BT: Market rally seen in 2nd half (27 May 2006)

Market rally seen in 2nd half
OVERVIEW

IT has been a volatile two weeks for Asian markets. All around the region, stocks were hit by concerns over US inflation and interest rates as well as falling commodity prices. Hedge funds were selling, while other investors scrambled to lock in profits amid rising volatility. The Singapore market experienced steep falls and gave up its hard-earned gains. With sentiment still nervous, BT seeks out the views of market watchers on what lies ahead for Singapore stocks.


PARTICIPANTS in the roundtable:

Moderator: Wong Wei Kong, BT senior correspondent

Panelists:

Chew Sok Chuang, head of research, Westcomb Securities Pte Ltd

Vasu Menon, vice-president & chief editor of finatiQ.com

Terence Wong, head analyst, Sias Research

Wong Wei Kong: Let's look back a little. How would you characterise the Singapore market's performance so far this year?

Vasu Menon: It's been somewhat of a mixed bag to date. Performance in the first four months was strong, led by China-related stocks and selected blue chips like offshore and marine stocks, property stocks and bank shares. There was a good mix of participation from both retail and institutional investors.

After April, however, profit-taking and volatility set in amid concerns about US inflation and interest rates, the outlook for commodity prices, and the impact of strengthening Asian currencies on the region's economic growth. China-related stocks listed here, which did exceptionally well in the first four months, bore the brunt of the sell-off as jittery investors locked in their profit.

Chew Sok Chuang: In the first four months of this year, the Singapore market was full of excitement with rotational interest in blue chips and small and mid-cap stocks as well as in themes such as oil and gas, water, property, China and laggards. Trading activity was vibrant with trading volume and value crossing the one billion mark.

Market sentiment was buoyed by the healthy global macro picture, sterling corporate earnings and continuing news flows on orders secured for jack-up and semi-submersible rigs and oil and gas related projects. News on the integrated resort project also renewed interest in stocks in the property, retail and hotel sectors.

We saw the ST Index climb to consecutive new highs and cross several psychological levels - 2,400, 2,500 and 2,600. The index hit an intra-day high of 2666.33 on May 3, but that was not sustained. Fresh concerns over inflationary pressures in the US and expectation of further interest rate hikes led to a sharp decline in overseas markets.

The Singapore market was not spared, as it mirrored the weak sentiment overseas and on a single day on May 15, the ST Index lost 3.3 per cent. Market weakness and volatility continues this month as some investors exit the market pending clearer signals while others bargain hunt for stocks which had corrected severely.

Terence Wong: For the first four months, it was a rising tide that lifted all boats. Blue chips continued to stump cynics, as they marched confidently past all-time highs. However, the show belonged to the small caps, particularly China stocks. Since the first quarter of 2004, the gulf between blue chips and small caps has been widening. The valuation gap was glaring by the end of last year, with many small caps trading at less than half the ST Index's 14 times price-earnings (PE). We finally witnessed a much-awaited convergence in the first quarter of 2006.

But gravity set in by the second week of May, with many stocks suffering double-digit losses within a week. Hints by US Federal Reserve chairman Ben Bernanke of further rate hikes to curb inflation sparked off a trading frenzy in the US and Asian markets. Things do not look any rosier in the coming month, with liquidity expected to slow to a trickle with the World Cup.

Wei Kong: Looking ahead, how do you expect the market to perform for the rest of the year? Is the bull phase over?

Sok Chuang: The Singapore market gave an impressive return of about 11 per cent in the first four months of this year, which was excellent compared to a return of 13 per cent for all of 2005. In the month of May, up to May 23, the market pulled back around 9 per cent from its peak on May 3. The ST Index at 2,429.55 on May 23 is about 3 per cent higher than at the start of the year.

After the fierce run-up early this year, we reckon the recent correction is healthy as market excesses would be erased. We are positive that the market will bounce back in the second half as soon as it has discounted the negatives such as rising cost pressures, inflationary fears and higher interest rate hikes.

Market valuation should be back to attractive levels on account of firm economic fundamentals and good corporate earnings potential. Now, market valuation is around 14 times FY06 earnings. Investors would return to the market with greater confidence on the basis that downside risks are minimal while the upside potential increases. With favourable catalysts and liquidity, the market will rally to higher levels during the second half.

Terence: The economy continues to hum along pretty nicely. Unlike 2000, which was driven by an untested dotcom pipe dream, growth is a lot more concrete this time round. However, there was a little too much exuberance in the stock market, which looked overvalued in April after hitting a new record high. The current sell-down is healthy, considering that the ST Index has appreciated almost unabated for the past three years. I believe there will be a recovery in the second half, though it is unlikely to beat the growth registered in the last two years.

