STI 10,000 is not an unachievable goal

[SINGAPORE] DBS Group Research made headlines last week with its Singapore 2040 report, which presented its views on how the city-state’s economy and stock market might develop and grow over the next 15 years.

Among the key highlights of the report were that Singapore’s real gross domestic product growth will average 2.3 per cent a year, outpacing other advanced economies; and that the Singapore dollar may approach parity with the US dollar by 2040, driven by productivity-led growth, safe-haven inflows, current account surpluses and a potentially weaker greenback.

Most interestingly, the report also projected that the Straits Times Index (STI) could rise to nearly 10,000 by 2040, fuelled by fading US exceptionalism and Singapore’s safe haven appeal as well as attractive stock valuations, low interest rates and efforts by the Monetary Authority of Singapore to revitalise the local market.

Judging from comments on various social media channels, the forecasts and projections in the DBS report were met by scepticism. Some detractors questioned their rigour, while others dismissively wondered what they might mean for the cost of living – in particular, the price of HDB flats and certificates of entitlement for cars.

As for the STI hitting 10,000 by 2040, some critics seem to doubt that the stocks and real estate investment trusts (Reits) that currently dominate the index have the capacity to deliver strong enough returns for that target to be achieved.

My own view is that DBS’ forecasts and projections are not unachievable, and the publication of its report last week could mark the beginning of a broad shift to a more positive narrative about the Singapore market.

By my calculations, the STI would have to rise by about 5.6 per cent a year from its Friday (Oct 24) close of 4,422.21 in order to reach the 10,000 level by 2040. This does not sound all that enticing, but keep in mind that the STI also offers a dividend yield of about 4 per cent a year. With the long-term appreciation of the Singapore dollar on top of that, the DBS report actually paints a very alluring picture for investors.

The problem is that the STI’s price return over the past couple of decades has been abysmal. Over the past 15 years, the benchmark index has risen by only 2.7 per cent a year, according to the DBS report.

Can the STI rise at twice this rate over the next 15 years? What will drive it? Which of its components will lead it higher?

A more growth-oriented STI?

This column has previously highlighted that the STI’s advance to new all-time highs earlier this year was driven by a narrow group of companies that were unlocking value and forging a path to stronger profitability.

Even after the benchmark index’s recent strong run, however, the market capitalisation of mainboard-listed companies in August was only equivalent to about 0.84 times M2 money supply, said the DBS report. This was close to the lows seen during the global financial crisis.

M2 money supply encompasses cash in circulation, bank deposits and negotiable certificates of deposits.

The way I see it, this general underinvestment in the local market is perhaps why there are still so many sceptical voices in the market.

If the ratio of mainboard market capitalisation to M2 were to increase to 1.1 times, which was the low end of its range during the 2012-2019 period, the STI’s theoretical level would be about 5,600, DBS said.

A sustained rise in the STI would need to be supported by earnings growth as well as more positive investor sentiment, of course.

Under the most aggressive scenario presented in its report, DBS assumed that the STI trades at 14.5 times forward earnings, while its constituents deliver earnings per share growth of 5 per cent a year. By its calculations, this would put the STI at 5,500 within three-and-a-half years, and close to 10,000 by 2040.

With higher stock valuations and elevated investor enthusiasm, the Singapore market might begin drawing more growth-oriented companies, leading to a shift in the composition of its key market index.

DBS said in its report that if Sea and Grab were included in the STI, they would be its second- and sixth-largest components, respectively, with a combined weighting of about 20 per cent. On the other hand, the combined weighting of the three local banks would shrink from more than 50 per cent currently to about 40 per cent.

“This would strategically trade some of the banks’ stability and yield for the enhanced growth potential that tech unicorns offer, positioning Singapore as a gateway for investors seeking exposure to Asia’s digital transformation,” DBS said.

Survival of the fittest

The inclusion of more large-cap and growth-oriented companies in the STI would naturally increase competition for a spot in the 30-stock benchmark index.

Since the pandemic, companies such as CapitaLand Investment, Keppel, Sembcorp Industries and Singtel have taken bold steps to unlock value and reposition their businesses in order to make themselves more attractive to investors. More companies may soon emulate their strategies in order to maintain their relevance to investors, and their positions within the STI.

Companies that have garnered relatively high market valuations – such as DBS and ST Engineering – may now also be inclined to further enlarge themselves through acquisitions, in my view.

Meanwhile, there could be some consolidation in the Reit sector. These yield-focused structures had been hugely popular with investors during the years leading up to the pandemic, partly because returns from stocks had been so poor.

If stocks begin delivering stronger returns over time, some of the smaller and less liquid Reits may suffer from reduced investor interest. A steadily strengthening Singapore dollar may also work against Reits that hold commercial properties in foreign countries.

This year, Paragon Reit and Frasers Hospitality Trust were taken private. In another interesting move, CapitaLand China Trust seeded CapitaLand Commercial C-Reit with one of its shopping malls, and took a 5 per cent stake in the new Shanghai-listed Reit.

For now, Reits are well represented in the STI. Earlier this year, Keppel DC Reit replaced Jardine Cycle & Carriage as a component of the index. Last year, Frasers Centrepoint Trust replaced Emperador.

At last count, eight of the STI’s constituents were Reits. The largest is CapitaLand Integrated Commercial Trust, with a market capitalisation of S$18.3 billion. The smallest is Frasers Logistics & Commercial Trust, with a market capitalisation of S$3.7 billion.

To maintain a strong investor following, the managers and sponsor groups of these Reits need to come up with more compelling accounts of how they will deliver value to their unitholders.