Market Commentary: Zero-Covid China | The Fed's Recent Rate Hike

10 November 2022
Stephanie Leung
CIO Office

Watch Stephanie Leung, Co-CIO, and Albert Kok, Deputy Country Manager, Malaysia, discuss the latest global events and their potential impact on the markets and on our investment portfolios.

In this episode:

1. The latest behind China's zero-Covid policy [2:07]

2. How markets reacted to the Fed's recent rate hike [7:08]

3. Are we heading into a recession? [12:30]

Albert | 00:01 

Hi! Good evening everybody, we are back live for our third Market Commentary and this is where we talk about the latest developments in the market, share our thoughts about what's happening and really discuss it out here. So I am Albert, the Deputy Country Manager for StashAway Malaysia and I'll be your host for this session. We are joined, as usual by Stephanie, who is the Co-Chief Investment Officer here. Since this is a live event, if you have any questions on what we talk about or even relating to StashAway, please do feel free to post those questions in the Q&A box and we will get to it afterwards. Yeah, how are you Steph? It's been a wild week. I'm sure many of you who have been following the news may have heard about what happened to the crypto exchange, FTX, so it's in addition to that and other events, it's been a very, very eventful week. How are you Steph?

Stephanie | 00:58

Now, I guess, I mean, we're experiencing very, very high market volatility in various aspects of crypto, particularly, of course, it is a very, very volatile asset as well. And interestingly for I guess the past two or three months, crypto volatility has been actually really low - so nothing much happening. And I think there was one point where crypto volatility is actually lower than the S&P. And when you have this kind of volatility compression, that means that a lot of energy is actually stored in the asset class. And when it was kind of exposed to the upside to the downside, a significant move would be following. So I think we're seeing part of that. And also, of course, there's events that are happening at centralised exchanges like FTX and also contagion effects on other exchanges as well. I think events will continue to unfold - so expect the market to be quite volatile. But also, I mean, crypto is one asset class which is, I guess sizable but not kind of systemic. We have a bigger asset class, which are bonds, which are much more volatile this year if you look at the longer history. So I guess, yeah, there's a lot to talk about and where should we start Albert?

Albert | 02:07

Well, I guess speaking about market volatility, one of the key events that happened a couple of weeks back is the 20th National Congress in China, which is pretty unprecedented because that's where we saw Xi Jinping essentially secured his third term as the Head of the Communist Party. What he did was he essentially consolidated power among the top lieutenants with him at the highest political decision-making body in China, called the Politburo Standing Committee. And markets didn't really take that very well because from that event itself, we saw the day after it, markets opened and was down 6%. They felt that this was really a tightening of Xi Jinping's power on the country itself. So what are your thoughts? What does this mean not only from a political standpoint, but also from an economic growth for China going forward?

Stephanie | 03:06

Yeah, I mean, of course, China's political system is very opaque and I guess sometimes quite a complicated system. From the looks of it, I think what you have described is correct in the sense that there are six kinds of the highest level party members appointed to the Politburo, which sits directly under President Xi. And among these six members, a few of them are newly appointed, and they are Xi's protege and close allies. And I think what also kind of shows a tighter grip is also that for the first time, the Minister of State Security is appointed to this highest level of authority and power. So I think markets reacted by basically selling off afterwards. But also apart from the political concerns, I think it's worth kind of looking at a broader picture and looking at how markets perform leading up to the Politburo or the meeting. Markets were actually rallying into it, and I think there's a lot of expectation on actually China announcing an easing of COVID-19 restriction policies. Unfortunately, or I guess basically the market was disappointed by the lack of very concrete announcements. I mean, there were some rumours, and I mean, the market basically gyrated according to what the latest rumour on COVID-19 reopening would be.

