Shield Up Against Mounting Macro Risks

Taking a more defensive positioning

There are many reasons to hold a longer-term positive  view on equities:

a) robust earnings and cash flow growth, supported by

b) above-trend real and nominal economic growth (aided by government infrastructure programmes),

c) still below-zero long-term real yields,

d) high levels of accumulated savings, and

e) a forthcoming boost from the elimination of Covid-related mobility restrictions globally.

However, in the short term we see that a number of key macro risks have increased sharply recently:

1. Multi-decade high inflation rates are depressing consumer sentiment more than expected and point to lower consumer demand (the US consumer represents two-thirds of the US economy);

2. Tightening financial conditions and weakening credit growth even before the Fed raises rates, putting pressure on the valuations of risk assets;

3. Russia-Ukraine geopolitical tensions is a current flash point, putting pressure on oil & gas, as well as other commodity prices. This could delay the normalisation of inflation, keep the pressure on global central banks, and lead to a further drag on global economic growth.

4. Higher uncertainty around central bank policy weighs on the risk appetite for equities: since late January 2022, the interest rate futures market has moved to price nearly 6 Fed funds rate hikes in 2022. This suggests that markets fear a much faster rate hiking cycle, which historically has been less favourable to equity markets. The uncertainty should fall later this year as inflation peaks.

With these near-term risks in mind investors should adopt a more defensive stance. We favour quality and dividend stocks. As for sector views, we have downgraded US Technology and Consumer Discretionary to negative from neutral. On the other hand, we think the Pharmaceutical and Consumer Staples sectors look interesting at this juncture, offering value, earnings visibility and dividend yield. 

Healthcare/Pharma

We see good defensive value attractions amongst the US Pharma names. This is a well-capitalised space with solid fundamentals and high free cashflow generation. This contrasts with the biotech part of Healthcare which is experiencing a period of relative underperformance, given the more speculative nature of the sector, pressure on balance sheets, more stretched valuations and the prospect that rising interest rates could weigh on the valuations of long-duration assets.

Within the pharmaceutical sector, our most favoured names would be large caps exposed to the Covid vaccine and antiviral therapy themes.

Consumer Staples

We find value in US defensive consumer staples names. Although there have been margin concerns, the sector has enjoyed better-than-expected performance due to an ability to pass on costs to consumers.

As a testament to this, a recent US household and personal care Nielsen survey showed that in January 2022, despite mid-single-digit price increases across categories, volumes have held steady.

Moreover, many of the sector names have earnings that are defensive in nature, due to the fact that many of their products are geared towards daily necessities. Adding to its earnings stability/visibility, the sector also offers dividend yields of up to 4%.

Re-opening remains an on-going theme despite geopolitical tensions

With more than 4 billion vaccine doses administered globally, the world is gradually normalising from the coronavirus pandemic. Despite the spread of the Omicron variant globally, countries (especially in the western hemisphere) are gradually phasing out social restrictions and opening up to international travel. Of note, US air passenger traffic and cruise bookings are now above pre-pandemic levels.

While the Russia-Ukraine conflict may impact travel to these countries, overall repercussions to the travel and hospitality sectors should be manageable as long as the conflict remains localised.

Names benefitting from the re-opening theme have pulled back in tandem with the broad market in late February 2022. We see tactical opportunities in companies exposed to cross-border payments, online travel agencies, resorts and hotels, as well as mobility.

Lastly, we want to express our sadness over what has happened in Ukraine and hope the conflict can be resolved soon.

Spotlight on payment networks

Growth trends for the two largest US payment networks have been encouraging, evidenced by their 4Q21 results. Both networks are seeing payment volumes above 2019 levels, with cross-border travel demand rebounding more strongly than expected. Notably, both payment networks called for an outlook on cross-border travel which implies a full recovery to 2019 levels by December 2022.

While our current house view underweights US technology, within this space, we think payment networks have room to be relative outperformers, underpinned by resilient growth backed by easing Omicron headwinds and continued improvement in cross-border travel.

Furthermore, we continue to see payment networks as beneficiaries from the ongoing global secular shift toward card-based and electronic payments (including new trends like buy-now-pay-later), with recent concerns over competition/disruption overblown.

Although concerns over intensifying competition with fintech companies continue to smolder, we think strong earnings will keep these fears in check. Meanwhile, both companies are undertaking mergers and acquisitions (M&As) and collaborations especially in the blockchain space to expand into new business areas and to hedge the risk of future disruption.

Tech megacaps – 4Q21 results wrap

The 4Q21 reporting season has been an extremely volatile one, even for the tech megacaps. We have put together some thoughts on this space as the dust settles post earnings. 

Within digital advertising, performance was bifurcated as privacy policy changes impacted companies differently, with search (which is driven by user intention) outperforming targeted advertising by a large margin (as social media platforms need time to mitigate the impact by rolling out replacement ad targeting solutions). We think this trend may continue in the next few quarters.

For one of the largest companies in the world by market cap, investor expectations have been low for its latest smartphone model, given low specs upgrade and the strong 5G model launch in 2020. However, the company has been gaining smartphone market share in China. Wearables and PC businesses have also been incredibly robust, while Services has been resilient. Adding to these, there has been increasing excitement over new consumer services and products that the company may roll out over the next few years, such as AR/VR, autonomous driving and payments, which should support continued rerating of the company.

Enterprise software spending was weak in the early recovery period after Covid-19 hit, being more impacted by Covid headwinds, but has been strengthening over the past quarters as budget dollars return. Enterprise software and cloud trends remain extremely resilient and have benefitted one of the world’s largest enterprise software companies, which saw its commercial bookings and cloud business grow 37% and 46% year-on-year (yoy) respectively in 4Q21.

Sentiment had become increasingly negative on a key megacap ecommerce company heading into earnings, as investors worried about waning ecommerce momentum, supply chain disruptions, and the impact of rising transportation costs and wage pressures on the company’s labour intensive business. However, 4Q21 results and forward guidance were better than feared. Looking ahead, with easier yoy compares, price increase of its membership service, and lower capex growth, we think the company should see an inflection point in revenue/earnings growth somewhere along 2H22. The company has also initiated their first stock buyback in 10 years, spending ~USD1.3 billion buying back shares in January 2022.

In the streaming/online TV market, the US market leader experienced pull forward of demand during Covid and is now facing headwinds from reopening – which we think is only natural, and likely temporary. The company remains king in terms of streaming content and we expect very decent earnings and free cashflow growth over the next few years. Of note, Pershing Square, which is known for its value-driven investment style focusing on companies with strong moats and cashflow, has taken a sizeable stake in the company post correction.

To wrap up, the tech megacaps have very diverse businesses with varying trends over the past quarters. While rising rates remain a key overhang, and these names may underperform the broader market in the near term, the common thread that runs across these companies is that they continue to represent quality (balance sheet and cashflow strength) and growth at a very reasonable price.