|Table 1: Market Performance (as of end June 2012)
|MSCI Asia ex Jap
||MSCI AC Asia ex-Japan
||MSCI AC World
|MSCI Emerging Markets
||MSCI Emerging Markets
|Europe (Stoxx 600)
Source: iFAST compilations; data as of end-June 2012; returns in SGD terms
A Reversal of 1Q 12’s Optimism
2Q 12 brought out the bears to the fore, as investors fretted over the fragile situation in the Eurozone. Investors also worried about slowing global growth, as some of the faster-growth emerging markets posted mixed economic data, suggesting that the Eurozone slowdown has had some spillover impact. Following a strong performance for equity markets in 1Q 12, markets under our coverage posted hefty declines in 2Q 12, dragging year-to-date returns for several markets into negative territory.
On a quarter-to-date basis, global equities, represented by the MSCI AC World, posted a -5.5% decline, while Asian and emerging market equities posted declines of -7.1% and -9.2% respectively. Some of the worst-performing markets were the Brazilian and Russian equity markets which lost -22.9% and -16.8% respectively (losses were compounded by currency weakness) for the quarter, while the equity markets of Malaysia, US and Thailand fared better with milder losses of -2%, -2.4% and -3.6% respectively. Following the latest quarter of weakness, markets like Brazil and Russia (which were two of the best-performing markets in 1Q 12) slipped into negative territory for the first half of the year.
In this end-of-quarter update, we look at some of the best-performing equity markets (Thailand, Singapore, US) over 1H 2012, as well as some of the laggards (Brazil, Russia, Europe).
[Otherwise stated, all returns in SGD terms, as of 29 June 2012]
Thailand (11.8% year-to-date, -3.6% in 2Q 12)
The Thailand equity market, as represented by the SET index, declined -3.6% in 2Q 12. Despite negative returns in 2Q 12 that partially offset the strong 16% gain in 1Q 12, the Thailand equity market still remained the best-performing market among the equity markets under our coverage, recording an overall 11.8% gain for 1H 12 (returns in SGD terms).
Several key leading indicators such as improving consumer confidence, business sentiment, manufacturing production and capacity utilisation have suggested that the Thai economy is in the midst of a recovery from the severe floods of last year. The timely fiscal stimulus package that aims to improve the infrastructure and water management system in the country has not only restored investor confidence, but also provides direct support to economic growth under the current weak external conditions. Based on IMF forecasts, Thailand is expected to grow by 5.5% in 2012, with strong growth likely to be seen in 4Q 12 due to the low base effect.
A potential reversal of foreign fund inflows remains one of the key risks when investing in the Thai equity market. Investors need to take note that the SET index tends to move in tandem with net foreign fund inflows. Based on fund flows data, the strong rally in 1Q 12 was very much a result of net foreign fund inflows while the decline in 2Q 12 coincided with net foreign fund outflows, highlighting the significant role of foreign inventors’ interest in the Thailand equity market.
Following the strong performance of the Thailand equity market, valuations have risen. As of 29 June 2012, Thailand equity market is currently trading at estimated PE of 10.7X and 8.8X for 2013 and 2014 respectively, as compared with our fair PE estimate of 12.5X. We estimate upside potential by end-2014 to be around 45.0%, which represents decent returns for investors, and maintain a 3.0 stars “Attractive” rating on the Thailand equity market.
Singapore (+8.8% year-to-date, -4.4% in 2Q 12)
Led by strength in banking and property-related companies, the Singapore equity market has managed to emerge as one of the better-performing single-country equity markets for 1H 12. While 2011 was fraught with global supply chain disruptions (due to flooding in Thailand and an energy crisis in Japan), 2012 has seen exports pick up, particularly for the supply-chain dependent electronics sector; the electronics sector PMI remained above 50 for a fifth consecutive month in May, suggesting improved conditions in the manufacturing sector. On the services side, retail sales have shown resilient growth, possibly due to the strong visitor arrivals which have been running at a 13.2% year-on-year rate (for the January – April period). Nevertheless, exports have moderated significantly in recent months, a widespread phenomenon observed amongst Asian exporters, hinting at some potential weakness in external demand; the MTI recently left its full-year growth forecast at 1-3%, citing the risk of a worsening European debt crisis alongside a fragile global economy which could hurt Singapore’s “externally oriented industries”.
