The Rise of Resilience

We believe 2019 will be an important year for active selection or alpha and our focus will be on delivering on stock selection returns by picking quality companies who are resilient in growth amid a rising risk environment.

We foresee a more challenging macro backdrop for Asia in 2019 as compared to the previous years. Concerns over rising trade tensions and global protectionism, as well as tighter financial conditions arising from domestic policy tightening and rising global bond yields, will likely dominate as key investor concerns as we move into a new year. We expect this to translate into slower growth for corporate earnings in 2019. On a more positive note, equity markets have already begun to price in these growth concerns and earnings risks. Since April 2018, the Singapore equity market has already fallen by almost 20% as a result. Valuations are now looking attractive, with P/B multiples close to retesting its trough, last seen in 2015.

We believe these factors set up an interesting backdrop for performance for Singapore equities in 2019. While we are cautious on the rising macro headwinds, our bottom-up view on stock selection is looking more constructive and we see good opportunities in quality value and oversold growth cyclicals. Notwithstanding further major cuts to EPS growth in 2019, we believe stocks could find a bottom over the next 12 months. Another key observation is that the earnings growth trajectory in Singapore is increasingly bifurcated and dispersed. In 2019, we have witnessed much wider sector and company dispersion. Industrials are offering a combination of good value and earnings resilience, as well as growth optionally, should there be some relief in resolution of trade tensions. Other sectors appear to showing vulnerability in exhibiting further downside in earnings revisions and deterioration in returns in capital. This makes us bullish as stock pickers, and we believe 2019 could potentially hold one of the best hunting grounds for relative return strategies and active selection.

Reflections in 2018 and 2017

To gain a better perspective of 2019, we review our previous strategy pieces in 2018 and 2017 to tie in our thought process in Singapore and also provide insights for the coming year.

A review of 2018: Beyond Expansion, Focusing on Sustainability

Our 2018 outlook piece argued for the need to focus on sustainable growth and defending returns as returns would moderate into 2018 on the back of rising growth risks, tighter liquidity and less attractive valuations. Equity markets peaked in April 2018 and have retraced by close to 20% on these concerns. We also argued that with a maturing economic outlook, greater bifurcation will ensue, and relative returns becomes a lot more important. Industrials (Capital Goods) and Consumer sectors were looking attractive in our report last year. As of end-October 2018, we note that Industrials and Consumer have topped the 2018 best performers list, with 8 of 10 best in the two categories. Industrials such as ComfortDelgro and ST Engineering and Consumer names such as Wilmar and Dairy Farm were among the year’s better performers.

In 2019, growth resilience will become a more defining feature in stock selection. We believe Industrials in Singapore depict late-cycle economic cyclicals, whose earnings are better equipped to cope with rising interest rates, while Consumer typically fare better than when we move from disinflation to inflation.

Best Performers in Singapore

Best Performers in Singapore

Note: Market Capitalisation >SGD1bn
Source: Bloomberg

A review of 2017: The Year of Expansion

2017 was a year of expansion where we witnessed a trinity of market drivers in earnings, valuations and liquidity all moving positively in tandem. We believed the Singapore equity market was well supported by the expansion of earnings momentum, valuation multiples and policy conditions. In 2017, earnings expansion or revision momentum was accelerating for the first time since 2013. Valuation multiples were also attractive and had room for multiple expansion as ROEs were improving. Finally, liquidity conditions were accommodative, which would allow for risk assets to perform better. The Singapore equity market registered a gain of 25.5% in 2017, as measured by MSCI Singapore Total Return index, its best since 2012.

In 2019, we will revisit the same three drivers in Singapore. The conclusion is balanced. The most positive indicator is derived from valuations, where we find equity price-to-book valuations attractive at close to -1 standard deviation of its mean and almost back to trough valuations experienced in its last low in 2015. Earnings however, look less positive with momentum having stalled since late 2017 and trending lower for most of 2018. Earnings will likely pose a headwind for equity performance. We find 2019 momentum generally challenging, with potential downside risk in interest-rate sensitive and economic-sensitive sectors. Finally, liquidity indicators which have been tight through most of 2018 due to domestic policy adjustments are now looking relatively more balanced following the rise in interest rate in 2018 and capital market outflows.

