• With the reopening of the borders and the resumption of tourism, Singapore’s equity market has generally outperformed global peers in 2022.
• Economic growth in Singapore is expected to moderate in 2023, as the global economy enters a slowdown.
• The local banks will continue to be prime beneficiaries of the rising interest rate environment via higher net interest income, as well as higher wealth management fees arising from a surge in wealthy families relocating here from abroad.
• Although S-REITs still do not present investors with an attractive risk reward given the competitive risk-free rates, there are some sub-sectors that may prove to be more resilient.
• We project an upside potential of about 27% for the STI by end-2024, with an average dividend yield of around 5% over the next two years. We maintain our star rating of 3.5 Stars “Attractive” rating for the Singapore equity market.
STI has performed relatively well amidst a year of carnage across global equity markets
2022 has certainly not been a good year for the equity markets. However, Singapore’s equity market, as gauged by the Straits Times Index (STI), held up well in the sea of red and managed to outperform global peers.
Despite macroeconomic challenges like supply chain disruptions, energy crisis and surging inflation, the STI managed to eke out a 5% gain in 2022, despite most of the other equity markets posing double-digit negative returns.
Figure 1: STI has generally outperformed other major indices
Being a trade-driven economy and with soaring inflation globally, prices of goods and services in Singapore have surged via imported channels. Despite inflation rates seemingly peaking in most major economies in 4Q22, and are likely to moderate in 2023, consumer price growth continues to remain elevated, way above the targeted 2% rate set by the Federal Reserve (FED) and European Central Bank (ECB).
Figure 2: Inflation in Singapore and major economies continue to remain elevated
Just like most of the central banks around the world, the Singapore Central Bank has also acted to cool down the economy. To date, the Monetary Authority of Singapore (MAS) has conducted five rounds of monetary policy tightening to rein in inflation, and expects headline inflation to average around 6% for 2022, and remain persistent at around 5.5% to 6.5% in 2023, before declining further in 2024.
We believe that inflation is likely to remain sticky, which would erode the purchasing power of consumers if their wage growth is unable to catch up to rising inflation, creating headwinds for growth in the near-term.
Related article: How long will it take for inflation to hit 2%? Hint: much longer than you think
All these monetary tightening by central banks to tame inflation does come with consequences, which can be seen in the purchasing managers’ index (PMI). Over the last few months, PMI has been slowly trending down for many major economies, including Singapore. Although the PMI of other major economies has experienced relatively larger drawdowns and volatility, Singapore’s PMI has remained firm and steady, hovering around the 50 mark, showing resilience despite the increasingly challenging macroeconomic environment. As of December 2022, most of them have entered into contractionary territory (a reading below 50), signifying weakness in the economies as economic activities wane.
Figure 3: PMI in major economies have entered into contractionary territory
Projected growth to slow down in 2023
As the global economy enters a period of slowdown and potentially a recession, Singapore is unlikely to be spared. Coupled with the multiple rounds of monetary tightening performed by the MAS, GDP growth rates in Singapore are projected to slow down to 0.5%-2.5% in 2023, down from the estimated 3.8% growth this year in 2022.
Fortunately, if the global economic downturn is shallow and swift, the growth of the Singapore economy is expected to rebound and regain its upward momentum in 2024.
Figure 4: GDP growth is expected to slow down in 2023 before rebounding in 2024
Local banks are prime beneficiaries of rising interest rates
With the Financials sector comprising of roughly 50% of the STI Index, the business performance of the local banks is of paramount importance.
On the back of the current rising interest rate environment, the local banks will continue to be prime beneficiaries as they are able to generate more income on their loans, increasing their net interest margins and net interest incomes. Given that more than 50% of the banks’ revenues come from net interest income and that interest rates will stay higher for longer, we believe the banks will continue to benefit from this new regime of higher rates.
Furthermore, there has recently been a wave of immigration of high-net-worth individuals and families from abroad, particularly China, as they see Singapore as a safe haven, with relatively low tax rates and political stability. According to the MAS, there has been a surge in wealthy Chinese entrepreneurs setting up family offices in Singapore, which has seen the number increasing from just 50 in 2018 to more than 700 in 2021, with more than 100 approved applications in just the first four months of 2022. This has brought about billions of inflows into Singapore, which could create tailwinds for the local banks’ wealth and asset management arms, while also boosting the local economy.
Finally, the Singapore banks have robust capital positions and have proven their ability to tide through the rough Covid-19 pandemic, despite liquidity constraints, deteriorating asset quality and setting aside higher provisions for loan losses. Furthermore, after taking into consideration the dividend cap set by MAS in 2020, they were able to payout dividends at a sustainable rate despite going through tough macroeconomic conditions, proving their resilience.
Figure 5: Dividends for local banks have remained steady through the Covid-19 pandemic
Mixed outlook for S-REITs as some sub-sectors show more resilience
Apart from the Singapore banks, REITs form another important component of the Singapore equity market. Although the S-REITs have seen a correction this year, we believe that the overall risk to reward is still unfavourable given the uptick in risk-free rates.