The banking sector (which makes up approximately a quarter of the index) was a significantly contributor to the market’s strong returns, with the likes of UOB and DBS rising by 22.2% and 20.4% respectively in 1H 12. Low PB ratios have characterised the sector, given that low interest rates have pressured net interest margins; latest earnings reports suggest that the banks have managed to offset margin pressures by stronger-than-expected loans growth, leading to a reversion to a higher multiple of book value for the sector. Property companies have also delivered strong year-to-date returns as domestic property prices have held up strongly even in the face of multiple “cooling measures”; City Developments, one of the more domestically-oriented property companies in the STI, posted a 26.7% year-to-date return. Of the 30 constituent STI stocks, only 7 were lower on a year-to-date basis (as of 30 June 2012), led by Wilmar and Olam on weaker-than-expected processing margins due to challenging commodity market conditions. Even after the moderate 8.8% year-to-date return, Singapore equities still trade at 10.7X estimated 2014 earnings, which suggests strong potential upside of almost 50% if the market normalises to a PE ratio of 16X. We have a 4.0 star “very attractive” rating on the Singapore equity market.
US (5.9% year-to-date, -2.4% in 2Q 12)
The US equity market has been one of the more resilient regional equity markets in recent quarters, with a -2.4% 2Q 12 return bringing the market’s year-to-date returns to 5.9%. In a growth-scarce environment, the US economy is still expected to post growth of 2.2% in 2012, even as the Eurozone is forecasted to post a -0.4% full-year contraction (based on Bloomberg consensus forecasts, as of 3 July 2012). Even while growth has been fragile, beleaguered segments of the economy like housing and employment have since rebounded (albeit modestly), lending support to the world’s largest single-country economy.
Latest data seems to suggest that financial market concerns have had some impact on the real economy; retail sales have taken a hit in recent months as consumer sentiment dipped, while the manufacturing PMI dipped below 50 for the first time since 2009 on slowing export orders and new orders, an indication of heightened corporate conservatism. While this may result in a soft patch going into 3Q 12, we expect improving consumer spending (on lowered gasoline prices) to offset some of the weakness in corporate investment, while continued accommodative monetary policy (and the potential for further easing measures) by the Federal Reserve should also provide some impetus for growth.
While US equities have delivered reasonable returns year-to-date, valuations remain attractive at 10.5X 2014 estimated earnings, a suggestion of over 42% upside to our fair value estimate of 15X earnings. The recent market weakness has provided longer-term investors with a good opportunity to seek exposure to high-quality global companies at substantial discounts to historical valuations, and we maintain a 3.5 star “attractive” rating on the US equity market.
Brazil (-13.4% year-to-date, -22.9% in 2Q 12)
Brazil ended 1H 12 as the worst performing country under our coverage, with the Bovespa index losing -4.2% in local currency terms and -13.4% in SGD terms. The country’s -22.9% performance for 2Q 12 in SGD terms saw its strong performance in 1Q 2011 erased. Brazil has long been suffering from an unrealistically strong currency for the past few years partly due to Quantitative Easing in the US, with the BRLUSD rate appreciating 63.25% until 26 July 2011, before it embarked on its current slide which saw it lose over -7.31% in 1H 12, which has exacerbated its losses in SGD terms. The BRLSGD exchange rate fell by -8.56% in 2Q 12 alone.
Brazil’s economy has suffered as industrial production and manufacturing slumped in the wake of a lack of international competitiveness due to its strong currency as well as what has been a persistently weak external global trade environment. To further compound its problems, Brazil’s largest trade partners are Europe and China, two heavy-weight regions of the world which have slowed significantly, and with 30% of all Brazilian exports historically headed to the two regions, it comes as no surprise as to why Brazil’s exporting companies have been hit. Also, with commodity prices having fallen off a cliff in 2Q 12, the materials and energy sector which comprises 42.1% of the Bovespa index has been negatively affected by slashed earnings forecasts.
The saving grace of Brazil’s economy thus far has been the consumer staples sector, which has been powered by a resilient domestic consumer. Domestic consumption in Brazil has undoubtedly been aided by a rise in real incomes, historical low unemployment rates, high loan growth as well as efforts by the Brazilian Central Bank to slash its key Selic benchmark interest rate to a historical low of 8.5% to keep companies hiring and consumers spending. Nonetheless, we note that personal default rates have been on the rise in Brazil to levels which warrant our attention, which could potentially see loan growth slow in the near future as banks tighten their credit controls, hurting consumer spending.
We continue to favour Brazil, with its strong underlying fundamentals, an economy underpinned by sustainable domestic consumption and attractive valuations as indicated by a PE of 8.3x based on 2013’s estimated earnings, representing 38% upside for investors. We maintain our 4.0 “Very Attractive” rating on Latin America’s largest economy.
Russia (-4.4% year-to-date, -16.8% in 2Q 12)
The Russian equity market, as represented by the RTSI$ index, was the second worst performing market under our coverage. As of end-June 2012, the RTSI$ index’s return was -4.4% on a year-to-date basis. The main reason for the weak performance of the Russian equity market was the drop in oil prices; in 1H 2012, West Texas Intermediate (WTI) and Brent crude oil prices dropped -17.5% and -10.6% respectively. The weak performance in oil may be attributed to a deteriorating economic outlook, especially with pronounced weakness in Europe; this has put downwards pressure on oil demand, affecting both oil prices and Russian exports. As over 50% of the RTSI$ index is made up of oil and gas companies, oil prices are an important factor in driving the benchmark index’s performance.
