Markets are volatile, with stormy rain alternating with sunny blue skies. Just four months ago, global markets started on a “very weak” note. The US shocked the entire Americas and beyond with the invasion of Venezuela, which was followed by the attacks on Iran. As a result, markets suffered a huge sell-off.
Yet in April, almost all key indices recovered, hitting new all-time highs, with the S&P 500 seemingly set for another strong double-digit gain this year. “Effectively, the market ignored the volatility and risk appetite came back into the market,” says Carmen Lee, head of equity research at OCBC Group Research.
For her, how and where the market moves boils down to three key elements. First, sentiment must be positive. Secondly, it must be supported by earnings and, thirdly, by valuations.
Lee notes that first-quarter earnings have surprised positively by a “wide margin”, not just in US tech stocks but also in Japan and, to an extent, here in Singapore. The key factor driving interest in the stock markets is the massive AI ecosystem, with semiconductors functioning as the core driving engines.
Nvidia, with its massive US$6 trillion ($7.7 trillion) market value — bigger than the Japanese economy — has been attracting unbridled interest from investors. In addition, the lower-tier names — including Singapore-listed AEM Holdings — are set to move, if not already. “If you have to invest, you have to follow the trend, because single-handedly, as a group, they will continue to lead the market in terms of direction,” says Lee.
In addition, the gains in these tech stocks are backed by earnings growth — unlike the dotcom bubble — suggesting they have legs, despite seemingly lofty valuations relative to a couple of years earlier. “So, do not miss the opportunity,” says Lee, who was speaking together with her team at the OCBC Securities Investment Forum.
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Now, investors’ attention, too, has been captured by a new era of volatile geopolitics that makes the Cold War look boring by comparison. The fighting in the Middle East, which has caused energy prices to spike, has “definitely” raised the risks of stagflation, warns OCBC’s senior equity research analyst Andy Wong.
“And with that, there are also uncertainties over the whole interest rate trajectory of major central banks,” he adds. At the start of this year, the market was expecting two rate cuts by the US Federal Reserve. Now, amid inflation risks, markets are pricing in a rate hike by next March, with obvious implications for asset prices, he warns.
Over in China, which is bearing the brunt of the US trade war, growth is seen tapering off somewhat as structural challenges remain. Market sentiment remains listless and consumption is weak.
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Nonetheless, there are some supportive factors. For one, China, with a bigger head start pushing for renewable energy, is less exposed to an energy crisis relative to many other Asian economies, says OCBC’s equity research analyst Chu Peng.
In addition, as the AI supply chain grows, spurring demand for supporting electrical and mechanical products, certain Chinese export sectors will do well. This means certain sectors are under pressure, but there are strong pockets of growth opportunities such as AI and advanced manufacturing, says Chu.
Samuel Wong, OCBC’s senior trading strategist, points out that China and Hong Kong’s markets were once labelled as “uninvestable,” but that investors should instead view them as “deep value opportunities” ideal for price discovery.
Samuel believes there is a good chance the market will bounce back when conditions improve. “In short, trading in China is betting on its value going up and trading in the US is betting on earnings getting better.”
So, on the one hand, Samuel will continue to bet on growth themes like AI and digital infrastructure, while sticking with a portion of stable, dividend-paying stocks like banks and utilities on the other. “Stay vested within the market, but also continue to adjust your portfolio according to the market sentiment,” he says.
Strong Singapore dollar
At home in Singapore, the sentiment is clearly positive. Lee, who has been covering the market for more than two decades, quips that she can spend five hours saying why investors should invest in the Singapore market.
She explains that a key factor making Singapore attractive is the strength of the currency, relative to other regional currencies and, more significantly, the greenback. A strong Singapore dollar is more than just making holidays in Japan or Korea cheaper. “What a strong Singdollar means to the market is that a lot more funds will come into the Singapore market and that is clearly what we have been seeing for the last few years,” says Lee.
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For a foreign investor, buying property here is probably not the top choice given the punishing taxes. Bonds, meanwhile, offer little return, so the local market is the obvious place to park their money. By investing in Singapore, gains come not just from the stable, attractive yields of stocks, but also from the gradual appreciation of the Singdollar, which can easily boost returns to 10% or more for those who invest in local blue chips such as banks.