Stephanie | 04:41 

So, of course, I actually sit in Hong Kong, and Hong Kong is also affected by what the Chinese COVID-19 policy would be like. And I guess just speaking from the experience of Hong Kong reopening, Hong Kong is now kind of, I would say partially we are open for business. So, for example, travel policies are less restrictive than a few months ago. But still, I mean, compared to a lot of the other economies in the world, there's still some ways to go on reopening. And it's actually taken Hong Kong quite some time, and Hong Kong has taken a very, very gradual approach. And if you want to be kind of more objective about it, there's actually indexes that track kind of the openness of economies according to COVID-19. And I guess if you rank it from 0 to 100 - 0 meaning a very, very open and 100 being very, very tight. China now sits at around 60. Hong Kong is about 40, 50. The US is actually about 20. So there's still some way to go. And I think the concern about the COVID-19 reopening is because China's economy is not doing so well.

Stephanie | 05:54 

If you look at China's PMI for example, it's been in contraction for a number of months for the better half of this year. And without a COVID-19 reopening, it's very, very hard to see China's economy rebounding significantly. As investors, when you invest in China or other kinds of growing economies, of course, you're looking for earnings growth, you're looking for economic growth. And when an economy such as China is not growing, when the company is actually not growing in revenues or profits, as a foreign investor, there's no, I guess, no good reason for you to get involved in that market. I think that's why the market is basically very much hoping that China will announce a reopening policy. From a seasonal point of view. I guess it's not just from my experience, but also from a seasonal point of view, we're entering winter, and actually if you track COVID-19 cases in China, it's picking up with the winter season as well. So I guess our base case expectation is that you will see a gradual relaxation, but that probably happens over a longer period than the market was looking for and also probably will have to wait after the passing of the winter season.

Albert | 07:08

Well, it seems like China has its own issues to sort out. But I guess switching gears a little bit to the US itself, in the last one week, we have had multiple economic developments coming out of that. I guess the biggest one being the rate hike decision last week where the Fed decided to increase interest rates by about 75 basis points. And that brings up the benchmark rate to about 3.75% to 4%. And this was kind of within expectations of the market, but what the market was more interested in was this commentary on the day itself, they didn't really take it very well. Initially, it was okay upon the decision to hike rates, but when Powell came out to speak, markets took it very negatively. So would you be able to share, Steph, a bit more about why markets didn't like what he said?

Stephanie | 08:01

Yeah, I mean, markets initially rallied after the statement was released because people were looking for signs of a pivot, a pivot meaning, oh, the Fed is actually going to stop tightening its policy or at least see a plateauing of the rate hike and possibly reverse course. I think there are expectations leading into the FOMC announcement because we've seen a few pivots from other central banks. For example, the Bank of Canada actually hiked less than people expected. And then also the European Central Bank (ECB) hiked 75 basis points, but in a communication, they were trying to be quite dullish. So there were some expectations that, oh, maybe there will be a pivot for the Fed as well. And if you look at the Fed statement, actually the part that got investors excited was basically saying, oh, our next hike is going to be 50 basis points instead of 75. So it seems like gradually, I mean, the Fed is actually stepping off from the gas pedal. However, I mean, I'm sure Powell was looking at the market as well. And when Powell actually went into the press conference, he didn't like what he saw, he didn't like the market actually rallying. And he basically became the most hawkish person in the room. And immediately in the first question and answer, he said actually hiking 50 basis points next should not be the focus. The focus should be our terminal rate, like where we are going to eventually take interest rates to. And his point of view and also what the market is now expecting is that the Fed will actually take interest rates above 5% and probably remain at about 5% for some time until they're very confident that they've actually killed the inflation beast. And also, I think if you look at how Powell has communicated, he's referred to Volcker a few times.

Stephanie | 09:56 

And for students of history, you'll remember that Volcker was a person that was in charge of the Fed in the 1970s, and his mission was actually solely to focus on bringing inflation down. And he hiked interest rates very, very aggressively at the expense of the economy. So what Powell hinted at was basically that he thinks if he needs to be more aggressive in terms of rate hikes or staying at 5% for longer in order to bring down inflation, he would do so. He would be willing to do so at the expense of bringing down the economy, because what he thinks is that if we bring down the economy, if I slow down growth, it's an easier problem for the Fed to fix. And in his mind, it's more difficult, it's a bigger risk if they don't get inflation down and inflation expectations continue to rise. So I think that sends a very, very hawkish message to the markets, particularly given also, I mean, the data still is very, very strong. Of course, tonight we're going to get the CPI data in about an hour's time or two hours' time given that we've changed the time zone. But that would be very, very interesting to watch because if you look at some of the leading indicators of inflation and also given the tightening, we expect inflation to actually start to peak and come off. But given, I guess the message that Powell has has said basically he will take inflation up to 5% despite inflation coming off. So unless inflation comes down very, very quickly, I think the Fed will actually stick to their path.