2019 Market Outlook

Earnings

Earnings revisions have reversed after its positive growth trajectory in 2017. Consensus expectations for corporate earnings growth in 2018 peaked in April 2018 and has been cut by 3-4% since. Likewise, the outlook for 2019 corporate earnings growth has moderated with a potential slowdown in growth expected for 2019. Currently, corporate earnings growth is expected to slow from 13.0% in 2018 to 6.8% in 2019 (source IBES, Credit Suisse)

Figure 1: Consensus 2018 and 2019 EPS cut by 1.3% and 1.8% respectively, post results

Figure 1: Consensus 2018 and 2019 EPS cut by 1.3% and 1.8% respectively, post results

Source: I/B/E/S

Figure 2: Singapore EPS growth expected to slow to 6.8% in 2019 from 13% in 2018

Figure 2: Singapore EPS growth expected to slow to 6.8% in 2019 from 13% in 2018

Source: I/B/E/S

While the general trend of earnings revisions have been negative in 2018, we have witnessed a more pronounced bifurcation across sectors. Positive revisions in selective industrials, financials and consumer sectors are seen in 2019, while telecommunications have been largely negative. Dispersion has also been equally pronounced at the stock level with a sharp dispersion in 2019 EPS revisions within the Singapore universe. We note that stock and sector dispersion is also reflective of a late stage of the equity market cycle, where sector and stock selection typically play a greater importance in driving returns.

Figure 3: Most sectors saw EPS cuts post-results, with Telcos having most significant cuts

Figure 3: Most sectors saw EPS cuts post-results, with Telcos having most significant cuts

Source: I/B/E/S

Figure 4: 3-month consensus 2019 EPS revisions for STI constituents

Figure 4: 3-month consensus 2019 EPS revisions for STI constituents

Looking forward, we expect earnings growth to moderately positive at 3-5% in 2019, but see the continuation and greater dispersion in returns. Against a backdrop of slowing growth, sector selection will be key and we expect sector and stock selection may offer better return opportunities at a time of growth scarcity. We overweight selected industrials where we find good valuations and cyclicality upside in growth. We also overweight selected consumer sectors where we find stronger earnings resilience and quality growth.

Valuations

Price-to-Book valuations have turned attractive (Trailing Price-to-Book of 1.2X) with the close to 20% correction witnessed since April 2018. We believe a further 10% correction from current levels would retest previous 2015 and 2008 GFC lows, where we can be reasonably confident equity markets will recover over a 12-18 month view. Forward Price-to-Earnings are also starting to look more attractive following the earnings downgrades, tracking close to 11X forward Price-to-Earnings ratio.

While valuations are attractive for Singapore, we believe a positive catalyst either in terms of macro conditions or a stabilisation in earnings downgrades is needed to raise our convictions to positive. We continue to monitor this over the next 6 months. In the interim, our primary focus remains on earnings resilience and quality growth in the current environment, despite attractive valuations.

Figures 5 and 6:

Figures 5 and 6:

Figure 5 and 6:

Liquidity

Liquidity conditions in Singapore has tightened in 2018 with the global tightening and rise of interest rates. Domestically, liquidity was also impacted with the introduction of macro-prudential measures targeted towards property in July and the policy decision by the Monetary Authority of Singapore to maintain its bias for rising SGD dollar against its trade-weighted basket in October. We have witness a tightening move in our proprietary leading liquidity indicator (see chart), which we believe underlie tighter liquidity conditions in 2018, challenging local equities to perform.

Looking ahead in 2019, our liquidity indicator is looking more balanced suggesting some normalisation in liquidity conditions. While as interest rates might continue to move higher and tighten liquidity further, conditions appear to have stabilised which could be supportive for equity markets.

Figure 7:

Figure 7:

Bullish on Alpha in 2019 – stock selection to make all the difference

With a sanguine outlook for macro, we believe stock selection or alpha to exert itself prominently in what could be a low beta environment in 2019. We centre on the theme of resilience – stable earnings growth, high and sustainable dividend yields and strong balance sheets. We believe that against a backdrop of rising interest rates, tighter liquidity and higher risk premium, cost of capital will increase, posing risk for asset-heavy and interest rate sensitive sectors not well backed by cash flows.

