Market Commentary: US-China tech war | Why invest before a recession

14 October 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. What does the latest US employment data mean? [2:00]
  2. The latest development in the US-China tech war  [8:00]
  3. How much higher could the Fed raise rates this year? [13:39]
  4. Why you should invest even if we’re headed for a recession [18:12]
  5. Bonds 101 [26:30]


Albert | 00:01

Hi, Stephanie! Hi, everyone! Thanks for dialing in today. Today's our second live market commentary that we're doing here at StashAway. And this is where we talk about the latest developments in the market. This is also where we share our thoughts on them. And to start it off, first, let me introduce myself. I am Albert. I am the Deputy Country Manager here in StashAway Malaysia, and I will be your host for today's session and we are joined today by Stephanie, who is the co-Chief Investment Officer at StashAway. And since this is a live event, if you have any questions regarding what we talk about or even on StashAway, do feel free to post it in the chat box and we will get to you after the end of the session. How are you, Stephanie? It's been a month since we last spoke and a lot has happened since then.

Stephanie | 00:54

It's been a very, very eventful month for markets. I mean, September tends to be quite notorious for risky assets in general, and I think this year has been no different. If we look at kind of all the risky asset classes, I see red across the board. So most risky assets are actually down. The difference is only down by how much? And I think we'll go into a lot more details, but mostly it's because of concerns of the Fed's action, not just at the latest meeting, but also in the few meetings that we'll face in the next few months.

Albert | 01:32

Yeah, I'd like to zoom in on that point because we have seen a very, very roller coaster, exciting week. Last week itself, we saw stocks - they took a big hit. We have seen Treasury yields jump and that was all on the back of stronger than expected economic numbers. So examples like US employment figures coming in better than expected. We have the Purchasing Managers Index (PMI) that came in also above expectations and also unemployment rate of about 3.5% for the latest month, down from 3.7% in August. So given these stronger than expected economic numbers, which on the longer-term basis, they are declining, what are your thoughts on this and where are we headed?

Stephanie | 02:28 

Yeah, I think the market is very jittery because of what Powell and the Fed has told us is that, they don't have a crystal ball and their decision is going to be data dependent so every piece of incoming data would be scrutinised and that includes two major areas. Number one is, of course, inflation, which is what caused the current hiking cycle. And of course, like different measures of inflation, we're going to get the CPI tonight. And the second area is, of course, jobs growth, because the other kind of economic metric that the Fed uses to gauge how strong the economy is, is actually the labour market. So that's why I think the jobs data was actually a very, very important driver of the Fed's decision and market performance as well. And as Albert correctly pointed out last week, we got the latest non-farm payroll numbers and I think the market was a bit surprised at the unemployment number, which fell actually from 3.7% to 3.5%. And I mean it's not the right direction because the Fed's tightening was actually targeted at cooling off the jobs market. Their theory is that once the job market cools down, wage inflation would be eased. And if people are not getting paid or if the wages are not going higher, they wouldn't have extra money to spend on goods and services. And that would actually put some downward pressure on prices. However, the unemployment rate was actually 3.5% - very, very close to historical lows. And if you look at kind of a longer-term horizon, the unemployment rate on average was around 5% to 6%.

Stephanie | 04:12 

So if you think about the Fed's job, if they want to get unemployment rate back to a more historical average number or even an area that they're comfortable with, it's still a long way to go. So I think the market was a bit disappointed at that number and hence the market sell-off. And also, of course, we had a very, very strong start to October so it's basically market volatility. If you look at kind of a one-week basis, the market was up very strongly at the beginning of October, gave back all the gains at the end of the week so again, it's just a very, very volatile market. But talking about jobs data, actually, the Fed has told us that they have an alternate, they have a different, I guess, metric that they also focus very, very squarely on, and that is the job openings per unemployed person in the US. And Chairman Powell has actually said that it is a one very important metric because the level of job opening to unemployed people basically tells you that, oh, if there's a lot more job opening than unemployed, then companies actually need to pay a lot more to get talent. And that puts upward pressure on wages. And in fact, for that number, it went up as high as two times, i.e. for each unemployed person, there's actually two job openings that are waiting for them to be filled.

