Punxsutawney Phil, the famous groundhog that resides in Punxsutawney, Pennsylvania, is the central figure in the annual Groundhog Day celebration that takes place every February.
According to folklore, if Phil emerges from his burrow and sees his shadow (and hence retreats to his hole), six more weeks of winter are expected. If Phil does not see his shadow, spring will arrive early instead.
This American tradition originated with the early European immigrants, and notwithstanding the patchiness of Phil's weather forecasting accuracy, the tradition has kept many people enthralled by the critter's every move come February. (Side note: Groundhog Day is also used to describe an unpleasant, repetitive situation -- a term made popular by the 1993 movie starring Bill Murray.)
January is behind us, and the Nasdaq and S&P 500 stock indices have put in yet another positive (albeit more moderate) month, each gaining under 2% to mark their third consecutive month of advances. Much like forecasting the weather by inferring the behaviour of a groundhog, there is no lack of stock pundits who attempt to predict how the year will pan out for the markets based on various methodologies such as the January Effect, the four-year US presidential cycle, or even using the Lunar Cycle to pick entry points.
Groundhogs and calendar effects aside, the current economic paradigm is clear -- the bull market in equities that began in October 2022 continues. Out of the "Magnificent 7" companies that have reported earnings, Tesla and Apple have lagged the other members of the exclusive club, with fourth-quarter revenue growth of just 3% and 2% year-on-year respectively. However, the rest of the group more than made up for this by posting revenue growth of 14% year-on-year on aggregate and an expansion of net margins to 23%.
'MAGNIFICENT 7' EFFECT
Some investors are now venturing comparisons between the Magnificent 7 -- Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla -- with the leading stocks of the internet bubble more than two decades ago. The rally at the turn of the millennium was the perfect combination of a massive wave of liquidity (as central banks eased monetary policy in unison to counter the shock of the Asian financial crisis of 1997-98), and a belief in the unlimited growth prospects of the new internet leaders (Pets.com anyone?).
Today, the picture is very different. On one hand, central banks are turning off the liquidity tap, while on the other, the free cash flow generated by today's technology leaders is reaching unprecedented heights, and share buy-back announcements continue apace. Most importantly, the Magnificent 7 companies operate in industries with huge addressable markets where economies of scale and network effects are more important and valuable than ever.
In our view, the current economic landscape is markedly different, and our assessment of endogenous market drivers and technical factors points to a continuation of the secular bull market in equities. That said, while the primary bull trend is intact, a pullback and consolidation should not be ruled out to digest some gains from the last three months.
On the other side of the Pacific, major Chinese equity indices have fallen around 10% for the year to date, making China one of the worst-performing markets globally. Against this backdrop, Chinese policymakers stepped up their efforts to counter the deepening stock market downturn by formally introducing short-selling restrictions.
Over the past year, Chinese authorities have repeatedly tried to stem the sell-off in domestic equities with measures including cutting stock-trading fees, restricting capital outflows, and ordering Chinese mutual funds not to be net sellers of domestic stocks on certain days. These measures have all had limited success.
KNOCK-ON IMPACT
We view the current Chinese market decline as largely driven by market and liquidity dynamics. There are a few areas that investors are focusing on, the first of which includes the downside knock-ons of snowball derivative products that were triggered by the China Securities 500 (CSI500) and CSI1000 indices continuously falling.
As the downside kicks in, dealers have to unwind part of their long hedges, which in turn causes additional selling pressure. We believe the bulk of these knock-ons should have happened, so the worst should be behind us.
However, we would avoid "catching a falling knife" and prefer to first see signs of stabilisation before placing any tactical rebound trades. We believe Chinese equities are cheap for a reason, and the asset class remains a poor risk/reward proposition strategically under the current government policies. With the primary bear trend not expected to reverse anytime soon, global multi-asset investors can afford to underweight them.
On a related note, a robust strategic asset allocation is the foundation of successful investing and should always be the fallback position of a portfolio, irrespective of prevailing market conditions.
Investors who wish to avoid the Groundhog Day cycle of seeing their portfolio values fluctuate with Chinese equities may fare better to rebalance some of these concentrated exposures to achieve a more diversified portfolio that includes developed market equities, fixed income and alternative solutions such as hedge funds and private assets.
Kean Tan is head of investment solutions at SCB-Julius Baer Securities Co Ltd in Bangkok.