Vasu: It's unlikely that the bull phase is over. What we are seeing currently is a correction brought about by a withdrawal of liquidity from emerging markets and commodity markets which has taken a toll on global equities, including Asian bourses. The Singapore market, based on the ST Index, has corrected by about 8 per cent from its high in early May.

Nevertheless, Singapore's economic and earnings fundamentals are healthy and the stock market's valuations are reasonable. In fact, with the recent correction, some stocks and sectors are looking more attractive, presenting retail investors and fund managers with a buying opportunity.

Wei Kong: What are some of the key factors that will impact stocks in the second half?

Sok Chuang: Key factors to watch will be the Fed's policy on interest rates in the coming FOMC meeting at end-June, the price volatility of commodities and oil, economic growth and corporate earnings. Interest rates had been on the rise and this led to concerns over increases in mortgage and lending rates. Markets were hopeful that the Fed would stop hiking the Fed fund rate in May, but were disappointed when the Fed raised the rate by another 25 basis points to 5 per cent. It appears that the pause in interest rate hikes may come in the second half of this year instead.

Singapore's economic growth in 1Q06 was above market expectations. The upward revision of full-year 2006 economic growth to 5-7 per cent suggests continuing momentum in the next few quarters. This assurance removes uncertainty on the economic front and hence investors are more willing to invest in growth and value stocks.

Price surges in commodities and oil have been largely driven by market speculation and short-term hiccups from geopolitical issues. A stabilisation in commodity and oil prices should provide certainty on price direction and allay investors' fears of inflationary pressures. Market expectation of good corporate results due in August and September should also set a firm market tone in the second half.

Vasu: Impending economic data in the US and how the Federal Reserve reacts to them is a key factor that will impact global equities and the local bourse. The current uncertainties that have spooked markets could go on for a couple of months until investors and the US Federal Reserve get a handle on the strength of the US economy and underlying inflationary pressures.

If the US economy holds up well and if there are no major signs of inflationary pressures, then the Fed could signal that it will pause and that could restore confidence in equity markets. On the other hand, if uncertainties about US interest rates persist, then global and regional stock markets will be volatile and the local bourse is likely to react in sympathy.

Terence: Interest rates in the US, as well as strengthening regional currencies, should feature prominently in the coming months. News of the Chinese government's attempt to cool the economy sent shivers through the region. If the government gets tough in taming the economy, China-based stocks may once again bear the brunt. This was one of the reasons for the sell-down of China stocks on the Singapore Exchange in 2004. Geopolitical uncertainties, if not curbed, will lead to surging oil prices. This has yet to make a significant dent in the global economy, but any further appreciation will likely take a toll.

Wei Kong: Which are the sectors that are likely to be in play, and why?

Terence: It is likely that investors will turn to quality dividend plays, as the market is currently feeling the jitters. They would be looking for high-yielding stocks with stable cash flow and decent growth.

With oil prices flirting with all-time highs, oil and gas-related companies will continue to be in play. But with order momentum peaking and the entry of new competitors in the industry, growth will unlikely be as impressive as in the past two years. As the economy improves, stocks which ride on the burgeoning consumer trend will also be beneficiaries.

Vasu: Given the strength of the domestic economy, stocks with a domestic orientation stand to benefit. This includes bank and property shares. The outlook for the property market looks promising, which is also positive for the local banks. Banks are also seen as benefiting from the higher interest rates and improved interest margins, and growing affluence both here, and in the region.

The offshore and marine sector is another sector to keep an eye on as oil exploration and production are proceeding at a heady pace and this looks set to continue for a few more years. Singapore companies are major global players in the offshore and marine sector. China-related stocks may also come back to life after a healthy correction, given China's robust economy.

Sok Chuang: Stocks in the offshore marine, oil and gas sector will remain in focus on the back of high oil prices and continuing robust demand in the industry. Companies in the sector have been growing their order books by leaps and bounds and these orders will ensure sustainable earnings growth. Selective stocks in the technology sector will also be in play, in view of rising demand for consumer applications globally.

Although margins may be under some pressure due to higher oil price, steeper steel and aluminium prices, and weakness in the US dollar, some companies have been able to manage costs, improve operational efficiency and achieve better performance.

Consumer stocks should continue to be hot favourites. Growing consumerism in huge markets like China and India will translate into promising earnings potential for companies in the consumer business. Selective China plays are likely to be in the limelight too.

Wei Kong: What are your favourite stock picks for 2H2006?

Vasu: The local bank shares are worth keeping an eye on, because they offer a play into the domestic economy and an indirect play into the recovering property sector here. Banks are also benefiting from growing affluence here and in the region which could boost their wealth management businesses.

