2021 Financial Frontiers Reflections & 2022 Outlook

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1. In retrospect, 2021 had been a challenging year living alongside Covid and several black swan events. We are truly blessed to have been more fortunate compared to many others despite a turbulent year. For that, we are grateful to have been treated rather generously.

2. Many of our peers and larger funds told us that they were negatively affected by the technology sector in the last quarter. Cathie Wood's ARK fund was amongst the larger funds caught in this sector. As her investors, we too were initially impacted. Fortunately, due to the careful outlook and strategy of our principal, we largely escaped the China regulatory crackdown and the U.S. market sell-off that had compelled other funds to shed and erode their gains on stocks that were badly beaten down, specifically in the last three months of the year. For example, ARKK had performed worse than QQQ over the past 2 years, despite taking on more risk and higher management fees.

3. Having a radically different view compared to the U.S. Federal Reserve following the spike in inflation earlier this year, we acted swiftly and decisively upon feeling uneasy about the extraordinarily high level of inflation. FF predicted that inflation would persist, and that a black swan could once again emerge from the zoo to upset the party. As a result, we took a different path and retreated 45% of our fund out from the markets and it helped us dodge the bullet that caught most of the market pants down.

4. As we conclude the year, we gather as a firm to reflect in retrospect of the decisions we made – on what has been done right and what can be done better. This includes strategising for the new year ahead and a possible new normal.

5. Looking ahead to 2022, neither a bottom-up approach nor a rebound strategy will likely work. As part of our investment evaluation methodology, we focus heavily on a top-down approach where we need to have a lucid understanding of events in the macro environment; after all, it is naïve to think that a company’s fundamentals could be independent of macro winds. We anticipate that a bear market is on its way and it will not be an ordinary bear, but rather a hybrid bear with two bull horns on its head. Thus, we must remain vigilant. Certainly, multiple compression will appear in a bear market scenario.

A “Bipolar World Structure”

6. In our opinion, we are facing the end of globalisation. We are instead inching closer towards a bipolar world where the world is decoupling into two major power blocs, the Western (the U.S) and the Eastern (China). Against this backdrop of bipolarity, we asked ourselves, “How can we outperform in absolute terms once again in 2022?”

7. Not only is it no longer practical, but it is also deadly to rely on traditional "buy and hold" strategies to survive in this bipolar world. Instead, we should focus on situational thematic plays to counter volatility and ride with the wind as the world is becoming messy, politically speaking, and coupled with unpredictable climatic situations. (From floods, wildfires, super tornadoes to perhaps, super-volcanic eruptions and earthquakes).

Economics' Big Lie Ahead?

8. S&P500 has clocked about 70 new highs out of 252 trading days in 2021. In essence, this means that almost 28% of 2021 had been record highs, closing in on the 1995 record of 77 highs. With each record high, it poses a façade tricking many young investors into thinking that the stock market is doing exceptionally well despite many black swan events, leading them to believe that the stock market is bullish. Some had even quit their jobs to become a full-time trader/speculator. Speaking from experience, this sight is both insane and unsustainable. The stock market has detached itself from the macro-environment where it is no longer supported by fundamentals but rather by loose liquidity (no thanks to the Fed).

9. In fact, if one digs deeper and looks at the details, one will realise that we are living in a 'Big Lying' world. Most of us have fallen into a cognitive trap, tricked by green bars within the indexes. Even though the U.S. indexes are going up, they are only being driven by a few big names, namely AAPL, MSFT, GOOGL, TSLA, and NVDA. Most other stocks have lost ground this year.

10. FF believes that the U.S. is heading towards a hybrid bear market, with only a handful of companies doing well and supporting the broader market. However, it seems as though an invisible hand has disguised the bear so well by adorning it with two horns and making everyone think it is a bull. Thus, it is not surprising that so many were caught badly as they were not able to correctly identify the bear’s shadow.

11. Furthermore, FF foresees that the multiple compression will continue into 2022. Companies that promised huge future growth like Sea Ltd and Grab, which are expected to continue burning cash to capture market share, will probably continue to be beaten down moving forward. Anyone unable to identify the 'bear in horns' deserves to suffer losses, including ourselves.