In the current new regime where both inflation and interest rates will likely remain higher for longer, REITs are not in a favourable position as they have to refinance their expiring loans at higher rates, which increases their average cost of debt. This increase in interest expense from higher borrowing costs is likely to affect the Distribution per Unit (DPU), while also putting downward pressure on rental rates due to a slowdown in commercial leasing activity.
Related article: S-REITs have seen a correction, but you should think twice before buying
However, there are some sub-sectors that may prove their resilience despite the global slowdown, backed by secular trends and structural tailwinds.
Industrial REITs: Although growth in the industrial property sector is set to moderate due to global uncertainties and an increase in supply, it is likely to be resilient as it benefits from industry tailwinds such as rising e-commerce adoption and the reshoring of supply chains due to deglobalisation.
Retail REITs: Rising prices have reduced the spending power of consumers, which would reduce retail spending and affect rental recovery. However, suburban malls that are predominately driven by essential spending should prove to be resilient despite the weakening growth outlook.
Office REITs: Despite the slowdown in the global economy, Singapore continues to be an attractive financial hub, as seen from the number of wealthy individuals and entrepreneurs setting up family offices and relocating here. However, with an increasing number of companies announcing hiring freezes or layoffs, there may be a softening in rental growth due to weakening leasing demand.
Data Centre REITs: With the world increasingly reliant on technology, coupled with the increase in investments in digitalisation, the data centre market should continue to benefit from secular growth trends. However, given that data centres tend to have long-term leases, it may affect their ability to adjust to high inflation.
Healthcare REITs: Healthcare REITs should prove to remain resilient given their defensive characteristics, as consumers will always require access to healthcare be it rosy or tough economic times. Furthermore, with an ageing local population, the demand for healthcare should continue to remain robust.
Hospitality REITs: Although pent-up travel demand and tourism have benefitted hospitality REITs in 2022 with the reopening of Singapore’s borders as well as other countries, growth is expected to moderate given the global slowdown. However, if China reopens its international borders in 2023, it could give a boost to this sub-sector given its strong consumer spending power.
Key investment risks
Prolonged and deep recession/Stagflation: While markets are currently pricing in a shallow recession in 2023, the prospect of a prolonged and deep recession is not out of the question. Furthermore, with persistently high inflation and slowing growth, the world could be headed for stagflation, which would throw a wrench in risk assets.
China reopening could be a double-edged sword: Although China’s potential reopening in 2023 could give a boost to the global economy, fuelled by its sheer consumer spending power, this may drive commodity prices higher and cause a resurgence in inflation. This may exacerbate the already slowing global economy and increases the likelihood that inflation may remain entrenched.
Valuations suggest further upside despite moderation in earnings
Despite the murky economic outlook, we expect further corporate earnings growth for Singapore equities in 2023, largely driven by the Singapore banks, albeit at a slower rate when compared to 2022 due to a higher base effect year-over-year.
Based on our fair PE ratio of 14X for the STI, our target price for the index is 4,122. This translates to an upside potential of about 27% by end-2024 using the recent closing price of 3,243 on 4 Jan 2023. We maintain our star rating of 3.5 Stars “Attractive” for the Singapore equity market.
Additionally, attractive dividends continue to remain a key characteristic for Singapore equity investors. Over the next two years, investors can expect an average dividend yield of about 5%.
Although we remain optimistic on the Singapore equity markets, we caution that dark times could be ahead. Furthermore, with risk-free rates rising to north of 3% for Singapore Savings Bonds and more than 4% for Singapore T-bills, the dividend yield spread between the STI and the 10-year Singapore government bond yield is currently below its ten-year average, suggesting that the fixed income market may be currently more attractive.
Nevertheless, if investors prefer exposure to equities, the Singapore equity market offers resilience due to its large exposure to value stocks, which is relatively more defensive as we head into a global recession.
Figure 6: Dividend yield spread below its 10-year average
Table 1: STI Index Valuation Table
|
2021 |
2022 |
2023E |
2024E |
|
|
PE Ratio |
13.6 |
12.0 |
11.6 |
11.0 |
|
Earnings Growth |
59.0% |
18.4% |
3.2% |
5.3% |
|
Projected EPS |
228.9 |
271.1 |
279.6 |
294.4 |
|
Target Price (Based on 14X fair PE Ratio) |
- |
- |
- |
4,122 |
|
Potential Upside |
- |
- |
- |
27.1% |
|
Dividend Yield |
3.24% |
4.10% |
4.89% |
5.17% |
|
Source: Bloomberg Finance L.P., iFAST Estimates |
||||
Table 2: Recommended products for Singapore equities
|
Equity Market |
Unit Trust |
ETF |
|
Singapore |
Figure 7: STI Index Price vs EPS
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