On their part, local banks have been actively capturing inflows of wealth from across the region. For some years, fee income, mainly from wealth management, has been a “very significant” portion of the bottom line and not just interest income. Interest rates may have come off somewhat, but thanks to continued growth in fee income, banks reported better-than-expected earnings in the most recent first quarter, says Lee.
Given the strong growth engines, the banks have been generous in paying out around half of their earnings as dividends to shareholders, which yield around 5% or more, thereby attracting investors, including big funds that like the stability of such returns. “This is way higher than what you can get from your savings account, way higher than what you can get from your T-bills and, of course, way higher than most asset classes,” says Lee. “So, banks remain an overweight for me.”
Diversification within REITs
Besides banks, the growing universe of S-REITs has been popular with dividend-seeking investors. However, with tensions in the Middle East, inflationary risks, and interest rate volatility again in play, the outlook is uncertain.
Now, compared to 2022, the environment today is “distinctively” different, says Ada Lim, OCBC’s equity research analyst. “While elevated inflation levels are actually much lower, while policy rates are much higher, this current setup makes it a lot more challenging for central banks globally to hike rates aggressively to prune inflation and this is actually slightly less negative for the S-REITs,” she adds.
Rather than approaching the entire S-REIT sector as a single broad swathe, Lim reminds investors to drill deeper into the dynamics of different sub-sectors. For example, retail and hospitality are quite heavily levered to consumer sentiment, while logistics and office assets are closely tied to business confidence, she says.
Investors ought to sieve for REITs with three key characteristics. First, they should be able to deliver solid, sustainable growth in their distribution per unit. “This is typically underpinned by a quality portfolio, strong sponsor support, as well as a visible acquisition pipeline,” says Lim.
Next, balance sheet strength is especially important in the current uncertain environment. So favoured REITs should have a healthy aggregate leverage ratio and prudent capital management.
Last but not least, diversification across sub-sectors and geographies should be considered. “Although we do retain a preference for Singapore assets, local capital values have been resilient,” she says.
Lim believes that S-REITs continue to have a place in investment portfolios and the current list favoured by OCBC’s research team includes Keppel DC REIT, Parkway Life REIT and CapitaLand India Trust.
Game-changing EQDP
To a certain extent, S-REITs and banks have long been sectors of focus. Before the government went all out to revive the market starting early last year, the small- and mid-cap universe was suffering from scant investor interest, despite many of them having sound fundamentals and low valuations.
With the launch of the Equity Market Development Programme (EQDP), which assigns various fund managers to invest $6.5 billion of government money in local small- and mid-caps, the mood has swung. “The EQDP is quite a game changer,” says Troy Cheng, OCBC’s equity research analyst.
There is also funding to boost more research for these stocks. “The idea is simple: more coverage drives liquidity and liquidity brings institutional interests.” In the first quarter of the year, small- and mid-caps here drew $170 million in net institutional inflow, mostly led by industrial stocks. “Importantly, we are still in the early stage of this cycle,” says Cheng.
Hong Leong Asia, for example, is a stock favoured by the OCBC team, given that its building materials business positions it well for the ongoing construction boom here. Besides the tens of thousands of new HDB flats, major infrastructure works are ongoing, such as the airport’s Terminal 5, the expansion of the integrated resorts and, across the Causeway, new infrastructure to support the Johor-Singapore Special Economic Zone, says Lim.
According to her, the defence sector is another growth cycle. ST Engineering, according to her, has made hefty gains, but she believes there’s still some valuation discount relative to its global peers. Nordic Group, meanwhile, is a small-cap covered by the OCBC team that is somewhat plugged into defence spending, given its niche role in building and maintaining shooting ranges, as well as equipment and facilities used at military bases.
The full effect of the EDQP fund deployment has not yet been felt, as not all the funds have been allocated. In the meantime, asset managers are all looking around for undervalued stocks to invest in, but from Lee’s perspective, that is not a tall order, as only a handful of the 600 or so local stocks have moved in a big way. “It is not really about finding a needle in a haystack; there are many needles in the haystack — you just have to be a bit more active,” says Lee.
She points out that “everyone” in the Singapore market ecosystem is involved in making the market vibrant again, not just the asset managers with vested interests in ensuring this works. “There will be exciting days ahead in the next 12 to 18 months,” says Lee.
