STOCK markets have been resilient in 2020, accentuating an apparent divide from the real economy. Thomas Rupf, head of investment advisory & treasury Asia for VP Bank Ltd (Singapore), shares his views and advice for clients.
What are you advising clients in terms of their overall risk exposure as economies continue to struggle under a still-untamed Covid?
The Covid-19 pandemic has caused and continues to cause severe stress to the global economy. Financial support from governments and central banks has led to an increased systemic level of debt. While this is happening, long term robust industrial trends have emerged - firms are now pivoting towards the digital economy, which is gaining momentum, and the health sector is benefiting from new and sustainable growth opportunities. We expect these trends to be further propelled by setbacks in the development of a vaccine, and the pandemic's effects will occupy market movements in the long-term run.
These are the trends that we are recommending clients, albeit with caution and focus. We are favouring companies with sustainable business models, healthy balance sheets, and robust cash flows.
Your latest investment view states that the valuation of corporate bonds is wrong. Given the strong appetite for income, what do you suggest for investors who need income?
Rating agencies expect bankruptcies to surpass levels last seen during the Global Financial Crisis (GFC). Credit risk (measured by option-adjusted spread (OAS)) for speculative grade bonds is now below 5 per cent compared to above 16 per cent during the GFC. Hence, the price is not reflecting the heightened risk.
The question now is whether central banks are committed to taking credit losses of large scale. With this scenario, we are recommending income-oriented clients to diversify out of credit risk.
They could invest in insurance-linked securities which are less affected by capital markets or economic developments. This includes insurance risk, where prices have risen in accordance with years of exceptional high natural catastrophic damages. For qualified investors, we recommend looking at private markets - such as the installation of renewable energy, which generates stable income streams comparable to bonds.
In equities, what factors/risks are priced in and what risks are not in valuations?
Central banks are keeping interest rates low to support a struggling global economy - this is priced in. On top of that, there is a divide between old and new economies. This has led to a run in technology stocks which has reached speculative levels. Growth and high-quality stocks (as against value stocks) are doing well as yield investors plunged into perceived low-risk stocks that provide specious, stable cash returns. These are all reflected in the heavily stretched metrics, based on traditional fundamental valuations like the price-to-earnings or price-to-book ratios.
At the current share prices, earnings of the top 10 performing S&P 500 companies are yielding just 0.01 per cent pa over the next three years, implying that investors are putting too much hope into the future. Even if the global economy performs as well as or even better than the stock market this year and interest rates stabilise at higher levels, there is still not enough earnings growth to justify current valuations.
Hence, for shareholders of such companies, there is more downside risk than upside opportunities. Finally, regulatory risk concerning data privacy must be considered. This is especially important in the multi-trillion dollar digitalisation sectors where currently there is a tendency to overstate the future potential, just as at the peak of the dot.com bubble.
What major themes are you positive about for investors with a mid to long-term horizon?
Digital transformation has emerged as the front winner in the pandemic. All digitalisation participants from education to healthcare have benefited from this. Capex expenditure is increasing and likely to continue increasing for several years, supporting this fast-changing trend, where its early beneficiaries are technology companies. New business models will be created, and the so-called old economy will benefit too. Some examples include Walmart, which is fast closing the digital gap to Amazon and European car manufacturers looking to outsell Tesla for the first time. Hence, there is deep value in high quality companies embedded in traditional industrial sectors which are digitising their business models. The same applies for us at VP Bank, where we've adopted several work-from-home measures to ensure the safety of our employees and clients.
Less cyclical related digital trends, including online education, healthcare, and digital security, will also grow strongly, given the current work-from-home models which most companies will adhere to post-Covid 19.