Hou Wey Fook of DBS Bank
Macro risks for India are by no means fading, particularly from high oil and food prices and potentially further rate hikes. The Indian market is vulnerable to a turn in risk appetite due to its high valuation, Hou Wey Fook, Chief Investment Officer at DBS, shares in an interview to Moneycontrol.
DBS remains neutral on the Indian market with a preference for selected opportunities in banks and consumer discretionary sectors and FMCG stocks, driven by resilient domestic demand.
This engineer and CFA charter holder with over 30 years of fund management experience sees the Fed Funds rate rising towards 4.5 percent before taking a temporary pause for the Fed to assess the full impact of these hikes on the labour market and inflation.
On the global front, DBS believes there is investment potential in soft commodities, and in particular food commodities. In fact, both industrial metals and soft commodities are underpinned by long-term tailwinds and present investment opportunities, Wey Fook believes. Excerpts from the interview:
Do you think the global equity markets are still worried about the headwinds like geopolitical uncertainty, elevated inflation, and an increasingly hawkish Fed?
Yes. On a quarter-to-date basis, US equities garnered slight inflows of $ 8.6 billion (as of September 7) and this marked a stark contrast to the outflows seen in other markets: Europe (-$ 14.3 billion), Japan (-$ 4.7 billion), and Asia ex-Japan (-$ 4.6 billion). Europe registered the strongest outflow during the quarter as asset allocators continued to de-risk their portfolios in the wake of lingering geopolitical tensions and spiraling inflation in the region. We stay underweight in Europe.
A series of domestic headwinds in China has weighed on the North Asia equity market, including rising geopolitical tensions, slowing corporate earnings, and issues surrounding China’s real estate sector. The Fed’s resolve in containing inflation through hawkish rate hikes is negative for the outlook of growth equities as the rising cost of capital weighs on valuations. Since the start of the year, valuations have indeed undergone substantial contraction. But at current levels, we believe many of the headwinds have been substantially priced in.
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While the segment may stay volatile in the coming months, the risk-reward looks fair from a 12-month perspective. Sentiment towards investing in Europe remains weak as the Russia-Ukraine crisis drags on and the euro drops below parity. Markets are also spooked by global tightening fears as the Fed’s hawkish message intensified, erasing hopes of an early pause or a U-turn on the path of interest rates. Meanwhile, global slowdown fears gain traction as PMI and export numbers start rolling over.
How do you see Treasury bond yields against equities? Do you expect the US bond yields to move near 5 percent by the end of current financial year as the Federal Reserve is likely to tighten monetary policy further?
Markets saw no relief last quarter with increasing concerns of a global recession. After five rate hikes by the Fed totaling 300 bps since March, Treasury bond yields have more than tripled while equities have fallen 25 percent. We see the Fed Funds rate rising towards 4.5 percent before taking a temporary pause for the Fed to assess the full impact of these hikes on the labour market and inflation.
The bond market does not require the Fed to start cutting rates before yields trade lower. As long as signs of a peak in Fed policy rates are imminent, bond yields would historically start trending lower as investors’ price forward. We believe this will also be the case in 2023.
Do you think the consistent rate hikes strategy is really helping the Federal Reserve achieve its inflation target? Also, is it impacting the labour markets in the US?
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The Fed wants more rate hikes which should keep the USD strong for the rest of 2022. Next year, a peak and pause in the Fed hike cycle could cool the dollar, barring financial stress and a hard landing.
What are the investment themes that you are betting on, considering the current and changing global environment?
Valuations have fallen as a result of rising rates and this translates to a sharp increase in public-to-private deals with more than $ 110 billion done during the first half of this year (as compared to $ 181 billion for the whole of 2021).
From a debt servicing perspective, rising rates will no doubt be a strain on the cash flow of deals that are highly leveraged. Henceforth, investments with low leverage in the venture and growth capital space are preferred.
The US Chips and Science Act recently signed into law in the US will provide over $ 52 billion for semiconductor research, development, and manufacturing, and also offers a 25 percent investment tax credit for capital expenses. The bill will enable many companies to accelerate investments in manufacturing and boost the outlook for capex spending in the semiconductor sector.