The government's push to attract tourists through integrated resorts and the development of the Orchard Road belt also augurs well for property stocks like CapitaLand and Wheelock Properties. Offshore and marine plays like Keppel Corp and SembCorp Marine should also benefit from the offshore boom.

Sok Chuang: Our stock picks include Utac, Technics Oil & Gas and China Sun Bio-Chem Tech. Utac is a beneficiary of the growing semiconductor industry and the outsourcing requirements by integrated device manufacturers and fabless companies. Its expansion via acquisition enhances the group's capabilities and capacity, customer base, and cross-selling opportunities. We expect earnings to double to US$82 million in FY06 and expand by another 41 per cent in FY07 to US$115 million.

Technics Oil & Gas has recently secured another contract worth S$5 million. Orders on hand as at May 16 totalled S$56 million. The group is poised to accelerate its growth in its niche market segment for gas compressor packages, given the huge market for gas compressors in the Asia-Pacific. Earnings are estimated to jump to $9 million in FY06, from $2 million in FY05. FY07 will see another 36 per cent rise in earnings.

China Sun Bio-Chem Tech's corn starch and modified starch products are in strong demand in China. Demand comes from a diverse group of industries including food processing, paper manufacturing, textile, petrochemical, building materials, oil and gas exploration and chemical industries. Its earnings prospects will be significant if it is given the fuel ethanol licence. Our earnings forecast of 25 per cent growth in FY06 to 303 million yuan has not factored in the impact of the fuel ethanol licence. FY07 will see another 25 per cent rise in net earnings.

Terence: At the start of the year, I expected the small caps to play catch-up, which they did in a big way. While I still believe that there is more potential in this space, it is time to be a lot more discriminating, given the run-up in the last few months.

For oil and gas plays, we like China Petrotech, which provides oil and gas exploration services focusing on specialised onshore and offshore services and equipment. Traditionally a seller of logging services software, it is moving further towards the highly lucrative oil field services business.

On the consumer side, Telechoice and Stamford Tyres get our vote. Telechoice, one of the largest mobile distributors in the region, has a stable business and strong financials, evident from its impressive cash hoard. Stamford Tyres is expected to see a strong pick-up in demand across the region for the tyres it distributes and manufactures. On top of growing businesses, both companies also dish out attractive dividends.

Wei Kong: Are there sectors or stocks to avoid?

Sok Chuang: An environment of high oil and commodity prices leads to increased operating costs for companies. However, some companies have been able to cushion the impact by passing on part or all of the increases to end consumers, whereas others have to absorb the cost increases and suffer a margin squeeze. We remain cautious on companies in the transport sector which bear the brunt of increases in fuel costs and the shipping sector which is hit by higher bunker fuel and weaker freight rates.

Vasu: Investors should be wary about investing in export-oriented sectors which could be hurt by the potential US dollar weakness. The uncertain outlook for the US economy given the risk of rising interest rates and a weakening housing market also makes export-oriented stocks a riskier proposition.

Terence: In general, I would avoid stocks of overvalued companies with little fundamentals to speak of. This may seem obvious, but when the market is good, investors will conveniently forget or choose to ignore this axiom. I would also be wary of some recent IPOs which have shot above their fair values. Sector-wise, transport and plastics-related companies would be natural casualties of rising oil prices.

Wei Kong: Where do you expect the ST Index to end the year?

Sok Chuang: Current market valuation of around 14 times FY06 earnings is compelling relative to valuations in the other regional markets and to its historical band. With sustainable earnings growth prospects, we expect market valuation to be re-rated to a more reasonable 16 times. This implies a target of 2,750 for the ST Index by year-end.

Vasu: The ST Index is currently trading at a price-earnings ratio of about 14-15 times compared to its historical five-year average of 17-18 times. If inflation in the US does not rear its ugly head, and if the US economy holds up well, then the local bourse could resume its uptrend, which could take the ST Index to around 2,800 by year-end.

Terence: Given the strength of the underlying economy, I believe revisiting the 2,600 mark should not be a problem. However,investors looking for impressive gains should focus on stock picking, rather than taking broad bets on the market as seen in the first half of this year.

KEY POINTS

- The Singapore market's sharp correction in May is a healthy correction from a record-breaking bull run.

- Economic and corporate fundamentals suggest that the outlook for stocks remains positive, while valuations have corrected to more attractive levels.

- Factors to watch include US inflation and interest rates, oil and commodity prices, and economic tightening by China.

- Stocks to look at include oil and gas stocks, consumer plays, and domestic stocks like banks and property counters.

- Stocks to avoid include transport issues that will be hurt by high oil prices.

- The ST Index is expected to rebound and end higher for the year.

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