• The STI was down 9.1% in 2Q22. After reversing all the gains chalked up this year, the index was flat in 1H22.
• The global economy is facing a downward spiral of demand destruction, caused by a duet of higher inflation and interest rates.
• Economic conditions in Singapore remain resilient. Industrial growth is hovering at 9% this year, FDI is close to the record levels of 2019 and employment is surging with record vacancies.
Review: The STI was down 9.1% in 2Q22. After reversing all the gains chalked up this year, the index was flat in 1H22. Its largest drags were banks (Figure 1), the consumer sector and industrial REITs (Figure 2). Despite rising rates that will benefit banks’ interest margins, recession worries buffeted cyclicals, particularly the banks. Reopening proxies also suffered. These included Genting Singapore and SATS. The biggest gainers were helped largely by company-specific factors (Figure 3). Dividends in specie of its financial arm benefitted Yangzijiang Shipping. Stellar earnings at Astra International provided a tailwind for Jardine Cycle and Carriage. Sembcorp Industries rallied on higher spark spreads in India and Singapore.
Outlook: The global economy is facing a downward spiral of demand destruction, caused by a duet of higher inflation and interest rates. Higher inflation is outpacing income, shrinking household budgets and confidence levels. For corporates, costlier energy and materials eat into margins and force cutbacks in production. The negative spiral that ensues has workers demanding higher wages and corporates jacking up prices. Aggregate demand is further worsened by rising interest rates, triggering a deflationary shock for asset prices. We are in the middle of this downward spiral. It is hard to short-circuit rising inflation without demand destruction. There are silver bullets to lowering inflation but these are of low probability: an end to the Ukraine conflict, lowering of tariffs on goods going from China to the US and higher crude oil production following Biden’s visit to Saudi Arabia. The most critical macro call this year will be inflation. We expect inflation to peak by 4Q22, though remaining stubborn. Supply chain conditions are easing (Figures 5, 6), commodity prices are rolling over (Figure 7) and capacity is responding to higher commodity prices, albeit cautiously (Figure 8). Any sustained rally in equities will also depend on the direction of the Federal Reserve’s interest rates. Our base case is rates will rise to a neutral level of 3% by the September FOMC meeting. Thereafter, we expect the Fed to step down on its rate-hike cycle to 25 basis points or even pause. Firstly, higher interest rates work with a lag. We believe the Fed will pause to assess economic conditions before resorting to more aggressive moves. Secondly, inflation has largely been driven by supply chain constraints and disruptions. Monetary tools cannot resolve these bottlenecks. As for the threat of recession, leading indicators point to a weakening economy, raising the probability of a recession in the US. But computing probabilities is pointless. A probability of say, 60%, only means the predictors were not wrong, whatever the outcome. Economic conditions in Singapore remain resilient. Industrial growth is hovering at 9% this year. This is slower than last year’s 14% but far stronger than the pre-pandemic level of 2% (Figure 9). Foreign direct investments into the country have recovered sharply. They are close to the record levels of 2019 (Figure 10). Employment is surging with record vacancies (Figure 11).
Recommendation: We remain positive on the banking sector. Banks benefit from higher rates through their excess liquidity or float and the repricing of variable loans. Benefits immediately flow through to the bottom line. Weaker macros and inflation will likely lead to modestly higher general provisioning. Staff costs will escalate due to a robust employment market. We prefer OCBC (OCBC SP, BUY, TP S$14.22) for its highest capital ratios, high CASA, exposure to a reopening of China and Hong King and dividend upside. Softer economic conditions will raise provisions but not significantly. For instance, the bank’s loan growth has been toeing nominal GDP growth, unlike the 2008 and 2016 provisioning cycles when loans outpaced GDP by 2-5% points over two years (Figure 12). The margin call now is in crypto assets. Residential property prices have been climbing back, to double-digit levels not seen since end-2019 and 2011. New launches have sold more than 70% just over a weekend. A dearth of supply with unsold inventories of 14,000 is the lowest in more than a decade and only 1.2 years to sales (Figure 13). Rising prices work in the favour of developers with planned launches such as City Developments (CIT SP, BUY, TP S$9.19).