BT: Uncertain times for market investors (15 Jul 2006)

Business Times - 15 Jul 2006

Uncertain times for market investors

OVERVIEW

HIGH oil prices, North Korea's recent missile testing and uncertainties over US economic growth provide a backdrop of uncertainty for investors. More political tensions came in the form of the deadly train blasts in Mumbai, India, earlier this week.

While Singapore's economy appears to be powering along, the local equity market has hit choppy waters. With an uncertain global economic and political environment, what should investors be concerned with and what would be good investment choices? BT speaks to a panel of experts to get some answers to these important questions in what are increasingly trying times for investors.


PARTICIPANTS

in the roundtable:

Moderator: Donald Urquhart, BT journalist

Panelists:

S S Teo, managing director, Pacific International Lines (PIL)

Bill Smart, Managing Director, Bengal Tiger Line

Thomas Orting Jorgensen, chief executive South-east Asia, AP Moeller-Maersk

Captain S Rajashekhar, senior vice-president trades, Emirates Shipping Line FZE

Ron Widdows, CEO, APL



Winston Loh, managing director, Winstonnage Agencies Pte Ltd

Leslie Yee: Should Singapore equity investors be concerned with developments in North Korea and why?

Peter Chiang: The developments in North Korea are among a number of prevailing geopolitical risks. It will add to the heightened risk aversion and uncertainty clouding global equity markets. The impact is more felt in the North Asian markets rather than the other Asian markets.

Kam Yoke Meng: The North Korea missile testing issue is, in our view, not very threatening to Asian equity markets at this juncture. This is based on the assumption that reaction from US is unlikely to be excessive, given the failure of those launches. However, geopolitical tensions could escalate if the US forces North Korea into compliance. Under that scenario, the equity risk premium for regional markets could rise substantially. Meanwhile, the situation warrants close monitoring.

Tay Han Chong: North Korea is an 'unknown unknown' - meaning it is difficult, if not impossible to calibrate the risks to investing. We also note that such hot spots, whether Middle East or North Korea, would have some impact when situations such as the recent missile launches flare up. Unless this leads to regional instability that fundamentally increases the risk of doing business, etc, the impact is likely to be limited.

Leslie: What sort of impact does high oil prices have on the earnings of Singapore companies? Who are the winners and losers if oil prices stay at current levels or trend even higher?

Han Chong: The Singapore economy is highly dependant on external demand, thus the concern over higher oil prices is very much related to its impact not only on growth globally, but on the region's economic growth as well.

Asean economies are important markets for many of its service exports. Any slowdown in the growth of Singapore's major export markets could potentially lead to weaker demand for its exports and lower real GDP growth. To date, though, that has not been the case as oil prices have been rising steadily, yet GDP growth for this region held steady. For the same period, Singapore's economy averaged 6 per cent growth.

Winners of high oil prices are oil and gas exploration and production companies while the transportation sector, ranging from land to sea and air companies, would be most negatively impacted.

Peter: High oil prices would have more impact on sectors that have higher energy consumption, such as those in transportation and airlines. The secondary impact would be on overall economic growth and consumer spending.

The biggest losers are the transport and airline stocks. The winners would be companies in the offshore marine sector which will benefit from more investment in oil exploration. A refiner like Singapore Petroleum will be among the winners.

Yoke Meng: In a persistently high oil price environment, the profitability of transportation, manufacturing and other companies that have oil as a large component of their cost structure would be adversely affected. This is especially true if consumption demand slows down substantially at the same time. The winners of high oil prices include stocks in the offshore marine and engineering sector due to a potentially higher demand for rig orders amid a longer new build cycle.


Leslie: What is your take on the economic picture in the US? In the event of the US economy slowing significantly, what would the impact be on Singapore companies?

Yoke Meng: We are expecting the US economy to start showing signs of slowdown from the above-trend 5.6 per cent quarter-on-quarter growth in the first quarter of 2006. In the last few years, the US economy has benefited from tax cuts, low interest rates, consumers' wealth effect from high house prices and mortgage refinancing, and the reconstruction effect due to last year's hurricanes.