Albert | 11:41 

So, well, the Fed has essentially two mandates, price stability and employment. Like you mentioned, we will have the CPI numbers out tonight. So that's something to keep watch for. And on the other hand, in terms of employment, last week we had non-farm payrolls coming out. Essentially, the jobs numbers came out better than expected. And on the back of it too, we saw the unemployment rate in the US rise from 3.5% to 3.7%. So on the back of this data, in addition to news that we're hearing from different companies out there like Meta, Intel, Microsoft or even Twitter, right, Elon Musk was cutting half of the employees there.

Stephanie | 12:28 

And then hiring back one third, right?

Albert | 12:30

And supposedly hiring back some, not all of them. We're seeing this kind of backdrop of increasing layoffs happening. So do we get a sense that we are entering a recession with all this being announced?

Stephanie | 12:45

Yeah, I think we've seen a lot of news flow on companies cutting staff. Now, of course, these are like unfortunate events for the staff that got cut. But also, if you think about the Fed communication, that was what they intended to do, that is kind of how they plan to get inflation down, basically because wage inflation is a very, very big component of inflation. And also wage inflation drives other inflation as well. If you get paid more, you can pay more for your cars, for food etc. So the Fed's very, very blunt tool to slow down the economy is such that companies will have to cut staff and also slow down inflation as well. But I guess as an investor, if you put on like a kind of contrarian hat, companies cutting staff means that the profitability of the company actually improves, especially for tech companies because for a very, very long time, given the very easy money, companies don't have to make profits. They just need to show revenue. However, in a new regime where liquidity is not so easy, I think what the market is telling you is that as a company CEO, you need to watch your profits, you need to show cash flow, you need to show profits in order for investors to have confidence. I think that's what we're seeing in a lot of tech companies, given that actually payroll is the biggest cost item for these companies. So I think as an investor, if you put on a contrarian hat, it may not be a bad thing to see that these companies are cutting staff because they're paying a lot more attention to profits. And ultimately a company is valued in profits and cash flow. So, I mean it's something that will continue and I think as an investor, you can get kind of more comfort in that companies are taking steps.

Albert | 14:51 

Great. And well, I mentioned earlier or you mentioned earlier that one of the data points that's coming out tonight, the CPI. But another thing that's happening concurrently, too, in the US itself is also the US midterm elections. So that is or at least that's a process that has started at the start of the week and it's taking some time. Overall results right now are pointing towards a poor display for Republicans because there was an expectation for them to have an overwhelming win. But the early results show that Republicans seem to be winning the House. And we have the Senate where it's kind of 50/50 between the Democrats and Republicans. So this is important because it has implications into how policies will be made and subsequent impacts on the global economy. So any early thoughts on this Steph? I know we don't have any hard concrete results yet, but anything that you can share?

Stephanie | 15:56

Yeah, I think the worst outcome for markets is that Democrats actually take both the Senate and the House. The reason for that is because, I mean, people worry about unchecked spending, which would, of course, push up the US government's debt and therefore push up interest rates and government yields even higher. So, I mean, that worst case scenario is now very, very low probability. And I think if you look at some of the early results, as Albert, you said, it seems like the Democrats are going to retain the Senate and the Republicans are going to take the House. So I think it's actually not a bad outcome in the sense that, oh, there will be checks and balances. And it's not all Republicans taking both the House and Senate either, because it also has implications. I think the broader implication is like in 2024, who will win the presidency. It seems like the candidate would be Biden from the Democrats - Biden has already said he'll run, and Trump, of course, said he'll run for the Republicans as well. So I think the more split outcome seems to suggest that it's not certain that the Republicans will have a very significant lead, and particularly Trump will have a very significant lead over Democrats or over other Republican candidates when it comes to the 2024 presidency.