12. Based on the latest YoY CPI of 6.8%, a 39-year high, compared to the U.S. 10-year Treasury yield of less than 1.5%, we are worse off in terms of real purchasing power, but the U.S. government continues to deny the situation over the past quarters, leading us to a 'Big Lying' world. This 6.8% figure is significant and is the highest headline inflation figure of the 21st century, a figure not seen since the Volcker-era disinflation of the early 1980s.

13. Finally, Powell has stepped back and retired the term "transitory". At this point, it appears that the Fed might have begun to act a little too late as we believe that runaway inflation seems imminent, and it is going beyond the government’s control. What would the investors do if the next month’s CPI reading (YoY) exceeds 7.2%? Should we continue to buy more stocks and hold?

14. We believe that a global systemic crisis is on the verge of the horizon, but the U.S. themselves are in denial. As of Nov 29, 2021, the U.S. has a national debt of $28.9 trillion. Should interest rates be raised? If so, by how many times and how much? The odds are all over the place whether it would be twice or thrice. Do keep in mind that every 1% increase in interest rates requires an additional interest payment that is equivalent to approximately 4.5 months of the 2020 U.S. global military expenditure.

15. In our opinion, we think that it will be challenging for the U.S. to raise their interest rates. In fact, they may not have the ability to increase the rates at such a frequency. In this case, how can we better protect our assets?

16. These days, there are many who prefer to work from home, and even worse, there are many who are selective or do not want to work and are content with simply collecting their stimulus checks from the government and idling at home. Consequently, the extremely tight labour market and supply chain are in shambles, and we do not anticipate improvements anytime soon. Moreover, thanks to the Fed's quantitative easing (printing money), so much money is now competing for so little goods.

17. Another big social issue in the U.S. is the wealth inequality, where a great deal of wealth is concentrated in the hands of the ultra-rich (The top 10% wealthiest owns 70% of the nation’s wealth), at the expense of many others who are homeless in the nation. The biggest social issue in the U.S. now is that both the rich men and the rich corporations are given “privileges” not to pay taxes (or knowing how to avoid taxes) despite the U.S. middle-income class being the poorest.

The Art of Thinking Clearly & Not to Follow Blindly

18. Despite the foreseeable challenges ahead, our greatest concern is that most of the world believes in the charming tales told by the Americans, so much so that they lose the ability to think clearly. This is not a model we should emulate. We must develop our own critical thinking process which will enable us to develop the cognitive tools needed to deal with Artificial Intelligence (AI) robots in the future.

19. Therefore, we must stay abreast of global risks and make plans accordingly in this "hybrid bear" market scenario. Instead of falling for the lies of the American politicians (neither the Republican nor Democrat is good), we have a choice to remain on the sidelines. We are not an open-ended fund, so why must we follow the young ones who are buying like no tomorrow? Why should funds stay fully invested? Why must we put pressure on ourselves to invest and buy in without a proper strategy? Why should we experience FOMO (Fear of Missing Out)? Why let greed push you gradually beyond the edge of the cliff till the point of no return? Why do the younger investors and fund managers always like to ask ‘why’ to their seniors but never asking why to their own subconsciousness?

20. The U.S. central bank had signalled that they will likely tighten their monetary stance in the foreseeable future, leading to continuous deflationary activities, even though we think this is just another lip service rather than sincere action. In our opinion, the U.S. has no intention to pay their debts.

21. China had already deflated the valuations of their companies before the U.S. had stepped into the 'hybrid bear market', bursting most of the bubble 6 months ago. For example, Tencent's valuation had dropped significantly from 40x PE and came down to 20x PE after a series of regulatory crackdowns. As such, if you were invested in China or Hong Kong, you would likely have lost money, including ourselves. 

22. At the moment of writing this outlook, we saw a sign. China is now releasing liquidity to spur economic growth. This will need more monitoring prior to confirmation. In addition, with the recent regulatory crackdowns, we may also expect many listings to come back to Asia from the U.S. It seems to us that in 2022, the dancing floor will be in Asia. Naturally, with Asia being closer to our home ground, we are excited about it.

Back to Basic!

