Singapore Strategy - DBS Research 2016-05-31: From Cautious to Cautiously Optimistic

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Singapore Strategy - From Cautious to Cautiously Optimistic

• Key events - 15 June FOMC Meeting outcome & 23 June BREXIT referendum
• STI – Correction halted at 2700, initial recovery to 2835 followed by 2870/2900
• Bargain hunt blue chips
• Tactical trade – Bank stocks OCBC & UOB to benefit from higher rates if economy stabilises or recovers

Looking back at May

• The stock market correction that started on 21 April continued into May with the benchmark Straits Times Index down by 38pts to 2800. US rate hike concerns, outcome of the June 23 BREXIT referendum, weak corporate earnings and the uncertain economic outlook continued to weigh down on the local bourse. 
• Still, the STI managed to find support around the 2700 level that coincided with the 11.32x (-1.5SD) blended FY16/17 PE level. 
• Individual stock performances were influenced by their quarterly results. Shares of Jardine C&C, Genting Singapore, Wilmar International, GLP and SIA were among the losers while Thai Beverage was the top blue chips performer.

Outlook

• The two key events this month are the outcome of the FOMC meeting on June 15 and the BREXIT referendum on June 23.

Next rate hike likely in July, not June

• While rate hike expectations have picked up in the past two weeks following “hawkish” comments by various FED officials, we think a June rate hike is less likely given the uncertainty of the BREXIT referendum just the week after. But a July hike is possible if economic data continues to be supportive of one.
• Consensus expects a 28% chance for a FED rate hike that increases to 60% in July. DBS Research believes that the FED will leave rates unchanged in June but sees a rate hike in 3Q and another in 4Q that will lift the FED funds rate to 1% by year-end.

BREXIT – Opinion polls favour ‘stay’, fallout hard to predict in event of exit

• The next key event is the BREXIT referendum on 23 June.
• Our economist says the fallout in the event of a BREXIT is hard to predict. Under a ‘gentle exit’ scenario, a short-term selldown and jump in volatility might be followed by the EU and UK returning to talks to re-establish agreements, especially on the trade and investment front. By contrast, a bitter BREXIT would surely hit sentiment and risk appetite harder, with market impacts felt beyond the EU/UK. It would be more difficult to re-establish trade/investments later. 
• Worse, a BREXIT would extend beyond the UK. A yes vote carries political ramifications for the EU bloc, running the risk of emboldening other euro-sceptic/ nti-EU parties that could hurt EU stability.
• Fortunately, the latest opinion polls show around a 10% lead for people wanting “stay“ rather than “leave“. The British pound has rebounded against major currencies in recent weeks.

Watchful of currency movement

• Keep an eye on the movement of Asian currencies against the US dollar as the prospect of US rate hikes return to the forefront. Historically, there is a correlation between the direction of Asian equity markets and Asian currencies against the US dollar. Rising Asian currencies coincide with periods of rising Asian equities and vice versa.
• The decline in the MSCI Asia-Pacific Ex-Japan Index that began from 21 April at 516 down to 474 coincided with the decline in Bloomberg JPMorgan Asia Dollar Index (ADXY) from 108.88 down to 106.4. Technically, we see support for the ADXY around the 106.4 level that should halt its decline and trigger a technical rebound in the short term. This should halt the recent decline in Asian equities, including Singapore. Beyond the short term, we are watchful on Asian currencies' behaviour as the FED rate hike cycle progresses.

Odds favour STI holding above 2700 level

• In our previous Monthly strategy update on April 26, we warned that following the February to April run-up, the Singapore equity market was due for a pullback given the weak 1Q corporate results season. The Singapore market corrected as expected with the STI falling to a low of 2715, below our initial support level of 2800.
• The recent low of 2715 coincided with 11.32x (-1.5SD) blended FY16/17 PE level. We think this level should hold up unless BREXIT becomes a reality. The odds currently favour a benign outcome –opinion polls show a higher chance that Britain will remain in the EU.

Initial June recovery off 2715 likely guarded

• A recovery from the 2715 level is likely guarded in the short term given the weak corporate earnings growth and the uncertain economic outlook and pending the 23 June BREXIT referendum outcome. We see technical resistances at 2835 followed by 2870-2900.
• We currently expect STI EPS growth of just 2.1% for 2016 and 6.6% for 2017. Consensus expectation is even lower at 0.25% for 2016 and 5% for 2017. Meanwhile, the latest data showed Singapore’s services sector contracted 5.9% q-o-q in 1Q16 while the manufacturing sector contracted by 5.7% if the boost from the volatile biomedical cluster is excluded.

What lies beyond?

