The hunt for Red October

Since then, Cold War yarns have almost gone the way of the dodo — except Captain Pete “Maverick” Mitchell who continues to dogfight against an unnamed enemy with US-supplied F-14s in the recent Top Gun sequel. Similarly, the Daniel Craig era of James Bond movies fought not against state-sponsored evil behind the Great Wall or the Iron Curtain but industrialists, technologists, megalomaniacs and other non-state threats.

Quite likely, there will be a revival of this genre, perhaps with an Asian tilt. Globalisation as we know it is being reconfigured into political-economic blocs as discussed in “Where angels fear to tread and sleepwalkers lurk” (Chew on This, Oct 31, Issue 1059).

Back in financial markets, contrary to TS Eliot’s poetic “April is the cruellest month”, October tends to be where the market bottoms yearly (even in the potential multi-year bear market which is happening now in the West). The Straits Times Index briefly dipped below the 3,000 level for two trading days but less than a week later, it was back in positive territory as one of the better-performing markets in the world year to date, again.

This column has described last year’s irrational exuberance in meme stocks, growth at all-cost business models and extreme ends of speculation including crypto alts and NFTs as unsustainable fluff. I have called the top a year ago and I have unashamedly waxed lyrical about the safe haven of Singapore, which has borne out thus far. Where this column erred was being early on China’s common prosperity in February and blindsided by the geopolitics of Russia and a US policy of protectionism and containment that has progressed far beyond the Trump era.

See also: Bitcoin’s Trump-inspired rally is bad news for Korean small-caps

Golden Week exodus

We warned in September that the fear of a lurch to the left by Xi Jinping following the 20th Party Congress was real. That the Americans chose to start the chip war on the eve of the congress and followed through with tough talk on Taiwan in the middle was unexpected but validated our view. The reaction to the unveiling of the Magnificent 7 of China’s new Politburo with Li Qiang — reportedly the apparatchik who locked down Shanghai early this year — as the premier-in-waiting led to selldowns in Hong Kong and Shanghai as soon as markets opened thereafter. Bloody Monday it was, in the North.

The October Golden Week break before the congress started, we heard, was the reason why several Chinese businessmen got out of the country. However, the “holiday” destinations for most of them were the financial capitals of the world, excluding Hong Kong. After the new Chinese leadership was unveiled, those who were already outside China might have made up their mind to stay put.

See also: That's what friends are for

For those who are still in China, chatter on the street is they have finally “given up”. Many have decided to go beyond diversifying their financial assets offshore to pursue residency and wealth transfers in earnest. Could this create a self-fulfilling vicious cycle between financial markets and the real economy? Or was it a sign of the final capitulation of Western investors and local entrepreneurs alike in the week leading up to Halloween?

The Western narrative had painted Li to be almost Stalinist red, together with several other members of the new Politburo (including Guangdong’s Li Xi). Yet, it is interesting to note that he had facilitated and led an economically vibrant region of Shanghai and had been a friend to economic expansion and China’s technology sector. It was under his purview, for one, that enabled Tesla set up its Shanghai plant in record time.

With markets at low to mid-single-digit P/E and stocks trading well within NAV (if you trust the numbers) and some below cash value, it was no surprise that any sign of relaxation of Covid measures such as the market talks on Nov 4 could lead to rallies of stock indices of between 5% and 8% in a single day.

With no one left to sell, financial deleverage in public markets was almost complete and for those who were wrong but unwilling to cut losses, any upswing would trigger bouts of short covering. China will eventually abandon self-isolation and open up. The question is when, not if. When that happens, I hope to travel to my favourite places before the floodgates of Chinese tourists open. If that is the case, then whether the great reopening starts in December for the (over)optimistic or in March after the “two sessions” or in the second half of next year is irrelevant.

Markets have a habit of discounting the forward and while it might have been blood red in October for investors in China, with the German Chancellor’s visit and BioNTech (not Pfizer, which is American) doing a deal, it may herald a new dawn, rebasing as “common prosperity” and dual circulation find their footing. Ironically, it is because the US has forced China’s hand in trying to be self-sufficient. Interestingly in North Asia, “red” on the stock market signals a price increase, not the other way around. I expect to see more “red” days on Chinese indices as we head into the yearend and 2023. As it is, the risk-reward ratio is favourable, short of the Taiwanese tinderbox which hopefully remains just talk.

Reading tea leaves of the Fed

In the West, only the scrutiny of what Jerome Powell says and minutes by the US Fed warrant as much speculation as who’s going to be Xi’s men. The July bear rallies of Western markets and a milder one in October, both spluttered out. Markets wanted to hope for the best, only to be disappointed by Powell’s promises to keep raising the Fed Funds rate — even if at a slower rate.

Sink your teeth into in-depth insights from our contributors, and dive into financial and economic trends

Being late to the inflation party, Powell’s Fed is now applying the brakes hard using blunt monetary tools. Having said that, the financial corrections and deleverage adjustments may have run their course for now, before the economic ones are beginning to be felt. There will be no soft landing and recessions will take hold as rates plateau out next year. Inflation will settle but at a higher level. Politicians will blame Putin, although, in reality, there are underlying trends out there which will keep it sticky for a while. This is good for (some) stocks.

In the three decades after the Cold War era, central bankers were fighting what Yardeni Research labels the 4Ds of deflation that constrain business expansion, which was also seen in Japan: Detente, disruption, demography and debt.

At the Barclays Asia Forum on Nov 3, Lim Chow Kiat, CEO of GIC, pointed out that we now have the 4Ds of inflation instead. Firstly, deglobalisation and geopolitics require additional spending to clone critical industries within each bloc and its networks. The US Chips Act is an example.

Next, decarbonisation, which ranges from rebuilding ships, industrial activities and renewable energy infrastructure, costs money, with McKinsey estimating the total bill at US$21 trillion ($29.5 trillion) by 2050 for just a couple of sectors.

Third, democracy is an ideal that costs money too. Populist governments subsidise energy. Sri Lanka and Elizabeth Truss’s 45 days as UK’s prime minister come to mind. And finally, public debt mountains could incentivise some inflation to debase local currency debt.

If inflation is here to stay, 4% yielding Singapore Savings Bonds will look increasingly attractive, given how the constant 2.5% generated by the CPF Ordinary Account may not be sufficient cover.

In the long term, stocks outperform throughout the cycles. The question is what phase we are in and which sectors and stocks will benefit from the first two Ds. Companies that are highly cash-generative with a strong balance sheet secure higher yields and can make clever acquisitions now that valuations are more compelling for M&As.

The same goes for the retail investor as DBS Group Holdings, United Overseas Bank and Oversea-Chinese Banking Corp led the recovery to 3,200 points following the dip below 3,000 points. That is a nice tradable pop of more than 5% in two weeks from Red October when we called it. So who are the laggards? Decarbonisation was the driver behind the outperformance of Yangzijiang Shipbuilding (Holdings) and could Keppel Corp and Sembcorp Industries continue their runs?

With bearish sentiment close to a peak across different segments of investors and cash levels high across the board from hedge funds to institutional investors, could October have been the cruellest month this year? For those who have thrown in the towel after seeing too much red ink on their portfolios, it may be time to pay some attention at the year-end to recycle and replace. If inflation is here to stay, doing nothing is but the way of the ostrich.

Chew Sutat retired from Singapore Exchange after 14 years as a member of its executive management team. During his watch, the exchange transformed from an Asian gateway into a global multi-asset exchange and he was awarded FOW’s lifetime achievement award. He serves as chairman of the Community Chest Singapore