Albert | 17:32

So I think those are the topics that I wanted to cover for the US. We talked about the rate hike decision last week, we've talked about jobs data. We talked about companies laying off people. And the two things to watch out for is the CPI data tonight, and also the results of the US midterm elections. I want to jump into questions because we have a question here from a listener, and he's asking how will the gradual reopening of China or Hong Kong affect the markets going forward? Will it be able to regain ground as fast as before?

Stephanie | 18:16

I think obviously reopening is going to be good for the economy and business. One major reason why China has been lagging behind in terms of returns and also just the economy is because people can't travel and the policy is very unpredictable as well, because today I guess you don't know what's going to happen - if you go to China, you don't know what's going to happen to restrictions tomorrow. So it's very, very hard for businesses to conduct on a regular basis. As far as kind of if the reopening is going to reaccelerate China's growth, I think it's a cyclical help. However, there are some structural issues that I think China still needs to address. For example, we've seen a big crackdown on some of the biggest sectors in China over the past two years, right? The property sector makes up 30% of the GDP. The internet sector was, of course, contributing to a significant amount of growth in China in the past few years. And both of these sectors actually had a very, very significant kind of, I guess, crackdown and also pushback in terms of growth. So with these two sectors kind of, I guess, suffering, we need to see where China would place its bet in terms of the next drive of growth. Do we actually see growth back into technology again? And if so, which parts of technology and is it going to move the needle for China? So these are questions that I think would still need to be answered even after COVID-19 reopening. But I do think that if you look at China, it is the top or the top two economies in the world if not the top in terms of GDP. So it is definitely a very, very important economy to monitor and also to look for investment opportunities given its weight. So this is an economy that I guess if you are an investor, you cannot ignore. So we'll continue to monitor the developments there.

Albert | 20:30

Wise words, China being an economy that you can't ignore. There's a last question here, I guess it kind of circles back to what we talked about at the beginning, which is about volatility, right? So how do we as customers or investors on StashAway's platform manage volatility going forward? Because we've seen so many things happening and sometimes data is good, data is bad. Markets take it differently. How should one position your portfolio accordingly?

Stephanie | 21:00

Yeah, I think that's a great question because actually when we designed StashAway products, we had risk as kind of a primary driver for how we design our portfolios. And that's why when we think about how our customers would invest, we think in terms of the drawdowns, the potential drawdowns that a customer will experience. And also does that drawdown actually match with our customer's risk profile. And if you look at our core portfolios, they have the StashAway Risk Index, which is a 99% value-at-risk, which means that over a 12-month period, what is the expected kind of drawdown in a very, very bad case scenario? Now, of course, this year is a very, very bad case scenario because of the bond volatility, which you haven't seen in 30 years. But I think it gives us a sense of if you are, let's say, more risk averse to the extent that you can only take, let's say, having 10% to 12% of drawdowns. Then, I mean, there are certain portfolios that you should not be involved in, right? For example, a 36% drawdown portfolio would not be a good portfolio for that particular investor. So I think it's important to keep that in mind. And then secondly, of course, is to try to, I guess, maintain a balanced portfolio of asset classes that all generate kind of long-term returns, but may have a different kind of path of return over a short period of time. Therefore, they can kind of balance out each other. And then I think lastly is if you are investing and I mean, markets go through ups and downs, right? And it's very, very hard to time the bottom of a bear market. However, if you have a habit of doing DCA, which is dollar-cost averaging, over time, you would make a better return than I mean, just timing the market. So I think these are a few tools that you can use to mitigate the risk and the volatility in this bear market.

Albert | 23:08

I guess kind of summarising it up then the three key things are maintaining a diversified portfolio, understanding your risks and if you are investing for the long term - DCA because it's hard to time your entries and exits. So great yeah, that's it really for this session and well thank you so much, Stephanie, for your time. Thank you to all our listeners here for listening in and tuning in. If you have further questions based on what we just discussed or StashAway, do feel free to reach out to us. We are available at and I hope you all have a good evening and please take care.

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