• If opinion polls results are reliable and assuming that Britain remains in the EU, the next key focus to drive equity markets is the implication of US rate hikes. We believe that the debate should not be whether rates are going up in June or July, one month makes little difference. Instead, the focus should be on whether investors take rising interest rates positively. 
• FED Chair Janet Yellen has consistently stressed that the FED will be data dependent. That is, higher rates mean better economy. Asian equity markets (Singapore included) will strengthen if the gradual pace of US rate hikes going forward is seen as a sign of confidence that the US economy is getting stronger that will eventually benefit Asia.
• Some “ifs” at this stage but uncertainties are common at a low point. For now, let’s first get past 23 June.

Strategy

• We had adopted a cautious tone on the previous two monthly strategy updates, preferring to either stay with dividend yield names or to take profit into strength on blue chips (example: banks, O&G) that have risen during the February to April short-covering rally.
• The benchmark STI corrected as much as 8.2% from the April high of 2964 and valuation has retreated to modestly above 11.32x (-1.5SD) blended FY16/17 PE level. While acknowledging that uncertainties such as weak economic data trend and corporate downward earnings revision trend remains, we switch our stance to neutral or even cautiously optimistic on the conditions that:
  1. BREXIT referendum on 23 June will see Britain remaining with the EU.
  2. FED continues with the policy of tying rate hikes with economic data strength and the pace of US rate hikes will be gradual.
  3. Oil price has seen its worst point at the start of the year and prices should stabilise around the USD 40pbl mark.

Bargain hunt oversold blue chips

• We wrote in our previous monthly strategy to take profit on blue chip stocks such as Genting Singapore, SembCorp Marine, Keppel Corp and SPH as well as be watchful of short-term pullbacks on OCBC, SembCorp Industries, ST Engineering, Wilmar International and City Developments. These stocks have corrected over the past month with Genting Singapore and Wilmar International underperforming the STI by a significant 11% and 6% respectively over the past month.
• Going forward, we look to bargain hunt blue chips on which we have a BUY recommendation and offer good upside to our fundamental TP (refer to table below).
• Property developers UOL and City Developments are among our Model Portfolio picks. Despite the prospect of rising US interest rates, property developer stocks can still be underpinned by the perceived policy loosening stance from the Singapore government. At 0.5x P/NAV (-2SD historical average), UOL is the cheapest large-cap landlord in Singapore and we believe that negatives from a weakening operating outlook have been priced in. City Developments has the largest exposure to the Singapore residential market at 27% of its RNAV. Possible inclusion into the FTSE EPRA/NAREIT.
• Global Developed Index (review date 2 June) could also underpin the stock.
• Shares of SIA underperformed the STI over the past month, sold down after core earnings for the full year came in below expectations due to soft yields and wider losses at SIA Cargo. The stock fell to a low of $10.50 recently. The stock currently trades at 0.9x FY17F P/BV. We see limited downside from here and look to bargain hunt the stock should there be any moderate weakness to around the $10.25 level.
• SembCorp Industries remain our preferred pick among the rig builders given its diverse earnings stream. SCI’s utilities business is valued at an undemanding 0.7x P/BV and 7.8x FY16F PE vs historical mean PE of 11x. It is one of the stocks in our Model Portfolio. The stock has corrected from a high of $3.28 in mid-March. Technically, the correction looks to have ended at the recent low of $2.60. Near-term support is at $2.72.
• We like ST Engineering for its defensive nature with a healthy balance sheet and secure dividend payouts. Earlier this month, the Singapore government projected S$2.82bil of ICT tenders across fiscal year 2016. The Electronics division is well positioned to benefit from Smart Nation projects in Singapore going forward.

Tactical trade on banks

• Bank stocks can be underpinned by rising expectations that the FED will hike rates at the July FOMC meeting and possibly another time before year-end. Investors are likely to be comforted that US rate hikes are dependent on economic data strength. That is, better economy equals higher rates.
• Our banking analyst currently has HOLD recommendations on both OCBC and UOB.
• But on the charts, we believe that OCBC shares had found support recently at slightly below the $8.30 level. We lift near- term support to $8.50 and see upside bias to around $8.85 followed by $9.10. The recent correction for UOB shares looked to have found support at $17.45. We lift near-term support to around $18 and sees upside bias to $18.90.
• Bank stocks are sector leaders in the event of an economic recovery. While it is still early days, bank stocks could eventually rise to or even take out their April highs if Singapore’s economic data improves and corporate earnings' downward revision trend halts or turns up.

Janice CHUA DBS Vickers | YEO Kee Yan DBS Vickers | LING Lee Keng DBS Vickers | http://www.dbsvickers.com/ 2016-05-31