks is risky, and quite frankly, has not performed, yet. But the weighted average risk for the Global Portfolio remains relatively modest, given our investments in low-risk bonds. Most foreign investors had already sold down their exposure in the country given the continuous stream of negative news flows and lowered growth expectations over the past months. Hence, there is a very low bar for the eventual stock market recovery when sentiment turns.

We also foresee that domestic brands will continue to gradually gain market share from foreign competitors over the coming years. As such, we decided to add shares for Li Ning, the company founded by the famed Chinese gymnast and Olympic gold medallist, to the Global Portfolio.

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The sportswear (primarily attire and shoes) and equipment (racquets, basketballs and acces- sories such as caps, socks and bags) company operates primarily in China, where the market is expected to grow at more than 10% annually. Currently, Li Ning has a roughly 8.2% share of the domestic sportswear market. While smaller than Nike’s (19.1%) and Adidas’ (14.6%), Li Ning has been gaining market share and we expect this trend to persist.

Chinese consumers, especially the younger generations, have shown an increasing penchant for home-grown brands of quality that they can identify with, that are more in tune with their needs, tastes and style preferences, and often retail at more attractive prices. These domestic companies have a much better understanding of the nuanced localised differences across the vast country, and are more sensitive to changing trends and traditional culture. They are, therefore, more savvy in terms of their product designs and marketing campaigns.

Li Ning’s revenue grew at a CAGR of 26% between 2017 and 2021, generating consistently positive free cash flow (FCF). FCF increased from RMB844 million to RMB4,989 million over this period. The company is sitting on net cash of RMB8,822 million. Inventory days improved from 80 days in 2017 to 55 days in 1H2022.

Meanwhile, our acquisition in Global X China Electric Vehicle and Battery ETF is based on expectations that sales of electric vehicles (EV) will enjoy strong growth not only in China, but worldwide for the foreseeable future.

Globally, demand is starting to enter the mainstream as EV prices continue to drop on better economies of scale and competition. Model choices from almost all major carmakers — both EV start-ups and traditional ICE (internal combustion engine) carmakers — are rising rapidly. There is also significant government support in terms of subsidies-incentives and the rolling out of charging and/or battery-swapping infrastructure. Many countries are accelerating their EV transition as part of the broader climate change initiatives. Consumers are also more confident in EVs with continuous improvement in battery ranges. Plus, current high fuel prices is an addi- tional incentive for cost-conscious consumers.

China is at the forefront of this structural demand shift and is currently the biggest EV market — accounting for more than half of all volume sold in 1H2022 — in the world. In fact, EVs are already very affordable in China. The vehicles are competitive against ICE, in terms of features and prices, even without subsidies.

The Global X ETF has a net asset value of HK$4.3 billion and includes companies — both upstream and downstream — ranging from EV carmakers to those producing systems and components such as lithium batteries, equipment for battery production, and critical battery materials such as lithium and cobalt (see Table 1 below for its top 10 holdings). In other words, their markets are, in fact, global. For instance, BYD is starting to ship its EVs for sale overseas.

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In addition to the benefit of diversification, there is also a practical reason for our decision to buy the Global X ETF — many of the key companies listed in Shenzhen and Shanghai, including Contemporary Amperex Technology Co, Limited (CATL), the world’s largest lithium-ion battery maker, are off-limits to foreign retail investors.

The Global Portfolio fell 2.7% for the week ended Nov 23. Chinese stocks were sold down anew as Covid-19 cases soared, including in the capital city, Beijing. Yihai International Holding (-10.8%), Li Ning Co (-10.6%) and Global X China EV and Battery ETF (-4.5%) were among the biggest losers. On the other hand, the iShares 20+ Year Treasury Bond ETF (+1.8%), DBS Group Holdings (+0.2%) and Telekom Malaysia (+0.1%) ended higher for the week. Total portfolio returns since inception now stand at 16.9%, trailing the MSCI World Net Return Index’s 39.5% returns.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.