Singapore Strategy - Rocky is the new status quo
- The path to a new status quo is likely to be a rocky one, given the expected Fed rate hike, Brexit, Trump presidency, multiple elections in Europe and OPEC.
- However, as low oil prices and low interest rates are becoming a thing of the past.
- Cyclicals could come into favour, if investors look past lacklustre earnings growth.
- We are not all-out bullish on cyclicals, as the sectors still grapple with structural challenges, but we see opportunity to buy on dips.
Is market ready to re-rate?
- As we enter a world of higher interest rates and oil prices, cyclicals could come back in favour. The latest run-up in the bank, and offshore & marine sectors suggest the market is pricing in an ‘all is well’ environment, ignoring near-term lacklustre fundamentals.
- At c.14x CY17 P/E, FSSTI is trading at historical mean against 2% EPS growth. We believe the market is impatiently looking past 2017, and re-rating ahead based on 2018 (EPS growth of 5%).
- A top-down index reading of 3,140 (7% upside) is plausible.
Downgrade REITs, look for dollar plays and net cash companies
- The CIMB fixed income research team forecasts a 2-year US Treasury rate of 1.5% (currently 1.0%) and 10-year Treasury rate of 2.75-3.00% (currently 2.35%) for 2017.
- The team expects one FOMC hike in 1H17 and another two in 2H17. Based on this, we downgrade REITs from Neutral to Underweight after blanket increase in risk-free rate across sectors. Higher interest rates, strong dollar and more hopeful US recovery send us searching for export plays, tech and manufacturing, and net cash companies.
Banks and capital goods hope for end to EPS downgrades
- Banks, capital goods and property trade at -1 s.d. below historical mean but this is in line with declining ROEs. We believe the cheap valuations could be unlocked as soon as the street is confident that consensus earnings downgrades have ended. 4Q16 will be the quarter to watch.
- Based on bottom-up approach, we keep banks Underweight as we think rate hikes may not fully offset credit costs.
- We upgrade capital goods from Underweight to Neutral as the worst is likely over as the sector re-rates against upward oil trend (capped by shale).
OW property and consumers, Neutral on commodities and telcos
- Our defence for our unchanged Overweight rating on property developers is their multi-year low valuations, pricing in bad news but limiting downside risks. With limited development opportunities at home, M&A/privatisation may be the sector’s route to re-rating. The consumer sector is an Overweight, especially for names that are seeing earnings turnaround from closure of unprofitable stores.
- We upgrade commodities from Underweight to Neutral on better CPO yield.
- Telco sector is a Neutral on slowing revenue and threat of fourth telco.
2017 is a story of two halves
- Given the many uncertainties ahead and a shorter market cycle, it is naïve to expect our sector preferences to last throughout 2017 due to the obvious unknowns:
- number of rate hikes (two or three), and
- OPEC keeping its promise.
- Our calls on REITS, banks and capital goods may be inverted in 2H17 depending on above outcomes.
Analysts’ Alpha picks
- Our big-cap Alpha picks are: Dairy Farm, First Resources, ST Engineering, UOL and Venture Corp.
- Our small-cap top picks are: Auric Pacific, Best World, CEI, Cityneon, Dutech, Mermaid Maritime, Sunningdale and Valuetronics.