While soft commodities have not matched the superlative performance of oil and gas, it is still an outperformer relative to other asset classes, returning +13.8 percent YTD as of August. We believe there is investment potential in soft commodities, and in particular food commodities, on the basis that demand is stable and growing but supply looks increasingly constrained moving forward.
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Both industrial metals and soft commodities are underpinned by long-term tailwinds and present investment opportunities. In a world where returns from equities and bonds are becoming increasingly correlated, commodities as an asset class, including gold, have an important role as a risk diversifier in our overall barbell portfolio construct. Exposure to commodities can be achieved through investment in diversified commodity funds, which give investors direct exposure to various commodity prices.
Asia is projected to be the fastest-growing market over the coming decades due to its vast population and underinvestment in medical facilities. To modernize its healthcare systems, Asia will expand its medical services capacity and readiness.
Why do you think luxury and healthcare segments are beneficiaries of new lifestyle choices and demographic changes?
By evolving with changes in lifestyles and demographics, we believe that the enduring appeal of top luxury brands to a new generation of consumers will allow them to maintain premium valuations, providing sectoral exposure that will not go out of vogue. As consumers become more affluent, they consume luxury goods to express their individuality, social status, and aspirations.
Luxury products are expensive, of high quality, and limited in distribution. But beyond premium price tags and intricate workmanship, it forms part of a bespoke experience and is held as a signifier of success. Millennials are now in their prime spending years and are set to form the bulk of the luxury market by 2025. This generation of consumers is the driving force behind the evolving concept of luxury.
The migration of consumers to the digital realm has created new opportunities that drive luxury consumption. While this was already in force pre-Covid, the pandemic catalysed a wider shift toward digital behaviour across demographics and geographies.
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The scenario for the healthcare sector looks promising, with aging populations, the prevalence of chronic diseases, and a growing demand for innovative devices and services underpin the sector’s expansion potential. By 2030, the global Total Addressable Market (TAM) of medical devices will reach $ 800 billion. The sector has delivered consistently strong returns over the long term, especially in the second half of the past decade. We expect this upward momentum to persist over the next decade as TAM expands amid rising end demand and the emergence of new devices.
Do you really see a global recession or just a normal slowdown? Is it likely in the coming calendar year?
Recession concerns have dominated investor sentiment this year and this is unsurprising given acute macro headwinds globally. Across the Atlantic in Europe, the region continues to grapple with the fallout from the Russia-Ukraine crisis and elevated energy prices.
Over in Asia, uncertainties surrounding China’s Covid policies remain a drag on consumer/business confidence and the country’s growth prospects. The untimely convergence of these headwinds suggests that economic moderation is on the cards. The probability of a Fed-induced recession is on the rise.
Most global investors expect India to outperform other equity markets. What are your thoughts and what is your view on India?
Attracted by a weak rupee and its position as an outlier in Asia’s growth outlook, foreign investors were net buyers in Indian equities in Q3-CY22, reversing the weak trend observed in first half of 2022. However, macro risks are by no means fading – particularly from high oil and food prices and potentially further rate hikes.
As such, the market is vulnerable to a turn in risk appetite due to its high valuation. We remain neutral in the market with a preference for selected opportunities in banks and consumer discretionary sectors and FMCG stocks, driven by resilient domestic demand. Urban consumption remains strong as a result of post-pandemic recovery; decent monsoon rains and higher agricultural prices are tailwinds for the rural income recovery.
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Do you see further weakness in leading currencies as the US dollar has been strengthening? Do you expect the rupee to weaken up to 85-86 against the US dollar by end of the financial year? Also is the current rupee weakness beneficial for India?
We see USD extending its rally for the rest of the year before pulling back in 2023. We expect the USD to peak when the Fed stops jumbo hikes and returns to normal increases before an eventual pause.
We expect INR to push into a weaker 80-82 per USD range in Q4-CY22. However, there is little room for complacency. Many Asian currencies have buckled on the Fed’s aggressive stance to control inflation with higher rates at the expense of growth but there is a limit to intervention, if Fed continues to deliver jumbo hikes.
India doesn’t benefit from a weak currency as it is not an exports oriented economy.
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