On the flip side, allocation of capital will become more efficient in valuing quality companies with strong cash flow returns and who are able to deliver resilience and sustainability in returns. Equity returns and performance are likely to better correlate with company’s returns on capital and cash flows as we move away from low interest rate environment. We also expect earnings delivery, transparency and quality to feature prominently together with valuations in driving performance at the stock level. This investment backdrop is very conducive for bottom-up company selection and we expect alpha and active returns to dominate in the next 12 months.

Our biggest convictions for 2019:

  1. Focus on earnings resilience, consumer and industrials poised to outperform
  2. New Singapore –the search for tomorrow’s service eco-system winners continues
  3. Dividends to dominate returns and dividend growth to outperform in a rising interest rate environment

Focusing on Earnings Resilience

We are more positive on stock selection in Singapore and particularly in industrials and consumer sub industries. We are selective within financials and underweight property and telecommunications.

We are selective in financials and underweight interest rate sensitive sector such as property developers. Within REITs, we are also more cognisant of the sustainability in earnings or dividend growth (DPU) as well as financial leverage in a rising interest rate environment. We believe domestic policy risks and rising interest costs could pose challenges over the next 12 months.

We are selectively more positive on industrials and the consumer sector in 2019. Industrials in Singapore represent a broad categorisation of conglomerates, transportation and marine offshore companies but most have earnings linked to the latter part of the economic cycle and who benefit from a recovery in the real economy i.e. capital expenditure (capex). We also find valuations in some industrials cases are attractive, close to multi-year valuation lows and deeply discounted to their book values. Other industrial and consumer stocks have strong quality franchises, are poised to have sustain earnings growth in 2019 and are able to maintain and improve on their return on capital amid challenging growth environments.

This is most prominently seen in earnings expectations for 2019 and 2020 where industrial and consumer staples lead in terms of earnings growth expectations. Also, notice increasing bifurcation in earnings growth for 2019 and 2020 and believe this will lead to greater dispersion in returns from sector selection.

Positive fundamental change (Growth) and Sustainability in Returns to come from Consumer and Industrials in 2019

Positive fundamental change (Growth) and Sustainability in Returns to come from Consumer and Industrials in 2019

Source: dataCentral, Bloomberg

Industrials to perform better in a rising interest rate environment

As more signs point towards the latter or closing stages of the economic cycle, we believe industrials could be set for better performance in 2019. Industrials are typical late cycle economic sectors and usually associate with the corporate capex spending cycle linked to job creation and the real economy. With the rise in interest rates correlating with the rise of economic activity and corporate spending associated with improved business confidence, industrial equities tend to perform better during this stage of the economic cycle.

MSCI World Industrials, a broad measure of global industrial companies, have outperformed the MSCI World Financials index over the past 3 years, as economic conditions improved and interest rate conditions tightened.

Figure 8: Relative Performance of MSCI World Industrials/MSCI World Financials

Figure 8: Relative Performance of MSCI World Industrials/MSCI World Financials

The case for Singapore Industrials however has been starkly different, where MSCI Singapore Industrials have underperformed MSCI Singapore Financials significantly over the past 3 years. This has started to reverse over the past 3 months as sector earnings revisions within industrials have improved and valuations have also remained supportive. Meanwhile, sector revisions in the financials have moderated due to tighter liquidity conditions and domestic policy tightening on the property sector. We believe the backdrop for industrials to build on its recent outperformance against financials remains supportive.

Figure 9: Relative Performance of MSCI Singapore Industrials/MSCI Singapore Financials

Figure 9: Relative Performance of MSCI Singapore Industrials/MSCI Singapore Financials

The return of inflation a potential tailwind for Consumer Staples

We believe consumer staples and food sector also represent a compelling investment proposition for 2019. The broad earnings backdrop for consumer staple is supportive, as sales (prices) are typically positive correlated to inflation and staple demand (volumes) is also less elastic and more resilient in a growth slowdown. We continue to have a positive structural thesis on Asia consumer staples riding on the rise of the middle class and trend of consumerisation in Asia. We also view consumer staples within the food supply chain as defensive in a slowing growth environment and relatively well placed in its ability to improve pricing margins as inflation rises. One example of this is that in 2018, we have noticed select consumer staples in Asia benefiting from potential trade dislocations and new market opportunities resulting from the current trade tension between US and China.

