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“Money is always eager and ready to work for anyone who is ready to employ it.”
— Idowu Koyenikan

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• The S&P 500 and Nasdaq 100 have outperformed even the most bullish analyst expectations in the first half of the year. This comes in the face of moribund earnings performance.  
• We believe these gains have stretched valuation metrics to significantly above the historical mean for the corresponding rate environment.
• China’s reemergence from the pandemic and its real estate troubles will be key to many segments of the markets in the near-term future. We expect monetary and fiscal policy support from the authorities to prop up the market.
• Therefore, we are cautiously optimistic on the economic outlook for emerging markets, as well as commodity markets, going into the second half of the year.  
• Junk-rated securities continue to outperform investment grade bonds on an absolute, but especially on a duration-adjusted, basis.
• Based on the above factors, we are rotating our portfolio positioning on the equity asset side, with a very small underweight in U.S. stocks and a minor overweight in Emerging Markets. We are maintaining our overweight in high-yield bonds in fixed income.  
• Our most notable recommendation for clients would be to add fixed income to their investment portfolios as it could outperform equities in the near to medium term, not just on an absolute basis, but particularly on a risk-adjusted basis.

INTERNATIONAL MARKETS

At first glance, U.S. equity markets look upbeat, with the S&P 500 up around 15% in the last 3 months. However, this has been propelled by robust performance in just a handful of technology names, which have been riding the wave of investor sentiment over Artificial Intelligence (AI).  Hence, the tech-heavy Nasdaq outperformed other equity indices whilst the Dow Jones Industrial Average, which excludes these “magnificent 7” companies (except Microsoft and Apple,) is lower. Semiconductor giant, Nvidia, has been the stellar performer, beating revenue expectations as the company is experiencing higher demand for AI chips. Further, exposure to AI and the ability to generate large profits by the 7 largest companies (by market capitalization) has driven almost majority of the gains thus far. Though the S&P 500 has now entered a bull market, the remaining 493 companies in the S&P 500 are, in aggregate, flat, reflecting broader or more tangible economic conditions.

The Federal Reserve held interest rates steady at 5.25% in its June meeting to assess the impact of previous rate hikes on taming price increases. Headline inflation rose 4.0% year-over-year (YoY) through May, relative to 4.9% in April. Core inflation rose more quickly, up 0.4% from April to May and 5.3% YoY, buoyed by elevated food prices, shelter costs, and services prices (excluding housing). Additionally, despite a steady increase in unemployment claims, a decline in job openings and layoffs in some sectors, the labour market remains relatively unscathed (in comparison to the Fed’s objective). The unemployment rate rose from 3.4% in April to 3.7% in May and payroll jobs growth remained resilient, averaging over 300,000 jobs per month.

Core inflation – whether PCE or CPI – is the Fed’s main gauge in determining rate hikes and there has not been much progress in bringing core inflation down in the last 6 months, as it remains in the 5% territory. The Fed would need to see core inflation trending downwards persistently, to be more confident in ending its hawkish stance. Although the Fed has aggressively increased rates, monetary policy is only moderately restrictive and that too, for less than 6 months. This comes as the real federal funds rate i.e., interest rate adjusted for inflation, only turned positive in 2023.  Based on sticky inflation and a softer economy but a resilient labour market, we expect the Fed to hike rates once more in 2023.

During Q2 2023, the U.S. Congress reached an agreement to temporarily suspend the U.S. debt ceiling avoided the possibility of a default. This did not have any major impact on equity markets; but the bond market experienced a more apparent impact as short term U.S. treasury yields moved higher as investors weighed the increased risk of a political gridlock. This issue is now put to rest until 2025. In exchange, a cap on Government spending in the 2nd half of 2023, which has been propping up GDP, could weigh on output.

In a move to support the decline in oil prices, Saudi Arabia decided to cut oil output by 1 million barrels per day in July. Moreover, the rest of the OPEC+ oil producers agreed to extend earlier cuts in supply through the end of 2024 by a further total of 1.4 million barrels per day. Though prices are lower than 2022 levels, potential supply-side constraints on the horizon for energy-based commodities due to a lack of reinvestment in upstream capital projects and OPEC+ production cuts, and the possibility for increased demand from China due to the reopening of the Chinese economy, are likely to keep prices elevated.

The poor performance of emerging markets (EM) has been influenced by China which is the major trading partner to virtually all other EM regions. Regulatory crackdowns on China’s global technology franchises, restrictions on debt restructuring among homebuilders and the zero-COVID policy, were the major factors which interrupted economic momentum in China. However, going forward, EM is likely to be more attractive for investors as the reopening of the Chinese economy, comparatively lower inflation levels and looser monetary policy relative to developed economies to stimulate growth, are likely to result in improved performance.

Investor Takeaway

Although the U.S. economy appears to be resilient, economic indicators such as (i) contracting economic activity measured by the purchasing manager’s index, (ii) sticky inflation, (iii) ‘tighter’ monetary policy and credit conditions, (iv) capped government spending, (v) deepening yield curve inversion, (vi) possible weaker consumption in coming periods influenced by lower savings rate and the resumption of repayment on student loans, are possibly going to lead to a softer economy and reduction in disposable income, which can ultimately reduce corporate profits. If a recession occurs, it is expected to be significantly less pronounced than previous recessions.

…short duration government treasuries are a good place for risk averse investors interested in U.S. markets.

Aggressive to moderately aggressive investors could take advantage of lower-than-average valuations in EM equities to benefit from potential improvements in this market. Additionally, short duration government treasuries are a good place for risk averse investors interested in U.S. markets. Overall, we expect U.S. fixed income to outperform the U.S. equities, especially on a risk-adjusted basis.  With the Federal Reserve expected to keep rates high for an extended period, investors should continue to focus on high quality companies with strong balance sheets, positive free cashflow and the ability to meet interest obligations.