In addition, the uncertainties of the global economy have caused investors to adopt a “risk off” mentality. As Russia has historically been a relatively risky and high beta market, it has consequently experienced massive capital outflows. In the first four months in 2012, Russia’s Central Bank reported USD42 billion of net capital outflow. The figure over these four months represented half of the total capital outflow last year.
Despite the decline in oil prices and capital outflows, there are several factors which will benefit Russia’s economy. First, it will join the World Trade Organisation (WTO) this summer. Once it becomes a member of the WTO, the development of Russian foreign trade can be promoted, helping to attract foreign investments. Second, the establishment of an oil pipeline towards China will help Russian oil and gas companies develop rapidly on China’s insatiable demand for oil. Following the fairly solid 1Q 12 economic figures (such as GDP and PMI figures), we believe that the Russian equity markets will benefit and rebound once sentiment improves.
The estimated PEs for the RTSI$ index are 4.9X and 4.8X based on estimated FY2012 and FY2013 earnings, much lower than our 7.5X estimate of the market’s fair PE. Therefore, despite the decline in the first half of 2012, we still maintain a 4.0 stars "very attractive" rating for the Russian equity market, as valuations remain relatively cheap.
Europe (-1.9% year-to-date, -8.7% in 2Q 12)
The troubled continent ended 1H 12 as the 3rd worst performing market under our watch, posting a loss of -1.9% for 1H 2012 in SGD terms. The long-running European Sovereign Debt crisis continued to plague markets across Europe, as the Stoxx 600 index fell -8.7% in 2Q 2012, erasing the gains it chalked up in 1Q 2012.
1Q 2012 saw bond yields in the periphery fall as the European Central Bank’s second batch of Longer Term Refinancing Operations (LTRO) saw EUR 529.5 billion worth of loans swapped with the ECB, with Spanish 10 year yields falling until the beginning of March, when renewed worries over the health of the Spanish economy and fears of the tail-end risk of a Greek Exit mounted. 10 year yields in the economically more important countries of Spain and Italy proceeded to rise by 229bps and 141bps respectively before falling after the announcement of the Spanish bailout and the better than expected European Summit at the end of the quarter. Worries were highlighted by the spread between Spanish and German 10 year issues, which rose to a Euro era high of 570.67bps, signalling the market’s worries over the financial health of Spain and its ability to repay its debt as Credit Default Swaps (CDS) rose to all time highs and implied a 41% probability of default for the sovereign.
Economically, Europe’s data and leading indicators continue to display extended weakness. With Eurozone 1Q 12 GDP figures indicating the economy barely grew/contracted, the trend looks likely to have persisted during 2Q 12 as both sentiment readings as well as forward looking indicators continued to reflect cautiousness and contractions across Europe. Nonetheless, we note that the disparity in growth and economic strength has widened between the core of Europe (Germany and France) and the periphery (Portugal, Ireland, Italy, Greece and Spain), leading to a “two-speed” Europe now clearly visible to one and all.
With the above having been said, we continue to remain cautious on the continent. Despite the latest summit and its unexpected positive outcome, Europe has failed to convince the markets with conviction several times in the past, and the road to success is often one that is winding with bumps. At current valuations as of 30 June 2012, Europe currently trades at estimated PEs of 12.3X and 10.5X on 2012 and 2013 estimated earnings, reflecting over 19% of potential upside by end 2013. We maintain our 3.0 “Attractive” rating on the region.
Investing in times of market turmoil
Investors will be glad to see the back of 2Q 12, which has been characterised by periods of strong market volatility and turmoil. While such periods are certainly stomach-wrenching for investors, they usually also offer some of the best opportunities for investment, given that price-value disparities tend to widen under such circumstances. With continued uncertainty over the Eurozone’s future likely to contribute to more market volatility on the horizon, we find it apt to reiterate 3 tips for investing in volatile markets:
- 1. Investing via a Systematic Investment Plan (SIP)
- This dollar-cost-averaging approach will help to smooth out the cost of the investment
- 2. Utilising fixed income funds to buffer downside volatility
- Allocating part of a portfolio to lower-risk fixed income funds may help preserve capital, and also allow for opportunistic investments via tactical rebalancing should equity markets plunge
- 3. Reviewing one’s portfolio
- Under tumultuous market conditions, investments tend to fall in tandem, usually without consideration of the merits of each investment; as such, volatile periods may offer good opportunities for investors to reposition their portfolios to better capture the investment upside when markets eventually recover