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Dr Chan: Market Overreading Into Federal Reserve’s Dovish Turn

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On 9 March 2019, I returned to Singapore to speak at the Shares Investment Conference (SIC) 2019 held at the HDB Hub in Toa Payoh.  As I always put up in hotels each time I return, it has been a while since I last explored our housing districts. This time round, I took the opportunity to walk around the neighbourhood of Toa Payoh after the SIC event.

Interestingly, I observed that there are many stores selling mobile phones and electronics, which retail China’s Oppo smartphones. While Oppo is rare in Hong Kong, it is a rather popular brand in China and seemingly in Singapore. Moreover, there are plenty of massage parlours that cost very little to set up.

In 2018, the US Federal Reserve hiked interest rates four times. During the last hike in December, the Fed further guided to two more interest rate hikes in 2019, sparking off a stock market rout. However, in a mere three months on 20 March 2019, the Fed flipped its stance and instead paused interest rate hikes in 2019.

But instead of reacting positively to the news, investors sold off short-term treasuries and piled on long-term government bonds on the Fed’s sudden dovish turn. This culminated in the inversion of the short and long term yield curve, a phenomenon reflecting the increasing concerns of a looming economic downturn. As a result, another bout of sell-off occurred on 22 March 2019, as investors scurried into safer assets.

In reality, the yield curve of the 10-year and 2-year treasuries actually inverted in December last year. During that time, bond investors have already perceived that US economic growth would slow and hence would call for the Fed to cut interest rates in the near-term.

However, the stock market seemed to have over-read into the Fed’s latest move. Had the Fed seen any signs of an economic recession, the US central bank would have slashed interest rates instead of just pausing hikes.

In the past three years or so, the Fed has raised interest rates a total of nine times, setting the conditions for a possible rate cut. With Trump running for re-election next year, maybe then would Trump begin to ratchet up pressure on the Fed.  Well, with the Fed’s sudden dovish turn, perhaps, Powell finally got the message and conceded.

According to World Intellectual Property Organisation, China’s Huawei led the world in international patent applications in 2018, while ZTE Corporation ranked fifth. This is testament to China’s growing strength.

In recent months, the US called for allies to ban Huawei’s equipment. However, the desperation seemed to be motivated by the fact that Huawei has surpassed the US in telecommunication technology and hence indirectly helped to put Huawei on the world map. This further prompted global consumers to look into other Chinese smartphones led by Huawei, which are not inferior to US’ Apple and Korea’s Samsung.

On 25 March 2019, the Singapore and Hong Kong stock market opened lower, following the US sell-off. However, there were still stocks that managed to buck the downtrend, such as HK-listed ZTE Corp and China Telecom which rose four percent and 0.5 percent respectively. On that day, investors reacted positively to China Telecom’s launch of the world’s first 5G mobile SIM card. It seems that another round of speculation on the concept stocks is building up once again.

On 20 March 2019, HK-listed K. Wah International Holdings (00173.HK) announced its latest earnings and I wrote an article recommending the deep value stock. Following the publication, its share price began to soar and even managed to rise against the tide on 25 March. In a matter of days after its earnings release, the stock climbed 8.9 percent!

In spite of the spike in share price, K. Wah is still a steal. Currently, the stock is valued at a price-to-earnings multiple of just 3.5 times, a price-to-book value of 0.4 times and offers a dividend yield of 4.3 percent. What’s more, the company sold over HK$12.2 billion worth of properties which would be booked over the next two years. Considering its market capitalisation of HK$14.5 billion, the stock is definitely flying under investors’ radar.

The US Boeing 737 Max 8 aircraft suffered two air disasters in five months. Following the second and more recent incident on 10 March 2019, the Civil Aviation Administration of China ordered all Chinese airlines to ground the aircraft.

At that time, Trump might perceive this as a tactical move by the Chinese government in the US-China trade war. However, following China’s lead, many countries’ governments also grounded the Boeing 737 Max 8, giving Trump no choice but to take similar action.

During the first incident, China already began to pay close attention to the initial investigation report relating to the aircraft. As the aircraft indeed has a design flaw, the Chinese government did not hesitate to ground the aircraft following the second incident.

According to various media reports, North Korea is said to be rebuilding its major missile launch site amid the collapse of denuclearization talks. North Korean Supreme Leader Kim Jong-un would likely be using it as a bargaining chip to get Trump back on the table, after the unpredictable US President walked away during the second summit in Vietnam.

Now, as US and Chinese officials try to close in on a deal, Trump vowed for nothing less than an “excellent deal” with China. If Trump really walks away from a trade deal when he meets China President Xi Jinping, it would definitely spark off a global stock market rout. Metaphorically, nowadays, the stock market’s performance is at the whims and fancy of Trump.

Of course, Trump’s threats are part of his negotiating strategy which resembles that of how real estate agents push for higher prices for pre-owned properties. First, the real estate agent would accept the prospective homebuyer’s offer price. The seller would then demand a higher offer right before the deal is struck and the real estate agent would then press the buyer to place a higher offer.

After a year since the opening salvos of the US-China trade war and after many rounds of talks, the US has always unilaterally “disclosed” information about ongoing negotiations. On the other hand, Chinese officials have consistently maintained that the negotiations are “progressing well”. However, the former Governor of the People’s Bank of China Yi Gang finally divulged some information about China promising the US that it would stop devaluing its currency to boost exports.

Last year, when the US formally imposed a 10-percent tariff on US$200 billion worth of Chinese goods, the Chinese Renminbi also depreciated by a similar margin within  a short period of time. Obviously, the depreciation was engineered to strategically counter the hike in US tariffs in order for China to maintain the competitiveness of Chinese goods. As such, if the US fails to make a deal with China, the Renminbi could depreciate once again to hedge against the impact of more US tariffs.

At present, many Chinese real estate developers are holding a lot of US Dollar denominated loans due to lower interest rates. Investors should bear in mind that these companies have significant exchange rate risks since they record revenue in Renminbi. In the event that the Chinese currency is strategically devalued, profitability would be impacted.

Recently, HK-listed MTR Corporation announced its earnings which marginally declined but managed to exceed expectations. Many big research houses upgraded the stock, lifting the share price to a new 52-week high. However, the stock has yet to reach its full potential. This is because as the largest land supplier this year, developments on these lands mean an enormous windfall in the years ahead.

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