Moving forward, these factors will no longer be present to spur growth. The Federal Reserve has hiked rates 17 times to 5.25 per cent and the higher interest rates will impact economic activity with some time lag. The leading indicators that we track are pointing to a soft landing, but not a recession in the US. The outlook for other economies like Japan, Europe and China is still positive and that should underpin global growth this year.

A sharp slowdown in the US is not our base case. However, if that should happen, the impact on Singapore companies would be negative to a varying extent across the different sectors. Companies exposed to the domestic construction cycle (eg, integrated resorts and tourism infrastructure), offshore marine and telecom sectors could see relatively more resilient earnings than cyclical businesses like transportation, technology and export-oriented companies, which could see the biggest earnings downgrades. Economic proxies like banks and media companies are also likely to face downward earnings pressure in a slower growth environment.


Han Chong: The US is expected to slow down in terms of growth. The situation facing policy makers is the challenge of balancing between this slowing growth and the potential risk of rising inflation. Slowing growth is not necessarily bad, so long as the US can maintain a reasonable growth rate that does not add to inflationary pressures. This would also be good for global investing.

However, this balance is delicate and can tilt, leading to recession or stagflation. Of late, this uncertainty has been bothering investors, though it has yet to be seen how it pans out. Volatility is expected for the rest of the year. The global outlook, though not as positive as before, does not appear to be all gloom. In this regard, Singapore would probably still be moderately positive.

Leslie: How much of a threat do rising interest rates pose to Singapore equities and why?

Peter: On balance we think the interest rate threat is contained. Our base case is for US rates to peak in the second half, due to the general economic slowdown.

Yoke Meng: Tightening monetary policy and consequent hikes in interest rates would generally be negative for the equity market. Consumer sentiment could weaken and a cutback in spending would result in slower property sales (especially the mid- to low-end housing), loans growth and a languishing service sector. However, if the job market remains robust, we would be less concerned with rising rates. As many Singapore companies are now less leveraged than in the past, a moderate rise in interest rates should not materially impact corporate earnings. We do not see significant upside in domestic interest rates.

Leslie: Currently, should investors be putting more money into Singapore equities and if so, why? If not, should investors be shifting funds into other markets or asset classes and what would these be?

Han Chong: This is truly a specific to investor question. From a risk premium perspective, one should ask if taking more risks elsewhere would likely reap higher returns, or for the same returns whether one can expect to have lower risks. Generally, I do not advocate being too concentrated in any one country. Singapore, being our home country, is likely to attract a disproportionately large share of investments already. I would be looking at how to diversify between styles, geographies, large/small cap equities, more than whether it should be more or less in Singapore.

Peter: We are positive on Singapore equities on its own and in the context of the region. The macro factors like growth and profitability are positive. Stock valuations are reasonable. The Straits Times Index's price-earnings ratio of 13 times is attractive compared with its historic range of 10 to 25 times. The market's dividend yield of 3.6 per cent is also attractive.

The current correction presents a good time for investors to build positions in quality blue chips. Additionally, the Singapore equity market's defensive qualities could translate to a shift of fund flows in the region into Singapore whenever there is a flight to safety or quality.

However, given the small size of the domestic market, Singapore is vulnerable to a global hard landing, especially in the US. This is likely to be offset by the recovery in the other major economic blocs like Europe and Japan.

For other asset classes, bonds will be priced attractively in the second half when interest rates peak and the rate cycle turns in response to the slowdown. We have lifted our rating for bonds.


Yoke Meng: In our view, the Singapore equity market offers a favourable risk-reward proposition. Encouraged by a stronger currency, higher tourist arrivals, a growing service sector and other business activities generated by the implementation of integrated resorts, we believe the economy will remain healthy over the next one to two years.

Over the longer term, the economic restructuring efforts by the government could start to bear fruit and the multiplier effect of the integrated resorts is likely to add value to the economy over time. While we expect the current volatility to continue for the next few months, we will look for opportunities to accumulate stocks that offer good value.

We prefer companies with reasonable valuations, strong balance sheets and high earnings visibility supported by an above-market dividend yield. We also like companies that offer structural and sustainable growth trends that could benefit from a more vibrant service economy going forward.

Leslie: For someone who wants to look for safe havens, are there areas outside of fixed deposits that should be seriously considered? What would these be and why?

