Infections and inflation: investment themes in H2
In the first half of this year, the global economy and investment performed quite well. First-quarter GDP growth in many countries is trending upward, while rising purchasing managers’ indices, especially in developed countries, point to a recovery in the manufacturing sector.
On the investment side, especially in the capital market, stocks have generally performed well. The indices of major markets such as the United States and Europe have risen by more than 10% since the start of the year, while most Asian markets are up 5-10%. The Chinese indices are a surprising exception, having barely budged even though the economic recovery there is well ahead of the global pace.
However, recently the image of the global economy has started to change. In previously high-growth economies like the United States and China, recent figures have been disappointing, including data on employment in the United States and retail sales in both countries. We expect the slower momentum to continue into the third quarter.
Meanwhile, we are witnessing an inflationary surprise due to the rise in prices of several commodities. Some, like copper, iron ore, aluminum and cobalt, have reached record levels. The prices of agricultural products such as corn, wheat, rubber, palm oil, sugar and others have also reached their highest level in years.
Therefore, we are seeing signals of tighter controls in large economies such as the United States and China, including tax hikes and the likelihood that the US Federal Reserve will start cutting its bond purchases.
In China, tighter regulation of financial regulation has affected three groups of businesses at risk: mining (especially coal), real estate, and special purpose companies owned by local governments. A notable example is struggling debt specialist China Huarong Asset Management, of which the finance ministry is the largest shareholder. Amid allegations of fraud and corruption against the company’s management, the prices of its debentures have plummeted, putting it on the verge of bankruptcy.
The Chinese government also continues to tighten its grip on tech companies like Alibaba and Meituan, imposing heavy fines for monopoly behavior.
VEXED BY VIRUS
Meanwhile, developing countries, especially in Asia, continue to be concerned about the worst coronavirus outbreak to date. The newer variants, especially the one first detected in India, are more contagious, last longer and can be more deadly. Infections and deaths continue to rise even as immunization programs in most countries fail.
The world economy has thus split into two groups, with most of the developed economies, especially in the Western Hemisphere, on the road to recovery and most of the developing economies in difficulty.
The third wave of Covid has hit Thailand particularly hard. During the second wave from mid-December to the end of January, the authorities boosted the economy through various consumer assistance programs, but the domestic sector, especially private consumption, contracted further.
A rebound in merchandise exports could not mitigate the negative impact of the collapse in tourism. As a result, overall exports of goods and services contracted significantly and contributed to the overall contraction of the economy in the first quarter.
Looking ahead, we believe sluggish domestic demand will persist as we are unable to open the country to foreign tourists. Phuket has made great strides in vaccination and is well on its way to opening its “sandbox” program for foreign visitors vaccinated on July 1. But under its ‘sandbox’ program, concerns about Covid variants could prompt Western tourists to delay travel plans to Asia and Thailand in particular. One of the main disincentives is the fact that they may need to be quarantined for 7-14 days upon return to their country of origin.
We believe the fate of the economy will depend on how quickly vaccines are rolled out. According to our calculations, 70% of the Thai population will have received at least one dose of the vaccine by October or November. This could promote a full recovery of the economy in the fourth quarter, after the arrival of tourists and a complete reopening of the economy.
The impact of a 224 billion baht stimulus package approved by the cabinet on May 5 will also help. It includes the continuation of cash donation programs such as “We Win” and “S.33 We Love Each Other”, and Phase 3 of the co-payment program. A new project, “the more you spend, the more you earn” could be a big incentive for consumption in the fourth quarter, when nearly two-thirds of the total budget needs to be allocated.
A new executive order supporting 500 billion baht of additional borrowing, in our opinion, will provide additional fiscal stimulus – or a line of credit if the economy has not fully recovered and we face another round of Covid .
But given the increasing economic and investment risks in the near future, we recommend an underweight to risky assets. The capital markets of developed countries are likely to have more growth opportunities than those of developing countries, which are at higher risk of new infections and low levels of immunization. European markets have more potential for expansion than the United States, which appears to present more political risk in the future.
In Thailand, despite the current headwinds, high levels of liquidity and relatively stable energy prices will remain a beneficial factor for the Thai stock market. However, we believe the economy faces a lot of risks, so we advise readers to invest cautiously and choose stocks with good fundamentals. These include small cap stocks that operate in backcountry markets and that can benefit from government programs.
The economic and investment situation has changed dramatically, so it’s time to carefully recalibrate your strategies.