Singapore Stock Strategy - RHB Invest 2018-06-26: Switching To Late Cycle Plays


Singapore Strategy - Switching To Late Cycle Plays

  • The global economy appears to have peaked and key indicators preceding a slowdown are in place for the US as well. A slowdown in Singapore’s GDP growth over 2018-2019 is now the consensus view. We recommend investors switch to defensive plays such as consumer and industrials, which tend to outperform during late cycles. While banks are a “crowded trade”, they remain the best exposure to rising interest rates.
  • Our bottom-up picks include stocks that can deliver earnings surprises, and we also recommend out of favour stocks like SingTel.
  • Impact to Singapore’s economic growth should trade tensions worsen, as well as slower earnings growth due to weakening of the SGD remain key risks.

Global indicators suggesting a likely slowdown.

  • In our Regional Strategy report (Regional Outlook: Late In The Cycle), we noted that the global economy appears to have peaked and key market indicators preceding a slowdown are falling into place for the US as well. As Singapore is highly dependent on trade, its economic growth has a strong positive correlation with the US and global economic growth.
  • While growth should remain resilient in 2018, a sustained slowdown in Singapore’s GDP growth during 2018-2019 seems to be the consensus view now.

Switching to late cycle plays.

  • Our study of price performance in previous economic cycles reveals that while the magnitude of outperformance may have varied, financials, telecoms, industrials and consumer sectors tend to outperform during late expansionary cycles. As a result, we recommend investors switch to financials, industrials and consumer sectors during the current late stage expansionary economic cycle. 
  • With changing business dynamics and rising competition, we do not view the telecoms sector as defensive anymore.

Rate hikes and strengthening of the USD.

  • Our economics team believes that the US Fed could raise rates four times over the next 12 months. Based on past trends, this should push SIBOR higher as well. Higher interest rates and rising inflation should underpin the USD’s strength as the year progresses. 
  • Given Singapore’s exposure to trade and the reliance on currency to manage inflation, the weakening of the SGD against the USD is a key risk for the economy and equity markets. 
  • STI’s EPS estimates and the STI Index are expected to be negatively impacted by the weakening of the SGD against the USD.

Investment themes for 2H18:

  1. Beneficiary of rising interest rate: Banks (UOB);
  2. Defensive late cycle plays: Consumer staples and industrials (Dairy Farm, Moya Asia, Sheng Siong, ST Engineering);
  3. Potential for earnings upside: Bottom up picks (China Aviation, Food Empire, GSS Energy, HRnet, Singapore Medical);
  4. Out of favour stocks: Telecoms (SingTel).

Year-end STI target: 3,650.

  • While not visible in economic data yet, the selloff in the STI suggests elevated concerns that Singapore’s economic growth could be impacted should trade tensions worsen, and the weakening of SGD against the USD leading to net selling by institutional investors in May.
  • We believe there remains downside risk to STI’s consensus earnings growth if SGD continues to weaken. 
  • Our 2018 & 2019 EPS growth rates for STI are below consensus.

Year Of Moderating But Resilient Growth

  • We expect Singapore’s real GDP growth to expand at a more moderate pace in 2018, in line with a slowdown in exports and on a higher base. This is as the strong semiconductor upcycle is unlikely to be repeated this year, while rising trade tensions between the US and China pose downside risks.
  • Overall economic growth is likely to remain resilient, as exports are expected to continue growing, albeit at a slower rate. In addition, domestic demand is set to rebound and, together with broad structural improvements in productivity, growth is likely to remain relatively strong in 2018. The former is premised on an improvement in the residential market and regulation-driven investments.
  • Singapore’s 1Q18 GDP grew 4.4% y-o-y, driven by the manufacturing and services sectors. Manufacturing grew 9.8% y-o-y, while the services sector registered 4.1% y-o-y growth. Following the strong 1Q18 growth numbers, Singapore’s Ministry of Trade and Industry has narrowed its 2018 GDP growth range to 2.5-3.5% from 1.5-3.5%. This compares with our Singapore real GDP growth forecast of 3% in 2018, a slowdown from +3.6% in 2017.
  • While we are expecting moderation in the full-year growth, there are no clear signs of a slowdown in either the manufacturing or services sectors. The manufacturing and services Purchasing Managers’ Index (PMI) continue to signal expansion, with May 2018 readings of 52.7 and 52.3 respectively.