Peter: High-yielding quality blue chips would be an alternative to consider. For the investor looking at a longer investment horizon, the current correction should be viewed as an opportunity. The local listed Reits also merit consideration. In the near term, bonds are also attractive as interest rates fall.

Han Chong: I personally think that dividend or income paying securities have a naturally risk dampening effect over the longer term. But without generalising, I would put some money in short term bonds (especially when the yield curve is still very flat), while exposing myself to industries such as properties/Reits, utilities, banks, etc. Dividends also provide some immediate returns to investing and gratification. They can also be a source of additional income for further deployment to the market.

Leslie: Have you turned more defensive on the Singapore equity market now compared with at the start of the year? And what are some of the key things you would be looking out for over the remainder of the year?

Han Chong: The environment is certainly not as rosy today as it was at the start of 2006. After glorious sunshine, we experienced a short burst of tropical rain which has subsided somewhat. The weather is expected to be cloudy with occasional showers. Let's hope there'll be no thunderstorms. So the answer is yes, it is more defensive. But also note that this comes after a time when most investors were weighted heavily towards aggressive exposure at the start of year. This is a good period to reflect and review your portfolio to understand the risks (more importantly than returns), and manage the portfolio with an eye on risk diversification and managing a core exposure that is well diversified.

Yoke Meng: While we continue to have a positive view of the Singapore market, we turned slightly more cautious in the second quarter and trimmed stocks that have outperformed the market and their peers in the respective sectors after a strong first quarter. Our portfolio consists of a balance of stocks with defensive earnings and medium term growth prospects.

In the near term, the Singapore market is expected to trade sideways and take direction from US economic indicators. The strengthening office cycle bodes well for rental reversion over the medium term. We are also positive on the healthcare sector which we believe is poised to benefit from medical tourism and the structural growth trend driven by an ageing population. We will continue to find opportunities in companies that could potentially better manage their surplus capital to raise returns and pay out more dividends to shareholders.

From a bottom-up perspective, it is important to track corporate earnings revision trends over the next few quarters in order to ascertain any possible downside risks to the Singapore market.

The key risks for Singapore are signs of sharp deceleration in US growth, higher than expected inflation, and intensifying geopolitical tensions.

Peter: We think the recent sell-off has presented us with buying opportunities, especially in quality blue chips. These will be corrected to levels that are attractive especially when market volatility stabilises.

Leslie: In terms of portfolio allocation, what should investors look at increasing and reducing in terms of their holdings? What are your views on alternative investments such as commodities, hedge funds and real estate?

Han Chong: I reviewed my own portfolio earlier this year and incidentally increased my holding of hedge funds and property/Reits. I was reviewing the portfolio to take some profit in areas that have done well, while deploying those funds into areas that I can gain some risk diversification. I liken these alternative asset classes to an exercise regime, while the core portfolios are like a well-balanced diet. Both are needed to keep us alive and healthy.


Peter: It depends on the risk profile of the investor and his time horizon. For investors looking only at a time horizon of three years or less, expectations of a slowdown will present good entry opportunities into higher allocations in fixed income investments and bonds. But for those looking at a longer time horizon of more than five years and with a higher appetite for risk, this is also an opportune time to increase equity holdings in regional markets.

Commodities have done extremely well over the last few years, and they have corrected very sharply in the recent sell-off. The main driver has been the strong demand from emerging economies like China and India. Estimates of demand, however, have become quite aggressive, and this could turn against commodities. Hedge funds have a place in a global portfolio for more savvy investors.

We are positive on the local real estate sector. The outlook for the residential sector is underpinned by strong demand especially from overseas for higher-end properties. The office sector is also attractive because of its positive demand and supply dynamics.

Yoke Meng: Alternative investments like commodities, hedge funds and real estate have a low correlation with traditional asset classes such as equities and bonds. Hence, they can act as portfolio risk diversifiers and investors can consider such alternative investments in their portfolio.


KEY POINTS

- Geopolitical tensions have limited impact on Singapore equities for now but such events should be closely monitored.

- The US economy is headed for a soft landing.

- The Singapore equity market is supported by reasonable valuations and its defensive qualities.
- Present equity market weakness does present buying opportunities.

- High yielding blue chip stocks and real estate investment trusts (Reits) are worth considering.

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