Stephanie | 05:41

And hence, one of the Fed's target is to actually get this number back down. If you think about kind of a more reasonable number, pre-COVID, that number was around 1.2, 1.3. So for each unemployed person, there was 1.2 to 1.3 job openings. And I think that is actually what the Fed is targeting to get it back down to pre-COVID levels. And actually, on that front, there is some good news, right? In the latest August JOLTS report, which is different report. Basically, job openings fell by 1 million jobs in a month in August and that was actually one of the biggest month-on-month drop in terms of job openings. The last time we've had that, that was actually during COVID-19. So the labour market, by a different measure, is actually cooling down pretty quickly. And given the 1 million drop in job openings, the opening to unemployed ratio actually fell by 20 basis points from 1.9% to 1.7%. So it's still not close to 1.2 to 1.3 that the Fed would be looking for. But it's making the right direction and it'll take some time. So I think if the market tends to focus on headline data 3.5 but if you look kind of underneath, there are other measures that shows the labour market is indeed cooling. And more importantly, I mean, the Fed also looks at a wider set of data.

Albert | 07:12

Yeah. So I guess there are a lot of noises or signals flying around and we just have to look into the devil of the details itself. Another, I guess, volatile or interesting event that happened earlier this week too, was where we saw the US itself introducing export controls on China's semiconductor development so this came in the form of the US essentially barring American companies from shipping certain grades of advanced chip equipment to any Chinese companies. And the result of that is that we have seen semiconductor stocks like TSMC or Samsung itself fall as a result of that news. In fact, there were new developments today saying that these companies, some of them were granted a 1-year exemption. So given this development and combining with concerns about rising inventories reported by some players in the industry, we have also seen a fall in factory shipments coming out of Korea, which is sometimes seen as a proxy for global semiconductor demand. What are the implications to this, to the broader industry as a whole? And also by extension, what does this mean for that rivalry between the US and China?

Stephanie | 08:37 

Yeah, I think you brought out two very important implications and they're slightly different. One is more cyclical, the other one is more structural. So let's talk about the cyclical part of that, which is the semiconductor business cycle. Actually, if you think about semiconductors, it's basically the oil of the digital economy. It goes into everything that we use, into our cell phones, cars, computers, etc. So, the sector is highly volatile because of two things. Number one, it's tied to the global economy. So if the economy is strong, when companies are spending capex, they will, of course, buy more computers. If you have, let's say, a very strong labour market, they would buy more cars and car makers then buy a lot more chips. And that explains why we've seen chip shortages coming out from COVID-19 because of the very strong economy. The other reason why chip makers or semiconductors as an industry is very cyclical is because there's something called the double booking. So chip making is actually a very, very long supply chain. And when the economy is going strong because it takes a few months for you to order the chips or along the supply chain so when the economy is good, actually the downstream players would double order, order extra inventory from the upstream players. And if the economy suddenly returns and when demand actually falters, it creates a bigger swing because of the inventory that's accumulated. And I think that's what we're seeing in general, because, I mean, globally economies are slowing, the US is I guess is expected why they expect it to go into recession in the next few months.

Stephanie | 10:24

There are some areas globally, for example, in Europe or even in China, where the economy has already been weak for quite some time. So that affects a whole supply chain. And I think that is kind of a cyclical part of the semiconductor industry. And the semiconductor industry, if you look at kind of a stock performance, which can be a proxy by some broader industry indexes, it correlates very, very well with economic growth indicators, for example, the US ISM. So it bottoms out and it peaks out around the same time when for example, ISM would peak out or bottom out. So we are not seeing a bottoming of the ISM yet. So I mean that's why the cycle in the near term may still be quite difficult. That is a cyclical part of that and the more structural part of the semiconductor industry is of course related to the bigger rivalry between the US and China. And I think I mean, we've all kind of seen the divergence in policies for both countries and I think given the importance of the semiconductor industry, basically think about it as like oil in 70's or 80's, both countries actually want to gain an advantage in its industry. And China has been trying very hard, doing a lot of investments in their own semiconductor industry, which powers, of course, some of the software, some of the infrastructure that is needed to run a modern economy.

