2022 has been nothing short of volatile and Q2 2022 was no different as recession risks loom. Global markets felt the pain of sky-high inflation, war, depressed economic growth, sustained supply constraints and quantitative tightening. These factors are not new to the markets and are now well understood. With central banks worldwide making inflation their main priority, one of the main supports for capital markets, easy monetary policy, has been removed. As core inflation has been nearing its peak and with aggressive tightening already priced in, both equities and fixed income may still be rattled by ongoing issues that quantitative tightening (QT) cannot target.
Global inflation may be nearing its peak with US hitting a high of 8.6% for the year, UK at 9% and Japan at 2.4%. The Federal Reserve’s Dot Plot indicates that reference interest rates in the U.S. are expected to reach 3.75% by mid-2023, though the reality of a recession by the second half of 2023 is setting in, the extent of its duration may be mitigated by the overall positive health in consumer and corporate finances.
US markets fell into bear territory as the S&P 500 index was down 5.53% for the last 3 months and -20.65% as of June 30th. Over the course of this quarter, we saw large cap stock valuations trimmed, bringing them closer to their fair values. However, earnings remained resilient, thanks in large part to healthy revenue growth.
Bonds experienced sharp sell offs during the quarter as well. The yield on the 10-year U.S. Treasury Note rose from 2.34% at the start of the quarter, to 3.106% as of June 30th, an increase of 76 basis points. The 30-year Treasury Bond yield rose even more, up 79 bps in that period. Despite these moves, we believe there is limited downside left for bonds as more than expected rate hikes have already been priced in. Credit spreads, which are a proxy of investor fear in the debt markets, also widened during the quarter. The spread on corporate investment grade 10-year debt rose to 207 basis points versus 162 basis points at the start of the April.
Risk appetite for equities has remained low, though a deep global recession is unlikely and there has been clear communication surrounding central bank policies. The main uncertainty for the U.S. economy is the speed and level of tightening which could trigger a larger bear market. Conversely the possibility for upside lies in a combination of peaked U.S. core inflation with a degree of softening in the labour market, and robust top line growth from core companies. Lower inflation readings can also encourage the Fed to become less hawkish in the second half of 2022, which may put a floor on equity valuations.
The Eurozone’s exposure to the Russia-Ukraine war, which shows no signs of resolving, makes equities in this market less appealing. High yield bonds are in focus as inflation pressures rise turning the European central bank hawkish. A 25-bps rate rise is likely to occur at its July meeting as it winds down its quantitative easing programs. The most significant risk is that Russia responds to a potential cap on its oil and gas exports by cutting off natural gas supplies to Europe. Europe has a heavy dependence on Russian gas meaning any retaliation can dramatically impact the recession risk for Europe.
Taking our analysis to the East, recent lockdowns in China have seen economic activity slow significantly through the second quarter, but reopening has commenced with a presidential promise of stimulus support. Furthermore, regulatory headwinds, which have affected investor sentiment on China since late 2020, seems to be dissipating. Regulators in the country have recently provided assurances that the technology sector in the country would be able to resume operations with less oversight and scrutiny. Markets trended high on stimulus hopes while further easing measures should help stabilize markets in the second half of the year.
Chances of a global recession, defined as two consecutive quarters of negative growth, in any of the major economies over the next year remain balanced. The brief inversion of the Treasury yield curve reversed, easing some of the recession angst in the U.S. as well. Investor sentiment indicates that markets may have accounted for many of these threats, but risks remain, especially if the war were to escalate further or the Fed were to hike rates even more quickly than priced in. We expect US stocks to outperform other developed markets. We expect emerging market equities can post a swifter recovery in the coming quarters.
It’s been a difficult and volatile first half of the year, with the MSCI All Country World Index down by -20.93% and the Bloomberg Aggregate Total Return benchmark losing about -13.91% as of June 30th. Investors were left with limited avenues in search for safe shelter as equities entered bear territory and bond yields rose, while cash was eroded by higher inflation. Consumer sentiment declined while investor sentiment signalled deep over sold levels last seen during the March 2020 market crash. Though indicators stipulate that upside is possible moving forward, in the event of a more pessimistic outcome, further panic sell offs can provide some of the best entry points for longer term investors.
Inflation and rate hikes have been setting the tone for volatility, amplified by geopolitical tensions and lower economic growth forecasts. U.S. core inflation can trend lower over the remainder of the year, which may ease the excessive levels of tightening by the Fed. Markets are expected to remain volatile until such time while risks continue growing elsewhere. For these reasons, a nuanced approach is recommended to accommodate for shifts in either direction.
Diversification across geographical sectors and resilient companies such as non-cyclicals and defensives via exchange traded funds are important to capture potential upside. Higher duration, short dated corporate bonds exposure can offer income while investment grade inclusion should improve overall credit quality for an investor’s fixed income portion of the portfolio. The bottom-line recommendation is for investors to position portfolios for long term success thus withstanding the uncertainties of the current market conditions.
Turning to developments on the local front, domestic equities continued their downward trend into the first half of 2022. The Cross Listed Index (CLX) lead the decline, down 21.5% as at June 30th 2022, attributable to a 31.5% decline in NCB Financial Group Limited (NCBFG), a 9.0% contraction in Guardian Holdings Limited (GHL), of which NCBFG holds a 61.8% stake and a 9.8% decline in the price of GraceKennedy Limited (GKC).
