• After an encouraging 3.5% rise in January, the Singapore market returned all its gains to finish 1Q23 unchanged.
• We believe the Fed impatiently raising rates when real-time inflation data continues to drop and lead indicators point to an upcoming recession.
• Disinflation is occurring although not immediately. Global growth is tapering off. We overweight any equities that looks like a bond. REITs are our tactical bet.
Review: After an encouraging 3.5% rise in January, the Singapore market returned all its gains to finish 1Q23 relatively unchanged. Higher-than-expected inflation in the US plus jitters over banks pushed markets lower. Singapore banks were sluggish (Figure 1). The largest gainers were conglomerates from successful restructuring and better- than-expected results (Figure 2). Property counters were surprisingly the weakest as higher interest and a large pipeline of new launches haunted investors.
Outlook: After the March hike of 25 bps we believe the rate hike cycle has paused. Firstly, real-time inflation data continues to drop: commodity prices (Figure 6), rental (Figure 7) and logistics. Employment was healthy but a notoriously lagging indicator (Figure 8). Secondly, raising rates will only deepen balance-sheet losses for US banks. With government and central bank stimulus, deposits in the US banking system surged by US$4.3tr over three years. Almost US$1.5t p.a., or triple the pre-pandemic level, was deployed to purchase government and mortgage securities (Figure 9). This raised bank balance sheet risk to interest rates. The curse of marking to market is either recognising the security losses immediately (as available for sale) or warehousing (as held to maturity). Thirdly, banks will only tighten their lending standards for fear of a deepening recession or shore up their liquidity with increasingly nervous depositors. A larger worry is the vicious spiralling of banks shrinking their balance sheets globally. Signs of stress remain as banks are still taking loans from the Federal Reserve (Figure 10).
We think the Fed is behind the curve. It is raising rates because economic weakness is not yet obvious. However, lead indicators point to an upcoming recession (Figure 11-12), especially in manufacturing (Figure 13). Conventionally, a catalyst to rally the market would be a Fed pause or interest rate cut. However, over the past three recessions, the Fed cut rates just 3-6 months before a recession. The market only bottoms 1-17 months after a rate cut, depending on the level of contraction in the economy. In Singapore, the external environment is weakening fast. Exports are in their fifth month of decline. The domestic economy will slow but we expect it to be resilient (Figure 14), supported by FDI flows, migration (Figure 15), tourism and fiscal spending (Figure 16).
Recommendation: Our strategy is to be more patient than the Fed. Disinflation is occurring although not immediately. Global growth is tapering off. We overweight any equities that look like a bond. REITs are our tactical bet. We are not disillusioned that REITs face an uphill struggle in increasing their dividends due to higher interest rates. REITs do hedge rates for three years, but also akin to an interest rate headwind for three years. REITs have enjoyed more than a decade of ever declining refinancing cost on their interest only loans. We still favour Singapore banks. They pay attractive yields of almost 6% and enjoy huge capital buffers. Unlike Silicon Valley Bank (SVB) and Credit Suisse (CS), there is no accident waiting here. Firstly, Singapore banks only have 15% of their assets in investment securities, unlike the 57% for SVB. Local banks did not experience a doubling in deposits over the last two years, again unlike SVB. Secondly, Singapore banks enjoy ROEs of 12%. They did not face two years of losses that befell CS. We added CapitaLand Investment (CLI) to our model portfolio. It has a unique real estate cradle-to-grave-to-afterlife model. CLI can develop a piece of real estate, fill the property with tenants (i.e. cradle), dispose of the development (i.e. grave) to its own private equity funds or REITs and still enjoy fees as manager of these funds (i.e. afterlife). The model was at a standstill when China was in lockdown and interest rates were rising. These conditions have reversed. We have removed Prime US REIT from our model. We still believe valuations are attractive but worry about headline volatility. A consequence of the collapse of several banks will be a tightening of commercial real estate lending. Several commercial property funds have already defaulted due to high gearing and large exposure to gateway cities. A binary outcome is creeping up.