Stephanie | 12:03

So this is just another sign that we're entering a I guess, a more bipolar world in which the economy may be less kind of interlocked compared to what we have in the past 20 or 30 years, in the sense that, I mean, China will try to develop its own system of technologies and the US will try to also excel in its own vertical. And I think it's probably going to kind of slow down innovation on both sides because if you don't have a lot of cross-cooperation, the same resources will not be as efficient as if you had, for example, global trade and global ideas sharing. But this is kind of a new, I guess, new macro environment that we're entering. And if you kind of zoom out into a much longer history, much of the human history is actually in a multipolar sort of world than a unipolar sort of world that we've had in the past 20 to 30 years. So I think we may be returning to a more normal sense of how the world operates. But, I mean, it has implications onto, I guess, how you invest and also the rate of return on various investments, which is a big topic. And we're not going to go into it today, but we can definitely when there's time, we can dive a lot deeper.

Albert | 13:39 

Yeah, speaking about implications, we have looking forward, right? We have quite a few big events that's coming up that potentially could impact asset classes in general or even our portfolios. And what's in fact happening tonight is that the CPI numbers for the US itself will be released and in roughly less than a month's time, we would have the Fed meeting to determine what the direction of interest rate hikes are going to be. So what are your thoughts on this stuff and what are the implications? Because markets are expecting at least another 125 basis points of interest rate hikes before the end of the year. So that's pretty significant considering where we were a couple years or even months back where interest rates were really low at near 0%.

Stephanie | 14:30

Yes, I think if you look at kind of the current cycle, it's been one of the fastest rate hike cycles we've ever witnessed. And also not to mention that we're actually coming off from a very, very low base. So that explains why this year, for example, bonds have been performing very, very badly compared to its own history and even relative to riskier assets like equity. Albert as you correctly pointed out, I mean, the market is already expecting 125 basis points of interest rate hikes into year end. And I think the question that the market is really struggling with or kind of asking is, number one, where is the terminal rate, i.e. where would the Fed stop? And if you look at market pricing, the terminal rate, i.e. the highest the Fed will actually hike to is going to be it's expected to be at 4.6% in early 2023. And that is quite in line with the Fed's own projection as well. So 4.6% is a very, very high number. And the way to think about it is that the Fed actually wants to... They've already said that they want to have real interest rates positive across the board. What is real interest rate? Basically, it's your nominal interest rate, i.e. if you take 4.6% and if inflation is also at 4.6%, then I mean, real interest rate is just one minus the other, which means it's 0%. So the market is basically saying by beginning of next year the Fed will be able to tighten enough such that interest rates actually fall to 4.6% or below. That's why CPI is so important tonight, because that will actually tell us not just where is the direction of CPI, but also how quickly CPI is going to come off.

Stephanie | 16:29 

Because I think just given all the tightening and if you look at commodity markets, which tend to be a good kind of leading indicator of the CPI, it will come off. The question is when and also how fast? If you look at... We actually did some projection on some of the bigger components of the CPI for example, rent is a big component. Also, wages are a big component. Some of the leading indicators already says that they have peaked out, but the pace of falling off or the pace of decrease is still quite slow, which suggests that we still have a few months of very, very high inflation. So I guess, yeah, the data is, it's going to be very, very hard to make a prediction. I'm not going to pretend that we can predict, but just bear in mind that the data is going to be volatile from a month-on-month basis. For example, the jobs data was actually surprisingly positive in September and a surprise negativity in October. Similarly, CPI may surprise possibly in one month and negative or the next month. So typically what we do is we look at a 3-month moving average. So if the market kind of reacts strongly to one print, it's just the market being very volatile. So number one, don't be shaken out by it. We need 3 months of data to establish a trend. And secondly, I mean, being a long-term investor, you want to kind of make use of some of these markets sell off to DCA or to dollar-cost average into risky assets and I mean, those may be good chances.

Albert | 18:12 

Yeah. Speaking about, I guess, the economic numbers and also implications to markets, we also have a question from one of the customers here on this point saying that with how the Fed is targeting to bring inflation down to 2%, whether that's a neutral rate or not, we will see but they're determined to do so. And many CEOs and fund managers are looking at potentially a long recession. Why should I invest now?