The Trinidad and Tobago Composite Index (TTCI) and the All Trinidad and Tobago Index (ALTT) dipped 7.7% and 1.7%, respectively. The TTCI’s volume traded contracted 5.06% during Q2 2022 to 50,873,358 whilst the ALTT experienced a 2.37% decline. The resilience of the ALTT compared to the other indices comprising of cross listed stocks may have been cushioned by the low interest rate environment, which improved the attractiveness of equity market investments. Agostini’s Limited (AGL) experienced the largest price appreciation of 42.3% to close of the quarter at $46.3, followed by Angostura Holdings Limited (AHL), LJ Williams Limited B and Scotiabank Trinidad and Tobago Limited (SBTT), up 27.2%, 13.0% and 12.2%, respectively.
Subsequent to NCBFG, First Citizens Group Financial Holdings Limited (FCGFH) was the second largest decliner for the HY 2022, contracting 19.7%. Unilever Caribbean Limited’s (UCL) price declined 14.3% during period to $13.89 after peaking at $20.07 on June 6th before the payment of a one-off, $4.30 dividend.
The 1-year government bond yield jumped 21 basis points from 0.71% in April 2022 to 0.95% in May 2022, reflecting a fall in excess liquidity conditions. Looking at the medium to longer term, the 10-year bond yield was marginally flat at 4.99% from 4.98% a month earlier whilst the 30-year yield stood at 6.92%. The larger increase in the short-term yield is influenced by sovereign fundamentals and higher inflation expectations.
As global inflationary pressures persist, headline inflation increased to 5.1% in April 2022 compared to 4.1% one month ago whilst food inflation reached 8.7% relative to 7.9% in March 2022. Increases in food prices were buoyed by higher prices for rice, margarine, oil and meat. Similarly core inflation advanced to 4.1% from 3.2% in March, attributable to fuel price adjustments, clothing, housing, furnishings, communications and restaurants and hotels sub-indices. Despite rising prices, the Monetary Policy Committee agreed to maintain the repo rate at 3.5% in its June meeting, as rising domestic prices are driven by external factors whilst credit and real activity in the local economy illustrate signs of recovery.
In the short-term, Trinidad and Tobago could experience nominal growth as energy prices continue to remain upbeat and given that the year-on-year comparative period involved lockdown activities. Profitability of local companies could possibly decline in the short term as
(i) rising prices reduces discretionary income, possibly denting revenue growth for non-essential businesses and as
(ii) increased cost and freight expenses squeeze margins across the board. Additionally, the aforementioned decline in financial market conditions could continue to present a challenge to investment portfolios in the banking and non-banking finance sectors, which could keep the profitability of companies in these sectors in check as volatility continues.
The Government of the Republic of Trinidad and Tobago (GORTT) is selling 10,869,565 of its shares in FCGFH in an Additional Public Offering (APO) at a price of $50.00 per share, in line with its current market value of $50.02 and within its fair value range. The bank’s much anticipated expansion in Guyana through the acquisition of Scotiabank Guyana purchase and sale agreement for the sale has expired and the agreement has been terminated in accordance with its terms. Despite this, the company remains fundamentally strong, has geographical exposure to Jamaica through its Barita investments and intends to continue its geographical diversification and digital transformation. The stock offers a 12M dividend yield of 2.4%, which is lower than the Banking Sector yield of 3.2%, but relatively in line with the 2.6% offered by the TTCI.
FirstCaribbean International Bank Limited’s (FCI) Earnings Per Share improved by 60.6% to TT$0.36 in HY 2022 and the group could experience improved profitability in the coming periods as its major operating jurisdictions see improvement on the Tourism front and as the country continues to work closely with the IMF to advance its economic development. The stock has a price to earnings ratio of 7.9 times, below the sector average of 18.9 times (excluding NCBFG).
National Flour Mills Limited (NFM) hiked flour prices in June after a recent price increase in January to maintain its profitability amid higher wheat, corn and soybean meal prices. Despite this, it is likely that NFM may just break even with this initiative and may not be able to generate a return to its shareholders.
In April 2022, GKC entered into an agreement to make a private equity investment in Bluedot – a full-service research and data intelligence consultancy – taking majority ownership. The Investment arm of GraceKennedy Financial Group, GraceKennedy Capital Management Limited (GK Capital) has signed a joint venture agreement with the Trinidad and Tobago Unit Trust Corporation (TTUTC) in May (subject to regulatory approval). If realized, this will enable GKC and TTUTC to partner in distributing mutual funds in Jamaica which could create new avenues for growth initiative for the group and expand its product reach.
The yield on short-term government paper in Trinidad is now lower than the yield on U.S. Treasury notes. The yield on 12-month U.S. Treasuries, for example, was 2.78% as of June 29th, or 1.83% higher than yield on the 1-year TTGOTT notes. This inversion in yields between the two countries is not sustainable and may force the CBTT to take action and raise rates in the near future. Investors bullish on domestic equities should continue to pursue companies that offer fundamental long-term value and consider liquidity challenges when making investment decisions.
Written by:Leeann Ramdial & Sharda Goolcharan
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