We also look back to the periods of 2004-2008 and 2009-2010 where inflation rose and find consumer staples typically outperform in these periods.

Figure 10:

Figure 10:

New Singapore to remain in focus in 2019

New Singapore continues to represent the new Singapore economy and companies within the service economy which is riding on innovation and restructuring to better compete in the new economy. We continue to like sectors such as technology services, data centres, healthcare, logistics, tourism and consumer services within Singapore which we believe are part of the service eco-system. We believe these sectors have long term structural growth drivers and are poised to outperform the economy in terms of growth in the coming years.

Restructuring has also been evident in industrials who are recalibrating their growth engines, fine-tuning their corporate and capital structures and building a bigger push towards services. A most recent example would be Keppel Corp’s privatisation of its data centre and logistic subsidiary Keppel T&T, consolidation of its telecommunication operations in MobileOne and growth initiative in Keppel Infrastructure via acquisitions.

We continue to like these sectors who offer growth exposure in companies well plugged into these service eco-systems as well as restructuring opportunities through companies reinventing their business models and/or restructuring to better compete in the current environment. We are currently overweight select companies in the healthcare, technology service and tourism sectors.

Dividend Investing to Outperform

Singapore remains a defensive proposition for investors in uncertain times, with a resilient economy, a stable currency and most importantly, an attractive market dividend yield of 4-5% backed by high free cash flow, strong pay-outs and defensive balance sheets. In a low beta or low return market environment, dividends will continue to feature strongly in driving returns. We expect a highly convictive dividend strategy encompassing both yield and growth is most well placed to outperform in today’s rising interest rate environment.

Dividend yields in Singapore are now very attractive having now risen to 4-5%, one of the highest in the Asian region. This has come from a combination of lower equity prices, the sustainability of dividend pay-outs and dividend upgrades from the banks. This has led to a scenario where dividend yield expectations have actually risen in 2018 helping to counter balance the weaker trend on earnings revisions. This is encouraging which supports our view that dividend yields will help support the market on the downside and Singapore offers a defensive growth proposition in the region.

Figure 11: Dividend (DPS) expectations in Singapore resilient and rising in 2018 and 2019

Figure 11: Dividend (DPS) expectations in Singapore resilient and rising in 2018 and 2019

Source: IBES, Credit Suisse

We continue to focus on companies who offer high and defensive yields with a steady growth in dividends. In high dividend yield sectors, we focus on selective financials, industrials and consumer companies where we see higher ROE expansion driving dividend returns as well as higher potential pay-outs from rising free cash flow and capital strength. Within REITs, we find good opportunities and like office, hospitality and industrial REITs with growth in DPU and selected infrastructure business trusts.

Summary

In summary, we believe resilience remains key for stock selection 2019. We measure resilience in the form of the sustainability of returns in earnings growth, business models and balance sheets. We believe active performance will come from companies which are able to deliver in sustaining earnings growth, have business models with defensible and quality growth and are equipped with the financial ability to take advantage of growth opportunities in the current environment of slower growth and tightening liquidity. Sustainability of Returns or resilience will be key for performance in 2019.

This makes us relatively cautious and selective on asset plays especially companies dependent on interest rates and more constructive on quality and value franchise with a good earnings growth trajectory. We see this particular in industrials, were capex conditions continue to suggest growth is continuing and late cycle capital expenditure remains supportive for earnings. Likewise, in consumer sectors, we believe companies are better able to cope with the rise in inflation and earning have room to see positive surprises from margins.

We also continue to be positive structurally on the service economy in Singapore. While many of these sub-sectors such as tourism, infrastructure and healthcare are sub-sets of industrial and consumer sectors, we believe these sectors have long term structural growth drivers and are poised to outperform the economy in terms of growth in the coming years. We see strong opportunities in companies who are re-inventing themselves to compete in the new economy and overweight select companies in the healthcare, technology service and tourism sectors.

Finally, we believe dividend investing will continue to be profitable in 2019. Dividend yields in Singapore are now the highest in the region at an attractive market dividend yield of 4-5% backed by high free cash flow, strong pay-outs and defensive balance sheets. In a low beta or low return market environment, dividends will continue to feature strongly in driving returns. We expect a highly convictive dividend strategy encompassing both yield and growth is most well placed to outperform in today’s rising interest rate environment.