Investing in a Brave New World

As the world grapples with high inflation – while there are some early signs of peaking inflation – it is very possible that inflation might remain high and sticky for some time. This is difficult not only for consumers, but also for investors.

Concerns about stagflation risks have hit both bond and equity markets this year, creating a double whammy for investors. As a result of higher inflationary pressures, central banks have begun to tighten policy, and bonds have fallen sharply. Equities were also impacted by policy tightening, concerns about inflation eroding into margins, and the slowing economic cycle.

With both bonds and equities falling, there seem to be few safe havens, but there is still a ray of hope.

If inflation gradually begins to level off and economic growth slows, some central banks may hike less than markets currently anticipate. As a result, opportunities for short-term global investment grade bonds will emerge.

On the growth front, the global momentum is clearly slowing, but the earnings season has shown that many high-quality companies are still achieving solid profit growth, though the earnings outlook will become more difficult with an impending earnings downgrade.

The fact that parts of the developed economies and Southeast Asia are experiencing relatively stronger growth should help keep the global economy from entering a recession. We are also anticipating that China’s stimulus will begin to stimulate activity in the second half of 2022.

Southeast Asia coping better

Despite the global uncertainty, the markets in Southeast Asia have been particularly resilient. Southeast Asia is gradually reopening its doors, resulting in a surge in consumer spending. Tourism is likely to be strong for the region.

Since late last year, we’ve been positive on the region.

The question is, should we continue our optimism for the region?

The answer is that we need to be more selective in Southeast Asia. Some things have changed.

The global trade cycle is cooling, and rising food costs will hurt the region, pushing up inflation and forcing central banks to tighten monetary policy in the months ahead.

While the short-term outlook for region is looking to become more challenging, the long-term prospect of Southeast Asia remains bright.

Position for longer term trends in Southeast Asia

The adoption of the Regional Comprehensive Economic Partnership (RCEP) will be a game changer for Southeast Asia, as it will re-ignite a new cycle of investment and infrastructure spending for the region, which has been put on hold for the past two years.

The move toward automation and regionalisation of supply chains will benefit Southeast Asia, especially Singapore, as it will stand to gain from more foreign direct investments.

Looking ahead, Southeast Asia is a kaleidoscope of strengths. Indonesia’s natural resources, Singapore’s well-established financial centre, Malaysia’s semiconductor chip manufacturing prowess, and Thailand’s strong automotive sector are all factors to consider. Southeast Asia has the potential to become a dominant manufacturing hub of the future, based on automation, robots, and artificial intelligence, as a region through the free trade agreement.

Don’t ignore Southeast Asia’s green transition

Southeast Asia’s green transition has the potential to create more than USD$1 trillion in annual economic opportunities by 2030, according to Bain.

For investors, Southeast Asia’s green transition is an emerging thematic trend.

The region is expecting a population surge of 90 million in the next decade, which will put more stress on existing infrastructure. Cities are a key contributor to climate change, being responsible for 75% of carbon emissions, with transport and buildings as the largest emitters. Smart building solutions can unlock cost savings by adopting efficient energy usage.

Globally, electric vehicles are expected to grow by 36% annually, reaching 245 million vehicles in 2030 – more than 30 times above today’s level.

Southeast Asia, coming from a low base, is expected to see bigger exponential expansion in the region, electric two- and three-wheelers will represent the lion’s share of the total electric vehicle fleet, as this category is most suited for the rapid transition to electric drive.

With such goals, there will be immense improvements in electric vehicle infrastructure. For example, Singapore is aiming to deploy 60,000 charging points and require all newly registered cars to be cleaner-energy models by 2030. Internal combustion engines will also be phased out by 2040.

Agricultural practices are also inefficient in many parts of the region and are threatening ASEAN’s food security. Employing technology and localising production are key to feeding a growing and large urban population in a sustainable manner.

Singapore as a small city with limited land for traditional agriculture has plans to increase its local food production through vertical farms and sustainable aquaculture.

Also, take for instance the upside in development of alternative plant-based protein, which is estimated to generate US$14 billion by 2025, globally. Singapore can be the launchpad for alternative plant-protein research such as cell-cultured protein, and the development of a plant-protein production hub for the region.

Sustainable agriculture and food technology can be scaled across SEA improving yield, production and security significantly. With higher food production and security, food prices can be better managed in the years ahead.

The investment case for Southeast Asia’s green opportunities will evolve from a small set of pure play renewable and clean tech companies to a broader set of opportunities across the whole economy that spans from sustainable infrastructure, transport and agriculture.

Investment Strategy

While the adoption of RCEP and Southeast Asia’s green transition are compelling investment themes over the long haul, there is a need for investors to raise portfolio resilience for the short-term, so that they can be opportunistic for long-term opportunities.

To increase portfolio resilience in the nearer term, one should prioritise quality, income, and diversification to reduce volatility while remaining invested and capturing the upside we anticipate in the second half of the year.

Periods of unusually high inflation necessitate a shift in investment strategy and asset allocation toward asset classes, sectors, and investment styles that benefit from it or are relatively resilient in an inflationary environment.

As a result, investors require differentiated investment strategies and asset mixes, which they may not employ during periods of low interest rates and inflation. A traditional 60/40 equity-bond portfolio is insufficient. There is a need to diversify one’s portfolio and include alternatives such as commodities, real estate, private markets, and hedge funds.

Commodities and other assets that can potentially act as an inflation hedge such as precious metals, infrastructure or inflation-linked bonds, may be beneficial additions to an inflation-fighting portfolio. Persistently high inflation may also contribute to a more volatile macro environment, with interest rates and currencies behaving more erratically than in the past, creating more opportunities for dynamic fixed income and hedge fund strategies.

In an uncertain world undergoing unprecedented change, it is prudent to build resilient portfolios to withstand the inevitable bouts of volatility, but it would be imprudent to overlook the wide range of opportunities that will emerge from this landscape.

A contribution piece by James Cheo, Chief Investment Officer, Southeast Asia, HSBC Global Private Banking & Wealth. A version of this piece was first published in The Straits Times on 19th September 2022.