SCB CIO advises caution with high yield debentures
The SCB CIO foresees a gentle slowdown in the US economy as inflation decreases, with a 1-2 year journey to hit the 2% target. In 2024-2025, the Fed might cut rates by 100-120 bps to 3.4%.
Caution is advised on high-yield bonds, especially tied to China’s property markets due to its high leverage and sluggish recovery. The SCB CIO has shifted Japanese stocks to neutral but recommends Chinese A-shares benefiting from targeted economic stimuli implemented in the second half of the year, alongside Thai stocks.
Dr. Kampon Adireksombat, First Senior Vice President and Team Head of SCB Chief Investment Office at Siam Commercial Bank, has revealed a shift in the SCB CIO’s view on the US economy. Formerly inclined towards the possibility of a mild economic recession due to consistent inflation deceleration, the SCB CIO’s stance now anticipates a soft landing. Despite taking 1-2 more years to reach the Fed’s 2% inflation target (expected by 2025), the strong labor market, especially in services, is predicted to mitigate a manageable slowdown in the US economy during 2023-2024, in line with the Fed’s latest projection (June 2023). The projected growth rates for the US economy are 1.0%, 1.1%, and 1.8% for 2023, 2024, and 2025 respectively, compared to the 1.8% average long-term growth rate.
The SCB CIO’s assessment indicates that due to the soft landing economic trend and the gradual decrease in inflation, the Federal Reserve’s rate cuts in the current cycle are expected to be both smaller and more gradual than the previous cuts. The Fed is projected to implement rate reductions of 100 to 120 basis points between 2024 and 2025, culminating in a year-end policy interest rate of 3.4% in 2025. This anticipated interest rate level has not been observed since 2008. Conversely, in emerging market economies where economic growth and inflation have slowed more than anticipated, adjustments to interest rates are likely. Countries like China and Vietnam could initiate interest rate cuts, while others like Thailand might put a hold on rate hikes. These variations would sustain the substantial interest rate spreads between the United States and emerging markets over the coming six months.
Examining the pattern of relatively elevated interest rates amid economic deceleration, nations grappling with high levels of corporate and household debt face the looming risk of a balance sheet recession. This entails businesses and households grappling with considerable debt burdens, a sluggish revival of asset values or even their decline, and a resulting decrease in disposable income allocated for consumption and investment. Consequently, these entities focus on debt repayment rather than seeking additional loans, aiming to alleviate their financial strains. A historical parallel can be drawn with Japan’s economic experience in the 1990s. Currently, similar concerns are surfacing in China’s market. However, in contrast to Japan’s situation during that era, China’s banking sector remains robust. Additionally, Chinese asset prices, particularly in the housing sector, are gradually rebounding and have yet to encounter the extent of price deterioration witnessed in Japan.
Dr. Kampon has remarked that considering the current status of the US economy characterized by a leaning toward a soft landing, our stance on investment-grade bonds is being adjusted slightly to a positive or accumulating position. However, we maintain our advice against investing in high-yield bonds, particularly within the Chinese corporate bond market. This caution arises from our assessment that inflation is likely to decelerate, coupled with the Federal Reserve’s inclination to halt interest rate hikes and the anticipation of a rate cut in mid-2024. These factors will likely contribute to a gradual decline in returns for both short- and long-term bonds over the upcoming 6-12 months. Nevertheless, it’s worth noting that persistently elevated interest rates throughout the remainder of the year could elevate the credit risk associated with high-yield debentures, especially those linked to heavily indebted business groups like the real estate sector in China.
In gaining insight into global stock market investments, the majority of companies surpassed expectations in their Q2 2023 earnings reports. Although sales growth on the US stock market moderated, the overall performance and profits either exceeded projections or experienced a milder decline than anticipated. Prominent conglomerates within the Nasdaq 100, followed by the broader S&P 500, demonstrated superior performance when compared to small and mid-cap counterparts in the Russell 2000 index. Meanwhile, the Japanese stock market reported a marginal slowdown in the sales of goods and services; however, profits continued to rise due to a resurgence in domestic demand, increased tourism, and the depreciation of the Yen. This growth not only exceeded forecasts but also outperformed initial projections. In stark contrast, the European stock market, as represented by the EuroStoxx 600 index, faced a contraction in both sales and profits. Conversely, the Vietnamese stock market is progressively recovering in terms of corporate sales, although at a pace slightly ahead of market expectations. Similarly, the Thai stock market reported sales and earnings that fell short of anticipated levels. The primary contributors to this underperformance were the energy, consumer goods, and real estate sectors.
The SCB CIO observes a notable easing in the previously taut valuations of developed country stock markets, particularly apparent in the diminishing strength of US tech stocks. As a proactive strategy, we advise redirecting investments from US tech stocks to defensive alternatives. Concurrently, our stance on Japanese stocks has been adjusted to neutral (indicating a pause in selling or holding) due to shifts in the yield curve control policy framework governing movements in the 10-year Japanese government bonds. This transformation is paralleled by ongoing market reforms, emphasizing improved governance and anticipations of corporate earnings revival.
Furthermore, we continue to advocate for a gradual accumulation of Chinese A-shares stocks, based on the outlook for targeted economic stimulus measures anticipated in the latter half of the year. Concerning Thai stocks, the diminishing shadows of political and policy uncertainties have paved the way for a more favorable view. Our perspective on Vietnamese stocks has also been adjusted to neutral, driven by moderate valuations and more favorable budget outcomes than initially projected. Regarding Chinese stocks, our outlook remains neutral for H-shares, despite considerable valuation declines. This neutrality is rooted in concerns encompassing banking stocks, constituting 18% of the total market capitalization, which might experience earnings impacts due to lowered interest rates and investments in local government bonds. Similar concerns apply to tech stocks, representing 37% of the overall market capitalization, primarily attributed to heightened risks associated with the ongoing tech war.