We May Be Close To Peak Growth, Globally

With the exception of the US, global economy appears to have peaked

  • In our recent Regional Strategy report Regional Outlook: Late In The Cycle published on 20 June, we noted that the global economy appears to have peaked, with the possible exception of the US. For Europe (both EA-19 and EU-28), 1Q18 growth was at 0.4%, down from around 0.6% in 4Q17.
  • Both the PMI and the Organisation for Economic Co-operation and Development (OECD) Leading Indicator signalled that a peak may be past. In Japan, it was a similar story and besides that, 1Q GDP growth was negative. In China, GDP growth in 1Q18 stayed at 2017’s pace of 6.8%, but – with an official expectation of 6.5% growth in 2018 and increased policy emphasis on stability – the economy is likely to slow.
  • However, in the US, we are noticing very little signs of a slowdown. After growing 2.3% in 1Q, the second quarter should have a clip of around 4.7%, according to the Atlanta Fed Nowcast. The latest manufacturing PMI reading was 58.7, up from an already strong 57.3, while the services PMI was 56.8, up from 55.7.
  • The OECD Leading Indicator is pointing up. And yet, some of the key market indicators preceding a slowdown are falling into place: The US Fed is tightening; risk aversion – as measured by the spread between AAA- and BBB-rated bonds is rising; the spread between the yields on 10Y and 2Y US Treasuries is falling; and the yield curve is becoming flatter, though far from getting inverted.

Equity Performance Around Peak Growth In US

  • Singapore’s STI Index, in general, has moved up a year before economic growth peaked in the US, delivering an average of 30% return during the last three economic cycles. However, the index movements in each of the cycles appeared to be different. This could be partly explained by the different regions’ specific economic factors that impacted Singapore during each of the previous cycles.
  • During the 1983 cycle, thanks to strong growth registered by Asian economies – especially the Four Asian Tigers, Hong Kong, Singapore, South Korea and Taiwan – the STI Index continued to perform well even after US economic growth had peaked.
  • The Asian Financial Crisis led to the STI Index peaking about six months before the US economic growth peaked during the 1991 economic cycle. However, during the 2001 economic cycle, Singapore was also impacted by the Global Financial Crisis and the STI Index peaked just a month after the peak of US economic growth. During this cycle, the STI Index delivered 51% before the economic growth peaked in the US.
  • To account for differences in economic cycles, we calculated the correlation between price performances of Singapore’s STI Index and the US equity market (S&P 500) for a period of one year before and six months after economic growth peaks in the US. We note that, within Asia, Singapore’s stock market has been among the most highly correlated to the US equity markets across all cycles. Moreover, the correlation between Singapore’s STI Index and the S&P 500 has been on a consistent rise with every cycle.

Sector Leadership Around Peak Growth In US

  • While it is impossible for a single sector to outperform in every stage of an economic cycle, there are some patterns of sector leadership within each economic phase. During late expansionary phase of a cycle – as the economy moves beyond its early stage growth and central banks begin to raise interest rates – economically sensitive sectors continue to perform well, eg energy.
  • Elsewhere, as investors begin to glimpse signs of an impending slowdown, more defensive-oriented sectors – such as telecoms, consumer staples and healthcare – start to outperform the market.
  • We noticed a similar trend in Singapore – where the financials and industrials sectors delivered outperformance during the last 12 months before economic growth peaked in the US in each of the last two economic cycles.
  • With respect to the industrials sector in Singapore, it is important to note that a number of energy related stocks in Singapore (eg Keppel Corp, SembCorp Marine and Noble Group) were categorised under the industrials sector by the Global Industry Classification Standard (GICS).
  • We also looked at sector price performance for periods around the peak of economic growth in Singapore and noticed that the industrials and consumer sectors have consistently outperformed the broader markets during the six months period after peak of economic growth. 
  • We looked at the relative price performance for sectors that are part of the STI Index and noticed that the late cycle plays started to outperform the broader index during the last one month.

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Shekhar Jaiswal RHB Securities Research | Singapore Research Team RHB Invest | https://www.rhbinvest.com.sg/ 2018-06-26
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