SINGAPORE (Jan 10): Most people usher in the new year with fireworks or by partying with family and friends. For US president Donald Trump, his way of marking the new decade was to assassinate a top Iranian general with drone-fired missiles, thereby raising tensions in the Middle East considerably. Global stock markets, which crossed from 2019 to 2020 in a bullish mood, were spooked right away.
“Trump welcomed the new year with a bang,” says Suan Teck Kin, United Overseas Bank’s group head of global economics. He was speaking at sister company UOB Kay Hian’s half-yearly Analyst Day on Jan 4.
Even without this latest salvo, trade tension persists. US-China might have reached a so-called Phase One deal. It remains to be seen if this is sufficient to eventually end the trade war.
‘Slaves to the market’
Trump’s actions have caused plenty of volatility for the market. Yet, according to Paul de Vierno, strategist in UOB Kay Hian’s private wealth management team, Trump’s re-election bid will not be a big factor moving markets. The US Federal Reserve will be wary of making changes to the rates this year as it would be perceived as interfering in the politics. Instead, the US Fed’s decisions will rely more on markets than economics.
As recent as December 2018, the US Fed was adamant that it is ending the decade-long binge of ultra-low rates, which was meant to support the economic recovery but proved more effective in boosting the stock markets instead. When certain US economic indicators such as employment reached levels deemed sufficiently healthy, the US Fed started tightening.
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Yet, less than half a year later, after the markets hit a patch of correction in June, the US Fed reversed course and has flagged that the reduced rates will be held steady this coming year, sending the markets to new record highs.
Vierno notes that the US Fed hires many top doctorate-level economists, from top universities, who spend their time poring over data to build models and recommend courses of action. “These guys are just slaves to the market. That’s bad,” he laments.
In the meantime, US markets continue to trade at ever higher levels. There are some who are bracing for the markets to turn the other way, with recession risks often cited as a key reason. Yet, a basket of big-name US technology stocks are still pleasantly surprising investors on the upside. To put things into perspective, the so-called FANGMAN group of stocks (Facebook, Amazon, Netflix, Alphabet’s Google, Microsoft, Apple, and Nvidia) have a combined market value of some US$5.2 trillion ($7.02 trillion). That is bigger than the combined GDP of France and the UK.
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While earnings growth plays a part, some of these companies, such as Apple, have helped lifted their own share price via share buybacks as their EPS improves amid a smaller share base. Vierno reminds investors to keep close tabs on the markets, and not become too overly conservative. “Last year, a client thought the whole world will end,” he says.
Even with the US indices currently at record highs, valuations are far from historical levels. Back in 2000, at the height of the technology bubble, the S&P 500 hit around 40 times earnings. By contrast, it is now around 20 times. Furthermore, there is a relatively big proportion of technology stocks—some 30%—within the basket of stocks that makes up the index, and they traditionally command higher valuations, says Vierno.
Flat rates
Now, the world economy is not able to enjoy the same support as the US stock markets. China’s economy, which was able to consistently hit double digits just some years back, is set to drop below 6% growth this year, although the slowdown has been going on for some time already.
Singapore’s open economy, where the value of trade is more than three times its GDP, naturally, is suffering. Last year’s 0.1% growth in GDP was the slowest in a decade. Regional economies are not doing much better. There is a synchronised slowing down in Asia and Asean. “World trade volume is declining, and a lower trade volume will have a direct impact on Singapore. We should take proper precautions,” says Suan.
He expects Singapore’s key interest rates to be held steady throughout this year, in line with the US Fed’s. UOB’s forecast for the benchmark 3-month SOR (Swap Offer Rate) is 1.45% and the 3-month Sibor to be at 1.55%.
Dividend plays
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With rates recently cut and likely to hold steady this year, UOB Kay Hian’s banking analyst Jonathan Koh expects net interest margin to stabilise in the second half of this year. For the full year 2020, net interest income should remain flat, but will resume the “usual expansion” the following year. Besides a steady net interest margin (versus a compressed one), factors supporting a 2021 earnings recovery for banks include stronger loan growth and continued growth in fee income.
Koh expects the banks to see largely unchanged earnings this year but for 2021, he estimates DBS Group Holdings to improve its earnings by 7.3% over 2020 and Oversea-Chinese Banking Corp to enjoy a 6.6% growth in the same period. He has an overweight rating on the sector, and his price targets for DBS and OCBC are $30 and $14.45 respectively (UOB Kay Hian traditionally has no formal rating on UOB — both entities are controlled by the Wee family).
Due to their strong capital reserves, Singapore banks have the potential to pay more dividends, on top of what is an already relatively attractive yield of around 4.6% in the case of DBS and OCBC, says Koh. Using a 55% payout ratio as a gauge, he believes DBS has the potential to pay a dividend of $1.32 per share for 2020—up from the most recent dividend of $1.20, which was a 55.9% payout ratio.
OCBC last paid 50 cents and might maintain at this level. Now, given its very conservative tier-one capital adequacy ratio (CAR) of 14.5%, Koh estimates that OCBC can potentially pay a special dividend of another 49 cents, which would then bring down the CAR to a more efficient 13.5%. However, OCBC differs from the other two banks by not committing to a fixed payout ratio range, preferring instead to maintain more flexibility. UOB last gave $1.20 per share in dividends and Koh estimates it can possibly pay $1.28. This number is derived from UOB’s consensus estimate EPS of $2.55 for 2020.
Given that banks already form the core of most investors’ portfolio, the useful advice Koh has is the price level at which investors should add more banking stocks. He sees an attractive entry point at the level where the yield generated reaches around 5.5%. This means investors can start accumulating DBS at $21.80 to $24; OCBC at $9.10; and UOB at $21.80 to $23.30.
In the event where the market takes a severe beating, causing the yield to climb up to 6%, that is when the banks are “strong buys” for Koh. In absolute terms, that means DBS at $20 to $22; OCBC at $8.30 and UOB at $20 to $21.30.
HK spillover
From a regional perspective, the prolonged protests in Hong Kong have caused more investors to shift their assets to Singapore. Multinational corporations are inclined to consider Singapore over Hong Kong when deciding where their regional headquarters should be. Singapore’s total assets under management (AUM) have been growing steadily, hitting 12.3% compounded annual growth rate in the decade to $3.44 trillion in 2018, notes Koh.
The increase in AUM is happening in tandem with growth in new sub-sectors of the financial services industry. For example, the number of family offices in Singapore quadrupled between 2016 and 2018, according to the Monetary Authority of Singapore (MAS).
For the banking industry here, there will be plenty of headlines on the new digital banks, which have drawn confirmed bids from parties ranging from Grab to Singapore Telecommunications to Far East Organization to iFast Corp. Koh believes the three local banks are capable of managing the impact of new competition from the slew of new digital banks. “The incumbents are quite ready [to defend themselves against the new digital entrants],” says Koh.