Stephanie | 18:41 

Yeah, I think number one is that over the long term, if you look at equities or other risky assets, basically you may be too early. You may be down, let's say 20% if you didn't catch the exact bottom, you may be down like 20% in a very short period of time, like several months. But if you hold on to the investment long enough, you can always make that back and much more. The problem with kind of staying out of market or trying to time it is that you never know when it's the bottom. At the bottom is always very, very scary because you would read news headlines like, oh, things have changed, things are not going to go back to where it was before. For example, I think the most recent example was COVID-19, if you think back when you were reading about news headlines in March 2020, I bet like it's very, very hard to invest because the world is changing and it will never be like what it was before COVID-19. And I mean, on the whole the Fed actually loosened and then, I mean, the stock market just came back and actually you would have gained much more afterwards than if you had been maybe 20% too early. So that is the risk of, I guess, trying to time the market. Now, of course, all of us are scared about market drawdowns.

Stephanie | 20:09 

So one good way is not to put everything or not to go all-in at one point. So a better way to kind of try to get into market during a bear market is to do dollar-cost averaging, meaning that you chunk, let's say you have $100 spare cash and you want to invest, right? But you don't know when there's a market bottom. So maybe chunk it up into several pieces. You can chunk it up into 2, 3, 6 or whatever, however many small amounts you want to. But at least, I mean, you get the investment going, you start the habit of investing. And if the market goes up, I mean, you would be quite happy because you would have invested part of your cash. And if the market goes down, then you don't feel too bad as well because you have spare cash to take advantage of the lower market prices. So I think that is one good way to think about it. At the end of the day, we're trying to, I guess, make investment less stressful and trading in a short term is very stressful. But investing for the long term shouldn't be that stressful. So using techniques like DCA helps to lessen the stress associated with investing in very, very volatile markets.

Albert | 21:25 

Yeah. And earlier we did touch a little bit on China itself with regards to the export controls imposed by the US. I'd like to allude to next week itself where we're going to see the potential 20th National Congress in China, and this is where it's quite likely going to be Xi Jinping potentially staying on as Premier for another 5-year term. And so we also have a couple of questions from customers asking, is China really an investable place right now? Because there's been a lot of focus from the top on stability and common prosperity. And I think this is something that they want to ensure leading up to the event next week itself. But on the back of it, when you look at property prices, which have plummeted quite a bit in China, there is some degree of instability there. So I'm happy to hear more about your thoughts regarding this topic.

Stephanie | 22:21 

Yeah, I think I mean, typically, I mean, China would try to do some window dressing into the party Congress and we actually haven't seen that much going on this year, which is not very typical. But I think what's on the Chinese leader's mind is informal stability, because as I pointed out, I mean, the real estate market is going through a lot of turmoil. We've gone through, I mean, a whole kind of common prosperity. There's whole industries, for example, education being taken out. So there's a lot of kind of, I think, ripple effects from all the cleaning up that the Chinese government was trying to do in the past two years or so. And not to mention, of course, the whole impact of COVID. And also, I mean, the new policies from the US, for example, and the strong US Dollar’s impact on, I guess on international economy and trade, etc.. So there's a lot of different issues that the Chinese government is trying to, I guess, grapple with. And I think one of the biggest questions that investors care about is actually will China reopen after the party Congress? Because there's been a lot of expectations.

Stephanie | 23:43 

The consensus is that China will actually start to reopen its economy and you're going to see a cyclical upturn pretty quickly. I think the answer to that may be a bit more nuanced. I do see that China is taking some steps to try to open the economy. But I mean, I'm sitting in Hong Kong and it's taken Hong Kong a long, long time to reopen. So I think from the Chinese leaders' mind, they will be quite careful about reopening the economy. But I guess, yeah, China being slow in opening the economy may be a blessing in disguise for oil prices or for inflation, for example, because if China reopens tomorrow, I mean, oil prices would actually shoot up another $20. So that may not be a completely bad thing in itself. But yeah, I think as investors we have to bear in mind the kind of constraints that sometimes political leaders actually face.

Albert | 24:46 

And well, Leon here has a question, which is essentially very direct. So he asks, should we invest in China? So given what we just talked about, what are your, what do you think? Yes? No? Maybe? Should we wait until there's a clearer idea coming out of next week?

