• Singapore’s equity market drifted downwards in 2Q23 with a decline of 1.6%.
• Global economy faces two headwinds , limited progress in taming core inflation and higher rates will only exacerbate the current weak economic conditions.
• We adopt a defensive posture on Singapore equities focusing on dividend yields. We expect banks dividends to still grow this year and the current yield of Singapore REITs to remain attractive.
Review: Singapore’s equity market drifted downwards in 2Q23 with a decline of 1.6%. Despite record earnings, banks disappointed over worries about the sustainability of their interest margins (Figure 1). Conversely, SIA’s share price witnessed a stellar performance after reporting record profits (Figure 2). The underperformers in the quarter were cyclicals and stocks with disappointing earnings (Figure 4).
Outlook: We believe the global economy faces two headwinds. Firstly, limited progress in taming core inflation, which is primarily influenced by the services sector, where wages are the largest cost input. The robust labour market is keeping wages high (Figure 5). We think the labour market strength especially in the US can persist, keeping the Fed hawkish. Worker numbers only returned to pre-pandemic levels in June 2022. The underlying growth rate in employment is still below trend (Figure 6). Furthermore, a significant portion of the hiring is occurring in non-economically sensitive sectors such as education, government and healthcare. An even larger worry is a negative feedback loop between wages and prices. The UK is experiencing the worst labour disputes on record (Figure 7). Workers will initially demand higher pay to recoup their current loss of real income. If inflation persists and inflation expectations become unhinged, their wage demands will be to compensate for future losses. Then a negative spiral will begin. Central banks in developed countries are undergoing a synchronised hike of interest rates to short-circuit this inflation threat (Figure 8).
Secondly, higher rates will only exacerbate the current weak economic conditions. Most economic indicators, in particular from the U.S., are either heading toward or are already in recessionary territory. Consumer demand (Figure 9), corporate spending (Figure 10), loans growth (Figure 11), exports (Figure 12), imports (Figure 13) and PMIs, are all sliding downwards. Higher for longer interest rates will only lead to slower for longer global economies. We maintain our view that a recession in the US is likely. Anyone predicting a recession has been vilified by most US equity bulls. Excluding the magnificent seven stocks, S&P 500 would have been largely flat this year. We believe US resilience is due to (i) AI pushing some tech stocks to 184x historical PE; (ii) Fed support of commercial banks with lending of US$285bn (50% below US$560bn GFC peak support, Figure 14); (iii) optimism over the job market fuelling expectations of a soft landing. All the Nasdaq gains this year are from PE expanding from 27x to 36x.
Recommendation: We adopt a defensive posture on Singapore equities focusing on dividend yields from banks and REITs. Bank dividends will still grow this year, supported by the windfall in interest margins and excess capital. High-interest rates will remain a headwind for DPU growth in REITs but the current 6% yield is attractive considering interest rates are close to peaking. Amongst REITs, hospitality REITs offer the highest opportunity for organic growth in DPU. Travel should still enjoy growth supported by outbound travel from China, which is only around 20% of pre-pandemic levels (Figure 15). Domestic travel has been the priority in China, already reaching 94% of pre-pandemic levels. RevPAR in Singapore remains robust and breaking new records. Stocks in our model portfolio, Phillip Absolute 10, that provide exposure to an expanding hospitality sector are CapitaLand Ascott and CDL. Despite the expected strength in travel, we are cautious on SIA [Reduce, TP S$6.80] due to increased competition from other Asian airlines as their capacities rebound, contraction in air cargo due to weaker global trade and cash-flows impacted by redemption on its convertibles, and fleet renewal and purchase of Vistara. In contrast to developed countries, China is following a separate economic trajectory. The central bank is easing monetary policy (Figure 16) and there are plans for stimulus targeted at the consumer and property sector. While growth in China may be slower than expected, the recovery post-Covid is still progressing. Stocks that benefit from a recovering China include CapitaLand Investment and Sasseur REIT. In our model portfolio, we are replacing DBS with Thai Beverage. We think the sell-down is unwarranted and valuations for Thai Beverage are looking more attractive at these levels.