In my earlier July investment reflection “battleground in a decoupled world”, I talked about my feeling that China has chosen to de-couple from the rest of the world and mind their own business. Here was my summary:

• China has politically decided to be head-to-head with the US.
• China’s “dual circulation” actually means to close the door. They have decided to be isolated since they can’t find a friend on the global stage anyway.
• China’s atmosphere of patriotism is extremely high. This paves the way for the government to make even bolder moves.

In the next few weeks, China has made drastic moves to clamp down on several industries. The action pulled down not China’s stock market, but entire Asia and Emerging market indices because China has a large weight. Fear was in the air and nobody knows who will be the next target.

I have thought about this long and hard and I wrote an article to express some of my views. But I hope you get my message correct. The political risks of China are no doubt high now, but it doesn’t mean that China is no longer investable. In fact, by decoupling from the developed capital market, China domestic shares (A shares) became a good hedge and diversification.

There are a few wild cards in the markets now.

• Which industry will be China’s next target?
• What will happen to global inflation?
• When will Fed raise the interest rate and as a result, impact the asset pricing?
• Will Delta variant dampen the global re-opening progress?

These are the questions that even the policymakers have no answer to. Here are my opinions:

• I think China’s clamping down on “capitalism” is still in the progress, we will see more news in the months to come. China’s reform or crackdown is not limited to the technology sector. The direction is moving towards solving long term social problems at the expense of short term damage to the capital market.
• China will work on three areas: Education, Healthcare and Housing. So companies that have generated huge profits in these sectors will be impacted or “nationalized”.
• The global inflation trend is inevitable as it is the only way to get out of the pandemic from an economic point of view.
• The Fed is eager to raise the interest rate. They are quietly preparing for it. The establishment of the “standing repo facility” (SRF) two weeks ago is the backup plan for “taper tantrums”. (I will explain this in the future if needed)
• Delta variant will have little impact on the financial markets just like all the past health crises due to “human adaptiveness”.

Will Delta variant dampen the recovery?

I think global governments have reached a stage that they will re-open no matter what. To understand this, I recommend you revisit my article in Feb 2010 when the pandemic just started. At that time, it was my opinion that Covid-19 was “weaponized” and used by politicians to achieve various goals. I believed that we can live with the virus due to “human adaptiveness”. Far forward today, Singapore has finally made a U-turn from the zero-Covid target to treat the Covid-19 pandemic as an endemic. This is essentially what I talked about last time.

At this juncture, the US and UK have removed/relaxed their mask and social distancing requirements. And life goes on. Japan has successfully pushed forward the Olympics despite much criticism.

So what will happen next?

The other governments will look at the US, UK and Japan and say, “Hey, we can do the same!” Of course, there will resistance initially, but eventually, people will get used to it, come out and spend money again. Air travel will pick up, demand for energy and other commodities will increase. With a lot of savings in the bank, people may start buying things that they don’t usually buy such as luxurious goods.

These are the sectors that I want to position the portfolio.

Will the US stock market rally continue?

Everybody talks about S&P 500 or Nasdaq is overpriced now. but I think it is fine. The S&P 500 was lifted by FAAMG+ stocks. 8 stocks of the 500 stock components are worth more than 27% of the total market now.

There are two ways we can interpret this.

1. You can say the market has no legs and once the tech stocks stop rising, the market will crash.
2. Or you can say the market has room to grow, but not so much for the tech stocks.

I am in the second camp. So go back to my previous assumption that re-opening is inevitable. If it comes to a time while the FAAMG+ stocks cannot support the market anymore.  We will see other sectors started rotating back. Maybe it is the financial sectors, energy sectors, industry sectors, so on and so forth.

I believe as long as Fed does not pull the liquidity plug (which they dare not to at this moment), that is how the market will be supported in the next few months.

What is the interest rate direction?

I have repeated a few times that the biggest risk is not valuation but inflation and interest rates.

You can refer to two of my past articles if you want to dive deeper into this topic

• First of all, the interest rate determines all asset prices.
• Inflation expectation determines the government’s interest rate policy.

When I say “interest rate”, I am referring to the US interest rate since most developed markets are correlated to the US (except China). And the market generally pays close attention to the 10-year treasury yield.

If you look at the chart below. The interest rate has been rising steadily from August 2020 to March 2021. That is the time our key positions such as Value Stocks, Financials and Commodities were doing well. It was also the time China stock markets outperformed the US stock market.

From April 2021 onwards, the interest rate made a U-turn, that is why Technology Stocks and other Growth stocks made a comeback and the US stock market started to outperform others

Let’s go back to the chart I showed you last month between the 10-year inflation expectation (white line) and 10-year bond yield (blue line).

The interest rate should be above inflation expectation, but there is an abnormality now. So either inflation will come down or the interest rate will go up. I think the interest will go up.

To sum it all…

“Ivan’s Reflection” is my monthly investment note. The purpose of this article is to document my thought on stocks markets and investment ideas so I can review if they are right and wrong in the future. The strategy I use is called Global Momentum Compass which I have developed over the years through my experiences of helping clients manage their investment portfolios. I think for now,

• Volatility in China will continue.
• There is a high chance the interest rate will go up and cyclical stocks may benefit.
• You may want to pay attention to stocks in industries and countries with lagged performance such as energy and financial stocks and those that may benefit from economic re-opening such as airlines.
• Don’t forget to maintain a diversified portfolio with low correlated positions to reduce portfolio volatilities.
• Don’t blindly chase outperforming stocks just because they have done well.

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