• Despite the strong performance for Singapore equities in 2012 so far, the market remains a far cry from historical highs; several issues have been holding back Singapore equities:
• Poor global investor sentiment weighing on valuations
• Concerns over weak GDP growth
• Weak earnings growth profile
• We expect these issues to alleviate going forward; despite our recent downgrade, our 4.0 star “very attractive” rating still represents a highly-favourable view on the Singapore equity market

Chart 1: performance of the singapore market

While the Singapore equity market was one of the stronger-performing markets under our coverage in 1Q 12 (see “Equity Market Review 1Q 12: A Positive Quarter for All Markets”), the benchmark STI remains 24% off its 2007 closing high of 3831.19 points (as of 11 April 2012). In this article, we examine some of the negatives weighing on the Singapore market, and whether Singapore equities still remain an attractive investment proposition.

1. Poor investor sentiment weighing on valuations

Numerous global issues weighed on investor sentiment

Negative investor sentiment has been a key feature of the global investment landscape for much of 2011, as investors fretted about numerous issues – a potential Eurozone break-up, soaring oil prices amidst unrest in the Middle East, weaker-than-anticipated growth in the US, and the impact of Japanese and Thai supply-chain disruptions on Asian exports (see “Equity Market Review 2011: Only 2 Countries Survived The Drop!”). Weakness in equity markets and widening credit spreads was accompanied by strength in safer bond segments like US Treasuries and German bunds, highlighting that the “flight-to-safety” mentality of investors was very much in force.

Valuations were driven down on weakness in risk appetite

In tandem with the general weakness of Asian equity markets (the MSCI AC Asia ex-Japan declined by -18.4% in 2011), Singapore equities delivered a -17% return for 2011, driving down valuations for the market (as of 31 December 2011) to just 12.6X full-year earnings on a historical basis (a substantial discount to our fair value estimate of 16X for Singapore equities). Such low valuations are a function of the extremely weak investor appetite for riskier securities, and also represented a very pessimistic earnings outlook for Singapore companies (see “In Defence of STI 3600”).

Sentiment has since improved, but valuations still muted

As concerns over several global issues alleviated in 2012, there has been a general improvement in investor sentiment, helping Singapore equities to stage a fairly strong recovery (the market posted a hefty 13.8% gain in 1Q 12). Nevertheless, the Singapore equity market currently trades at just 14X last year’s earnings (as of 11 April 2012), representing relatively muted valuations even as general investor sentiment has seen a substantial turnaround.  

2. Concerns over weak GDP growth

Weak growth expectations remain a cause for concern

Following a blistering 14.9% expansion in 2010, the Singapore economy posted a 4.98% expansion in 2011, which makes the government’s guidance of 1-3% growth in 2012 a rather major letdown. Even if growth comes in at 3% this year, it will still be less than half the 7% annualised rate of expansion since 1975, or the 6.3% rate over the past decade.

Slow economic growth due to external issues

Given Singapore’s strong dependence on external demand, it is not surprising that growth expectations have dropped off significantly in the current economic landscape, with slowing growth in major trading partners like China (see “China: What are the implications of a 7.5% Growth Target?”) and the US, while the Eurozone (which is a major recipient of a significant proportion of Singapore’s exports) is also widely expected to enter a mild recession this year.   

Economic data rebounding, regional growth of higher significance

Despite the weak expectations, latest growth data has provided more cause for optimism (see Table 1), as advance estimates for 1Q 12 GDP growth came in at a better-than-expected 9.9% quarter-on-quarter (annualised), or 1.6% year-on-year. Manufacturing and construction both posted a strong rebound from contractions in 4Q 11, helping overall GDP to rebound from a -2.5% contraction in the prior quarter, thus avoiding a technical recession (two consecutive quarter-on-quarter contractions).  