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LOCAL MARKETS

Domestic equity indices all declined sharply in the second quarter, with the Composite Index (TTCI) contracting by 7.31%, ALL T&T Index closing in red by 5.30% and the CROSS-LISTED Index declining by 14.39%. Endeavour Holding Limited (EHL), Agostini’s Limited (AGL) and National Flour Mills Limited (NFM) were the top 3 stocks advancing for the quarter with EHL and AGL appreciating as much 18.18% and 16.95%, respectively. ANSA Merchant Bank Limited followed closely behind with a price appreciation of 8.87% for the quarter. EHL posted significantly improved financial performance. The increase in profits included acquisition gain of Endeavour POS Properties Limited alongside an increase in contract revenues with decreased rental expenses. AGL has continued to deliver results this quarter with a substantial 34.4% year-to-date return owing the run to strong fundamentals, which is likely to carry forward over the long term.

Guardian Holding Limited (GHL) led the charge on declining stocks with a whopping -31.88% in Q2, followed by West Indian Tobacco (WCO) and Trinidad Cement Limited (TCL) which contracted by 27.54% and 25.28%, respectively. GHL saw a steep decline in price after experiencing some changes in reporting standards and management. Events that negatively impacted investor sentiment. WCO’s ability to consistently distribute dividend income to its’ shareholders proved to be an unsatisfactory contribution to the company’s overall performance in the markets despite efforts to diversify into the electronic cigarette space. TCL’s drag on price appreciation was attributed to their provisions for restructuring costs at the Arawak Cement Company in Barbados and lower operating earnings due to higher inflation, a drop in seasonal demand and higher transportation and import costs. Whether the company can withstand the upcoming turbulent economic conditions through effective cost management and improve productivity and performance, remains to be seen.

Post mid-year budget review all eyes have been on the economic state and subsequent policymaking in the near term. Energy and oil prices, which would help shape the narrative on how the government navigates the unstable road ahead, have missed the initial budget target significantly, thus lending towards lower-than-expected GDP growth. Additional funding requested of TT$3.58 billion without a reasonable plan for revenue growth would also increase the central government’s fiscal deficit. A major policy objective is diversification away from energy-related activities to stimulate confidence and drive non-energy related revenue contributions.

On the topic of economic conditions, headline inflation treaded downwards to 5.70% in May 2023 from 6.0% in the previous month. Core inflation, while still high, cooled slightly from 6.7% in January 2023 to 4.80% in May 2023. Food inflation also eased to 9.70% in May 2023 down from 17.3% in the beginning of the year. We believe inflation should steady further through the course of the year. The Central Bank of Trinidad and Tobago held repo rates steady at 3.50% while adjusting open market operations to cope with changes in liquidity conditions.

The 1-year government bond yield increased a further 17bps or to 1.37% in May 2023 from 1.20% in February 2023. Looking at the medium to longer term, the 10-year GOTT bond yield was relatively steady at 5.17%, as per the latest reading from the CBTT.   

Investor Takeaway

As of June 30^th, 2023, the CBTT maintained its repo rate at 3.50%, highlighting the sluggish but steady recovery which occurred through the first quarter of 2023, albeit due to reduced energy production. Strengthening in the non-energy sectors, transportation, trade, and other sectors would fortify the loose monetary policy stance. However, the situation is being carefully monitored as we see a slowdown in global growth and inflation.

Most equities that are expected to achieve positive returns in the long-term would-be companies that are resistant to shifts in economic conditions and are making effective and efficient management of resources, costs, and diversification in revenue streams, as well as companies that have highly inelastic products or are autonomous in decisions regarding pricing power.

Overall limited selection makes choosing winners versus losers in the local equity more difficult, especially when considering the considerably narrow trading volumes. Thus, a long-term passive investment strategy consisting of income generation, sector diversification, balanced with short to medium term quality fixed income options in the sovereign investment grade and corporate space, where available, will generate the greatest benefit for investors within the domestic markets.

Written by:

Leeann Ramdial & Sharda Goolcharan

If you would like to speak with a trusted expert about what investment opportunities are right for you, please reach out to our helpful Wealth Managers at ANSA Merchant Bank.

IMPORTANT DISCLOSURES AND DISCLAIMER

ANSA Merchant Bank Limited (hereinafter “the Bank”) has prepared this report which is provided for informational purposes only and without any obligation, whether contractual or otherwise. The content of the report is subject to change without any prior notice. All opinions and estimates in the report constitute the author’s own judgment as at the date of the report. All information contained in the report has been obtained or arrived at from sources which the Bank believes in good faith to be reliable.  The Bank disclaims any warranty, express or implied, as to the accuracy, timeliness, completeness of the information given, or the assessments made in the report. Any opinions expressed in the report may change without notice. The Bank disclaims all warranties, express or implied, including without limitation warranties of satisfactory quality and fitness for a particular purpose with respect to the information contained in the report. This report does not constitute nor is it intended as a solicitation, an offer, a recommendation to buy, hold, or sell any securities, products, service, investment, or a recommendation to participate in any trading scheme discussed herein. The securities discussed in this report may not be suitable to all investors, therefore Investors wishing to purchase any of the securities mentioned should consult an investment adviser. The information in this report is not intended, in part or in whole, as financial advice. The information in this report shall not be used as part of any prospectus, offering memorandum or other disclosure ascribable to any issuer of securities. The use of the information in this report for the purpose of or with the effect of incorporating any such information into any disclosure intended for any investor or potential investor is not authorized.