23. As we all know, climate change is affecting every country in every continent. It is disrupting national economies and affecting people’s lives. Weather patterns are changing, sea levels are rising, and weather events are becoming more frequent and extreme.

24. For instance, natural disasters like volcanic eruptions could spew ash thousands of miles across the U.S. (in the case of a Yellowstone eruption), damaging buildings, smothering crops, shutting down power plants, and destroying life. Similarly, Mount Fuji has not erupted in more than 300 years.

25. With prudence, we must keep these black swan factors at the back of our mind, giving ourselves a holistic investment approach and preventing cognitive bias. We must keep a strong reserve, building up our food, water, and resources to prepare for the worst, as these are naturally essential items during a crisis and also a defensive play.

26. FF is of the view that the weather havoc will affect all investment themes in the next 2-3 years. We are not talking about a black swan here, instead we are talking about a bunch of ‘big black baboons’ in the stock market. Maybe, in the next 2-3 years, all the ‘black animals’ will come out from the zoo. We must think out of the box and look at the current state of the world in a different perspective.

Are ‘P’-inocchio and his team running the Federal Reserve?

27. It is our view that the bond traders and the market have lost conviction in Powell’s statement, which explains why the Fed intend to increase interest rates, yet the bond yield rate is going lower. It indicates that the Market does not buy into the action.

28.  Furthermore, we believe the Biden administration lacks the political capital and is limited in its ability to increase rates.  Thus, Powell, as chief of the U.S. Federal Reserve was being as ambiguous as possible towards the speed of rates increase.

29. It seems that in our view, Biden is only interested to secure his mid-term position and the rest is not important to him.

30. In the latest FOMC meeting, policy makers have indicated their expectations of 3 rate hikes in 2022. This will not happen. Our take is to anticipate two times or less as Old Joe does not have the political capital and is limited in his ability to increase the rate. If the rate increment needs to happen, it will have to happen before the summertime.

FF 2022 Investing Strategy

31. To wrap up our conclusion for 2022, we consider that the broader market outlook is going downhill, with many uncertainties and abnormal climate phenomena, we fall back on the concept of life. Next year will be a great time to think about how we should live our lives in this new era.

32. First, one must live healthily to reap the sown seeds. After observing the black swan event of coronavirus in 2020, it stressed the importance of staying healthy amidst concerns of an outbreak or worrying about the side-effects of vaccines. Longevity is the keyword as we explore sectors which prolong and enable a healthy living, this means that healthcare & medical sectors are favoured. Taking it one step further, we think about medical advances that will disrupt healthcare as we know it. Genomics is a sector which is a play on the future of humankind.

33. Next, with the current restrictions, expansions and contractions of the Vaccinated Travel Lanes, we must embrace the technology that enables us to live more conveniently. E-commerce and technologies that enhances our quality of life, albeit till the point of laziness, should be monitored as it fundamentally changes our way of life.

34. Lastly, we must embrace the future by living ‘smart’. Soon, smart gadgets and smart cars will take over our current tools and machines. The trend is already set with the push by governments for Electric Vehicles and on the global field for semiconductor chips and optics, which are the building blocks of these smart devices. We should not ignore the trend but choose to dive deeper into this digital world. We may all wear smart glasses down the road, and we may meet each other in a virtual reality environment.

35. While we pursue the 3 core scenarios in our framework, we must not forget that we are still living in a new normal (Covid environment) and people still often ask questions about going back to a normal life.

36. Furthermore, we should not neglect cryptocurrency. Although at its infancy stage, it is slowly becoming a digital alternative of fiat currencies or a store of value like digital gold. A recent study conducted by Fidelity Digital Assets found that 7 in 10 institutional investors expect to buy or invest in crypto assets in the near future. More than half of the 1,100 respondents surveyed between December 2020 and April 2021 revealed that they already own such investments.

37. As a seasoned ‘captain’, it is imperative that we make the best out of the cards we are given, dealing with the upcoming volatility created and invest wisely through the disparity between the New Normal (current time) and the original normal world. Thus, all else considered for the upcoming year and years ahead, we do not believe in the concept of buying and holding long-term, as the future is always changing at a rapid pace. This is Financial Frontiers' guiding principle for the year ahead.