Stephanie | 25:01

So just taking a look at data, typically Chinese equities, I'll assume we are talking about equities. If we're talking about FX or bonds, right, we can answer that as well. But Chinese equities tend to perform better - if you look at China's PMI, if its PMI is above 50 and trending higher. So I guess we're still I mean, not very affirmative on China's economic recovery. And I think we need to see some more signs that the economic recovery is stronger and is taking place before Chinese equities would start to outperform the world. And also remember, Chinese equities tend to be a bit more cyclical or a bit more volatile than for example, the US. So especially when the currency is weakening, if you buy into Chinese equities, you would also take on FX risk as well. So right now the US Dollar is still trading very, very strongly and I think it's very hard for the Renminbi to appreciate unless all the different trading partners, including Europe, Japan, currencies actually start to appreciate. So we're monitoring it very, very closely. And I mean, the data doesn't suggest that it's a good time to go into China. But when it says so, I mean, we'll be ready to actually invest in China again.

Albert | 26:30 

Yeah. Pivoting a little bit to bonds itself because there are a couple of questions from our listeners. We have seen this year that bonds have probably had their worst year in a very long time. And if you look at the Bloomberg aggregate bond index, it's down roughly around 15% and a drop of 15% is pretty, pretty big. And so we've got a question here from one of the listeners asking that given a rising interest rate environment, why should I? Why is it firstly, why is my bond portfolio dropping and should I continue investing into it?

Stephanie | 27:08 

Yeah. I mean, bonds are so... Well, I mean, let's do a bit of Bonds 101, right? So bonds are basically if you issue bonds, you're borrowing money. And if you buy bonds, you're lending money to somebody else, right? So every bond has a maturity date. And let's say if I borrow money for or if I lend money to you for 10 years, it's a very, very long time, right? So in 10 years' time, you're going to get your principal back, but also your coupon back. The value of this bond is actually discounted by the interest rate because, oh, I don't get my money back until 10 years later. If inflation is very high, in 10 years time, that money will not be worth that much. That's why the longer the so called duration, the longer the maturity of the bond, the more it is affected by interest rates. So when interest rates actually rise, the bond value, because of the discount actually comes down. And I mean, this is what we've seen this year. And I said when I was talking about the Fed's action, I said, number one, basically this is one of the fastest rate hike cycles we've ever seen. And secondly, because we started with a very, very, very low interest rate environment, the increase in interest rates actually has a much bigger impact on prices. So when we started the rate hike cycle, it was almost starting from zero. And if you think about the bond returns, it has two components. Number one is, of course, the coupons. So if a bond is paying, let's say, 4% interest rate, which I mean, which is what the US Treasury is paying now, at least I would get that 4% every year.

Stephanie | 28:52 

So it doesn't matter if the bond price fluctuates, I get that 4%. But if bond prices come down, let's say by 2%, my total return will be 4% minus the 2%. I still get 2%, however, at the start of the year, because interest rates were almost 0%, you don't get that buffer. And let's say having a coupon was just 1%. But actually because of bond prices movement, the bond price return was -3%. You still lose like 2%. And that explains why this year, bond returns have been so bad. But if you fast forward to today, I think, think about the terminal rate that I talked about. The market is expecting a 4.6% terminal interest rates, the highest interest rate in this cycle. For 2 years, we're already at 4%. So, I mean, we've gone through a lot, right? We've gone through maybe 3/4 or I don't know, 2/3 of that rate hike cycle or even more maybe 80% of the rate hike cycle. So there may be still a bit of pain, but at least you're starting from like a 4% environment, which gives you some buffer already. So I think that's how I would think about investing in bonds right now, because what happened in the last 12 months was a combination of a very fast interest rate hike and very, very low starting interest rate.

Albert | 30:17

Right, there you have it. In terms of a 101 class on bonds from Stephanie itself. Unfortunately, we are out of time but we do have a couple more questions. So if you are curious to learn more, understand more on our views, please do write in to us at and we'll be happy to address those questions from you. But that's it for tonight itself. We will be doing this live Market Commentary every month. So do stay tuned and we will see you back again. Thank you very much, Steph. And take care, everybody.

Stephanie | 30:51

Thank you, Albert. And thank you, everyone, for sparing your time tonight.

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