Headwinds could continue to rattle Singapore market in H2 despite attractive valuations

VALUATIONS in the Singapore market are attractive, analysts say. But macroeconomic concerns remain in focus given high interest rates and an expected slowdown in the external environment.

Market watchers believe the local market could see some turbulence in the coming months, with uneven performance across sectors.

Singapore stocks turned in a mixed performance in the first half of 2023, despite a strong performance in equity markets in the US and parts of the Asia region.

The benchmark Straits Times Index (STI) was up 0.3 per cent in the year to date to Jun 16. In comparison, key indices such as the S&P 500 in the US, Nikkei 225 in Japan and South Korea’s Kospi have posted double-digit growth over the same period.

In Singapore, around half of the STI counters posted positive returns in the first half, led by Sembcorp Industries, Keppel Corp and Singapore Airlines (SIA). The trio was up between 40.5 per cent and 68.3 per cent as at Jun 16.

Equity markets have recovered from their lows last October, noted Carmen Lee, head of OCBC Investment Research. But whether the performance can be sustained would largely depend on the earnings growth for companies, she said.

“On the earnings front, even in the US, I think there’s still the view out there that actually earnings (expectations) are still a bit too optimistic, and it could still come off a little bit more,” Lee said.

However, she believes the earnings expectations in Asia are slightly different, amid expectations that China could contribute to the recovery. “(For) a lot of the Asian economies, you are still actually expecting some kind of growth.”

Shelter from a potential recession

DBS equity market strategist Yeo Kee Yan noted that earnings-per-share growth for the index this year is forecast to be 13 per cent, mainly driven by earnings recovery from banks.

But the STI performance has remained relatively muted so far, as investors have mostly sold on rallies over the past six months.

“The equity market valuation for Singapore has been very conservative,” Yeo said, adding that the current valuation implies the market had priced in some kind of technical recession, even though the economy is not in one yet.

Already, market watchers have flagged the risk of Singapore slipping into a technical recession – defined as two consecutive quarters of contraction – amid weakness in the manufacturing sector.

But the way CGS-CIMB analysts Lock Mun Yee and Lim Siew Khee see it, there are still opportunities for investors to “hide in defensive stocks” in a recessionary environment.

These include counters such as Sheng Siong – as a proxy for consumer spending – or ST Engineering and Singapore Exchange , which have typically outperformed in times of weaker gross domestic product growth.

Meanwhile, Yeo of DBS is more optimistic on the services sector instead of manufacturing.

“We think the services sector will be more resilient, although we are also watchful on China’s consumer sentiment and its impact on our services sector recovery, given China’s weak property market and economy,” he said.

Yeo expects that the outlook for travel-related clusters in Singapore will remain positive, with the air transport, accommodation and recreation segments as key beneficiaries. This could include SIA , as well as hotel real estate investment trusts (Reits) such as Far East Hospitality Trust and CDL Hospitality Trusts .

Yeo added that Lendlease Global Commercial Reit may also benefit from the tourism recovery, as its portfolio comprises 313@somerset, giving it prime shopping district exposure.

The broader Reit segment, however, may still face headwinds as global interest rates remain high, even though the US Federal Reserve paused its interest rate hikes at the latest Federal Open Market Committee (FOMC) meeting.

OCBC’s Lee noted that investors are currently able to tap other income-generating instruments such as Treasury bills.

“In this kind of environment, Reits tend to underperform, which they did the whole of last year,” she said. “The Reit space is still very much about being very selective in terms of which sector you want to be exposed to.”

The CGS-CIMB analysts observed that the sector’s forward dividend yield of 6 per cent – similar to long-term average levels – means that Reits’ valuations are not viewed as very compelling at this point.

“We see investors looking for opportunities to buy on dips or on confirmation of a peaking of the interest-rate cycle,” they said.

Bracing for turbulence

Despite higher interest rates boosting net interest margins (NIM), the banking sector has underperformed in the first half, contributing to the muted STI performance.

DBS and UOB were among the biggest decliners for the year to date, down 8.1 per cent and 8.9 per cent, respectively. OCBC , meanwhile, was up 3.9 per cent.

This comes amid concerns over a peak in interest rates and a slowdown in the global environment.

The CGS-CIMB analysts have maintained a neutral view on banks, noting the dividend yields of around 6 per cent. While NIMs expansion may taper, they added that banks could see upside from wealth management picking up to pre-Covid levels.

OCBC’s Lee noted that banks are currently not expensive valuation-wise, trading on average at around 1.1 to 1.2 times book value.

“Apart from the banks having low valuation, earnings are also actually quite nicely moving up,” she said, adding that this could drive some upside in the local market over the next 12 to 18 months.

On the manufacturing front, the outlook remains muted.

Singapore’s non-oil domestic exports fell for an eighth consecutive month in May, declining by a larger-than-expected 14.7 per cent. Both the electronics and non-electronics segments experienced a decline.

Yeo said the research house would be watching out for a potential recovery in the second half.

“The third quarter would be typically the start of a ramp-up for the Christmas season production, so we will be watching numbers for any uptick,” he said.

In the near term, tech companies such as Nanofilm or Micro-mechanics that have exposure to China may still see some caution from investors, even though their share prices have corrected significantly over the past year, he noted.

Market watchers believe that there may continue to be choppiness in markets ahead as investors eye potential rate hikes in the US.

OCBC’s Lee noted that the market’s fear barometer – the volatility index, or VIX – has come off sharply, while prices of safe havens such as gold have also eased off recent highs.

She believes the market could be range-bound as it is in two camps: While some investors may be concerned about underlying uncertainty, the fact that “valuations are actually not that expensive” may still see people buying selectively.

Yeo believes that the Singapore market should hold up in the near term, with interim results and dividends being announced and paid out in the coming months.

“Essentially, I think the next few months will be a sideway trend,” he said, noting that there may be some downside volatility heading into September.