Review: The STI was up 9.1% in 1Q22. This was its best performance since an 11.3% rally in 1Q21. Banks (Figure 1) and conglomerates (Figure 3) led the gainers.  Rising interest rates was the dominant theme in the quarter. Banks rallied as higher interest rates will lift margins. On the flip side, REITs retreated (Figure 2) as higher rates can affect dividend growth and lower the attractiveness of their leveraged dividend yields. Conglomerates were the major outperformers from higher electricity spreads, increased dividends and aggressive share buybacks.

Outlook: The global economy is facing stagflation (i.e. high prices but lower incomes) shock. Inflation has been made worse by the Russia-Ukraine conflict, which has driven up crude oil prices to their highest in 13 years. Global growth is expected to decelerate as interest rates continue to climb. The yield curve has recently inverted, placing the market back on recession watch (Figure 5).  The debate rages as to whether the Fed can orchestrate a soft landing for the economy. We are more upbeat. In the recent six rate-hiking cycles, two led to a soft landing (no recession) and three were followed by recessions that were not entirely triggered by the hiking cycle (Figure 6).

The Singapore market stands out as a shelter in the current stagflation environment. We will say this – it is an alpha generator in global equities. Almost every sector in the STI enjoys a tailwind: (i) Bank earnings will enjoy a huge lift as we enter an interest-rate cycle (Figure 7). A 100 basis point rise in rates can increase earnings by around 18%. We believe the three domestic banks have excess deposits or float totalling S$160bn that can immediately benefit from the rise in short-term rates. Banks are well represented, with a 45% weighting on the STI; (ii) The reopening of borders and relaxation of social restrictions will be a further boost for corporate earnings. Primary beneficiaries are transport, telecommunications, retail and hospitality. They make up a combined 20% of the STI (Figure 8).  Tourism accounted for 5% of GDP in 2019 (Figure 9). So, it becomes a huge economic driver over the next 12-18 months. (iii) Singapore has not been dragged down by the current de-rating of tech stocks from stretched valuations, regulatory risks and supply-chain disruptions. Tech is only 2% of the STI; and (iv) Another 6% of the STI are rerating candidates due to share buybacks, restructuring and defence-related spending. Finally, the Singapore dollar is expected to stand firmer against regional currencies with the MAS tightening bias.

Recommendation: The Ukraine conflict has long-term implications for several sectors, most notably defence.  An unfortunate arms race has developed due to this conflict. Germany kick-started the race with a one-off EUR100bn fund to upgrade its defence budget. It will be investing more than 2% of its GDP in defence. We worry every country will now look to outdo one another in military spending. The two stocks with defence-related revenue are ST Engineering (STE SP, Not Rated) and CIVMEC (CVL SP, Not Rated). Another repercussion is the diversification of energy sources away from Russian energy and the volatility (or unreliability) of renewable energy. Renewable is still dependent on the weather. Last year, renewable energy production in the UK fell 15% (Figure 10). A repricing of energy is underway after years of underinvestment in fossil fuels. Coal looks interesting, as even the German Chancellor mentioned the need to build a reserve for coal. In Singapore, we favour the financial, construction and reopening sectors. Financials will ride the rise in interest rates. The Fed funds rate is expected to rise by more than 2 percentage points this year (Figure 11),  producing a two-year tailwind for the banks and exchanges. Construction, namely building materials, will gain from a return of foreign labour and construction activity. Following the government’s relaxation of border controls and group activities (aka “Near Freedom Day”) on 29 March, reopening stocks look attractive to us. Comfort Delgro (CD SP, BUY, TP S$1.80) is down 48% from pre-pandemic levels despite generating S$905mn of FCF over the past two pandemic years. Telcos are another reopening sector. Roaming is around 15% mobile revenue and almost pure profit. We estimate roaming is around 50% of Starhub’s (STH SP, NEUTRAL, TP S$1.35) 2019 PATMI.