Economics Markets Strategy - the DBS Vickers Securities Equities ...

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Asian Equity Strategy Economics – Markets – Strategy The interpretation of rising US bond yields can be viewed on two fronts - from a rising inflationary pressure view point, or outlook for a stronger than expected US growth accompanied by benign inflation fears. In view of this we believe the positive impact of rising bond yields on the Singapore market makes the most sense as Singapore interest rates do not necessarily move in tandem with the US as it has a managed currency policy. A more positive outlook for US and global growth should bode well for Singapore stocks. The STI is also least impacted by a strong USD, probably due to a relatively larger portion (vs. the rest of the region) of USD earnings from the offshore marine sector and SIA. Moreover, the SGD is pegged to a basket of currencies that includes the USD. The SGD will weaken less than the rest of the region when the USD strengthens. The negative correlation can be analysed from a top down view. Impact of rising oil prices are stronger in the TWI, STI and KOSPI, which all seem to be industrial nations that rely heavily on oil imports. Thus, profit margins will be impacted by higher oil prices. Rising bond yield impact is greater for the SET and KLCI, which are so termed as "emerging" markets where currencies (and hence foreign fund outflow) are vulnerable during periods of rising yields and volatility. The interpretation of the impact of a strong USD is interesting. One, they are markets which currencies are pegged (CNY and MYR) at some period in time. If the USD weakness is associated with stronger commodity prices, then it suggests a reason for the H-shares and the KLCI to be negatively impacted by a strong USD. Impact on Sectors Fig. 14: Asia ex-Japan sector indices’ sensitivity to oil price, bond yields and US$ strength Top 3 sectors Positively correlated Oil Bond yields US$ strength Oil/Eq Svs/Dst Aero/D efence Consu mer Gds Basic Mats S/W & Comp Svs Tch H/W & Eq Top 3 sectors Negatively correlated Oil Bond yields US$ strength Tch H/W & Eqt Ivst Eq Ins Elt ro/El H/C Eq ec Eq & Svs Life Fd & Insura Drug nce Rtl Mining Gen Retailers Tobacc Auto & Personal o Part s Goods Utilities 0.2 0.18 -0.02 -0.04 -0.03 -0.15 0.1 0.17 -0.03 -0.01 0.06 -0.15 0.08 0.16 -0.04 -0.01 0.06 -0.15 Source: Datastream, DBS calculations Direct links can be found with the oil & gas services sector, which benefits from rising oil prices. The tech sector, which are normally USD earners will also benefit from a strong USD. The negative impact on margins for manufacturers are evidenced in their negative impact on oil. Where higher oil prices coincide with strong economic growth and low unemployment - there will be structural shifts due to a stronger desire to live nearer to town or residential areas with convenient public transport. This should support property prices in Singapore and Hong Kong. Meanwhile, with the removal of fuel price subsidies, Malaysians might consider moving closer to cities rather than drive 2 hours between work and office. Governments, such as in Malaysia and Thailand, will also be encouraged to build better mass transportation infrastructure. In the bond market, expectations of rising bond yields should attract flow of funds from the bond markets to the equities market. 62
Economics – Markets – Strategy Asian Equity Strategy Country asset allocation recommendations and changes Overweight markets: China-H, Taiwan, Singapore Underweight markets: Malaysia, India, Thailand, Indonesia Neutral markets: Hong Kong, Korea Singapore: Upgrade to Overweight from Benchmarkweight Singapore remains the cheapest market in the region, based on the number of standard deviation away from historical average of consensus 12-month forward P/E (see Fig. 15). There was a lot of uncertainty in the 'E', specifically fear of more downgrades, but that has been largely priced in. Consensus now expects negative earnings growth for 2008 instead of 4% growth early this year, and 10% in September. 1Q08 results were mixed but generally met expectations. Fig. 15: Regional markets' 12m fwd P/E: No. of standard deviation away from average - Singapore is the cheapest market based on historical trend Singapore Taiwan Malaysia Thailand Indonesia AXJ Korea China 'H' Hong Kong India -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 Cheap Expensive Source: Datastream, Bloomberg, DBS calculations. Average and standard deviations from 1993 - present. Going forward we expect the Singapore economy to experience a modest slowdown y-o-y in 2Q and 3Q before recovering in the 4Q. Engines of growth should remain in services and construction, refinery and offshore marine sectors. Inflation should come off in the next few months as year-on-year effect of the GST hikes in July last year diminish. However price level should remain elevated and continue to hurt consumer spending. The moderation in the GDP we expected is in private consumption. While high inflation will slow private spending, we believe the strong reserves and social fiscal balance will be a safety net for the needy Fig. 16: Singapore earnings growth downgraded 20 15 10 5 0 -5 -10 % 2009 earnings growth 2008 earnings growth Feb-06 Jul-06 Dec-06 May-07 Oct-07 Mar-08 Source: IBES, DBS calculations and less of a social concern for Singapore. The impact of macro changes on Singapore equities should be minimal in our view, and selective on sectors that are sensitive to such changes. We now forecast higher bond yields with a flattening yield curve and a stronger USD. Singapore bond yields have risen in recent weeks in tandem with US bond yields. Recently, an extraordinary case of poor auction response to Singapore 10- year treasury bonds lifted yields by 100bps. With our new US Fed funds forecast (50bps hikes in 4Q08 and 75bps in 1Q09) we expect the Singapore long bond yields to rise another 50bps by year end and 35bps in 1Q09, taking bond yields from 3.4% currently to 4.15%. Among stocks under our coverage, 48% of them are offering more than 3.4% dividend yield, and 40% more than 4.15%. But investing for dividends may not be an appropriate strategy in a rising bond yield environment. We expect the USD to strengthen as the Fed easing Fig. 17: Singapore exchange and interest rates forecasts (% ) Fed funds 3m SIBOR 12m SIBOR SGS 2Y SGS 10Y SGD / USD current 2.00 1.36 1.91 1.24 3.64 1.37 3Q08 2.00 1.31 2.06 1.60 3.80 1.38 4Q08 2.50 1.52 2.27 2.22 3.90 1.40 1Q09 3.25 1.94 2.69 2.40 3.93 1.42 2Q09 4.00 2.31 2.81 2.65 4.04 1.44 3Q09 4.50 2.67 3.02 2.66 3.92 1.42 4Q09 4.50 2.64 2.89 2.42 3.79 1.40 Source: DBS 63
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