Looking at the world economic and investment picture in the final quarter of the year, it is rather disturbing to say the least. For a start, the 10-year US Treasury yield has surged to 5%, a level not seen since the global financial crisis 15 years ago.
The Chinese economy may look better than expected, but only because of aggressive monetary and fiscal stimulus by the authorities. The all-out war between Israel and Hamas is the most dangerous in decades. What is happening in our world? And how should we invest? Let's find out.
Looking at rising bond yields, we view them as a result of the Federal Reserve signalling that US interest rates will stay higher for longer amid continued good economic numbers. Inflation risks remain high, especially if the Israeli-Hamas war is protracted.
The US fiscal deficit is likely to continue increasing. Fitch estimated in August that the deficit would rise from 3.7% of GDP in 2022 to 6.3% this year and 6.9% in 2025, as government spending is not being reduced enough while taxes are not increasing enough to support that spending.
The Fed, meanwhile, continues to withdraw liquidity, causing short-term bond yields to increase. The liquidity withdrawals of $95 billion per month have brought the Fed's balance sheet down to about $8 trillion, from $9 trillion at the start of 2022.
Looking at the four recessions since 1990, it is interesting to note that they occurred 4-8 months after the yield curve returned to normal following a period marked by an inverted yield curve (short-term bond returns higher than long-term ones).
YIELD CURVE OUTLOOK
US bond yields are normalising. The 10-year yield is 4.9% to 5.0%, while the 2-year yield is at 5.0% to 5.1% (making the difference between the 2- and 10-year bonds only slightly negative, from being close to -1% in the past). It is possible the US economy will enter a recession sometime next year.
Although bond returns are not a direct cause of recession, they reflect a psychological factor -- markets and citizens believe interest rates are too high, that the economy will decline and the central bank will cut rates.
When this happens, short-term bonds will be in demand. This causes short-term returns to decrease, which always happens before the policy interest rate is going to be cut.
In the Middle East, we believe Israel intends to remove Hamas from ruling the Gaza Strip and establish it as an autonomous area similar to the West Bank.
However, a ground assault has yet to start, while global unease is growing about the heavy civilian toll of Israeli air bombardment.
A peace summit would be the first step towards finding an end to this war. But negotiations just to get the conflicting parties to the table could take at least one or two months. As long as the war persists, we will see continued fluctuations in the economy and investment sentiment.
DEFLATION RISK IN CHINA
In China, the 4.9% GDP growth figure in the third quarter was encouraging, but the real estate market remains shaky and deflation risks are intensifying. The IMF expects China's GDP deflator to fall this year from last year. Combined with a weaker yuan, nominal GDP may contract in dollar terms.
This picture is consistent with the Chinese government sending signals that it's ready to help the economy expand as planned. President Xi Jinping recently visited the People's Bank of China for the first time in 10 years, while the government has announced fiscal measures worth 1 trillion yuan.
The Chinese economy has recovered better than expected because of large-scale use of monetary policy, both from reducing interest rates and increasing the money supply. This helps in the short term, but could cause debt to become a problem again in the next period, leading to another slowdown.
Locally, Thai stocks have dropped to their lowest level in three years. This is in line with the regional trend, though the Thai decline has been even more pronounced.
Regionally, we have seen heavy selling pressure on technology stocks as investors are worried about the outlook for major tech companies in the US. This, coupled with concerns about the Middle East and US interest rates, has kept investors worried.
Meanwhile, negative factors in Thailand stem from concerns that measures to stimulate the economy through the distribution of digital money may yield less than expected. Accordingly, we recommend three strategies as follows:
- Undervalued stocks for which prices have entered the oversold zone, with good fundamentals and attractive valuations. Choose BDMS, CPALL and MINT;
- Stocks with good performance expected to continue, such as AP, AOT, BLA, BCH, CENTEL and KCE, and;
- Stocks that pay high dividends (yield plays), such as BCP, BBL, KTB and DIF.
Dr Piyasak Manason is Senior Director of the Investment Strategy Department, INVX-Research Group, at InnovestX Securities Co Ltd.