In addition, we note that there is a mismatch between the make-up of the Singapore economy and the exposure of the STI’s underlying companies. As shown in Chart 2, the manufacturing sector (which represents over a quarter of Singapore’s economy) has been a key contributor to aggregate growth due to its volatile nature, but has little actual representation in the Singapore benchmark index. For example, the electronics cluster remains one of the largest components within manufacturing, but has no representation amongst the current 30 STI companies. Neither has the biomedical manufacturing cluster, which has had an increasing influence on quarter-on-quarter changes due to the volatile nature of the segment.

Chart 2: attribution of GDP growth contribution

Furthermore, analysis in a prior article suggested that just 26% of STI revenue was derived domestically (see “How much does your Singapore equity fund depend on the local economy?”), and that figure appears set to decline further as local companies expand abroad (particularly in Asia), a case in point being the latest proposed acquisition of PT Bank Danamon in Indonesia by DBS. As opposed to focusing solely on economic growth in Singapore, external growth (particularly that of other Asian economies) is likely to be a more critical determinant of corporate sector growth going forward.      

3. Earnings drive stocks, but earnings profile has been weak

Chart 3: earnings drive stock performance

Earnings remain off their 2007 highs

Over the long term, earnings remain the key driver of stock market performance. Despite the strong recovery from 2009-lows, STI earnings have yet to attain the levels seen in 2007 when earnings last peaked (see Chart 2); correspondingly, the STI remains off its historical highs by a fair margin.

Weakness in several sectors have contributed significantly to the relatively modest earnings profile of the Singapore equity market over the past two years, with high oil prices pummelling the industrial transportation sector, driving the segment to a loss in 2011 (see Table 2). The real estate sector has also been impacted by cooling measures in both Singapore (see “Equities Weekly - Additional Property Cooling Measures in Singapore [12 December 11]”) and China, while the implementation of new accounting rules has also delayed the recognition of revenue. Expectations for food producers have also come off substantially for 2012, with the sector expected to post earnings growth of just 1.1% as continued commodity price volatility weighs on processing margins.

Expectations for earnings to hit a new all-time high by 2014

Nevertheless, many of these issues are expected to alleviate in 2013 and 2014, which should allow STI companies to deliver earnings in excess of the 2007 peak. Other than the oil equipment, services and distribution segment (Keppel Corp, SembCorp Industries and SembCorp Marine) which is expected to see a mild decline in earnings following a prior boom in the rig-building cycle, all other sectors are expected to post positive EPS growth from 2011-2014 (see Table 2), led by general retailer Jardine C&C where explosive profit growth is expected to be driven by robust Indonesian domestic demand, while earnings for the travel & leisure segment should see a strong rebound as SIA recovers from a profit slump while Genting Singapore continues to post strong growth on improving tourism arrivals. Banks, the largest component within the STI (see Chart 4), have been hurt by record-low interest rates which have eroded net interest margins; foreign forays should help mitigate some of the pain, while rates are widely expected to increase by 2014 which should improve the fortunes of Singapore’s domestic lenders.

Chart 4: Break-down of the STI by sector

Issues remain, but compelling valuations beckon

Chart 5: Singapore market valuations

While a combination of poor investor sentiment, weak economic growth expectations as well as a modest near-term earnings outlook have weighed on the performance of Singapore equities, we expect many of these concerns to alleviate in the longer-term, driving stock market performance. At present, Singapore equities remain an attractive investment as valuations remain compelling, both on a historical basis as well as on a forward-looking basis. With consideration of the extremely low interest rates on risk-free securities as well as the market’s historical valuation range, we believe a fair value PE ratio of 16X for Singapore equities is reasonable, which suggests the market is poised to deliver over 43% upside by end-2014 (as of 11 April 2011). Despite our recent downgrade (see “Investment Outlook Review and Changes to Star Ratings – 1Q 12”), our 4.0 star “very attractive” rating still represents a highly-favourable view on the Singapore equity market.

Chart 6: Singapore Equity Market Star Rating Changes

Related Articles:

Equity Market Review 1Q 12: A Positive Quarter for All Markets
In Defence of STI 3600
Idea Of The Week: Managing Currency Risk [23 Sep 2011]