|Market||Index||1Q 16 Returns|
|Emerging Markets||MXEF Index||-1.7%|
|Asia ex-Japan||MXASJ Index||-4.9%|
|Hong Kong||HSI Index||-11.0%|
|Shanghai A||SSE50 Index||-16.8%|
|China A||SHSZ300 Index||-19.7%|
|Source: Bloomberg, iFAST Compilations
Returns in SGD terms excluding dividends, as of 29 March 2016
1Q 16 started the new year off on the wrong foot, with financial markets around the world posting hefty declines that saw many indices entering 'correction' and 'bear market' territory as the sell-down ensured 2016 was the worst start to a year seen in just 10 trading days. Subsequent to the initial wave of selling seen in January and the first half of February, financial markets managed to find their footing and stabilised from the second half of February to end the quarter with significantly reduced losses. The MSCI AC World index capped the quarter with a loss of -1.2% after recovering from an initial drawdown of -11.5% while the JPMorgan Global Aggregate Bond Index delivered returns of 4.9% for the quarter (returns in local currency terms as of 29 March 2016).
The dominant theme in 1Q 16 centred on fears of a global slowdown, the efficacy of monetary policy and potential negative effects of negative interest rates (triggered by the Bank of Japan's foray into negative rates), concerns over European banks and the low commodity prices/threat of deflation, as well as issues from China. While negativity permeated the financial markets in the opening few weeks, central bank policy changes together with relatively positive economic data saw some of the fears abate and markets rebounded sharply.
Central bank policy changes saw the European Central Bank (ECB) announced yet another slew of easing measures in 1Q 16, with March's policy meeting witnessing ECB President Mario Draghi firing his bazooka. Apart from yet again sending the deposit facility rate further into negative territory, the ECB also reduced the main refinancing operations rate to 0.00%. As for its unconventional monetary policy actions, the ECB has increased the amount of its asset purchase programme (APP) by EUR 20 billion to EUR 80 billion per month and expanded the range of instruments to include investment grade non-financial corporate bonds. Not content with rate cuts and enhancements to its APP, the ECB launched a new series of Targeted Longer-term Refinancing Operations (LTRO II) as it seeks to reinforce its accommodative policy stance and to strengthen the transmission of monetary policy by further incentivising bank lending to the real economy. The combination of the rate cuts and the LTRO II has far reaching effects for banks who lend to the real economy as banks will be able to borrow up to 30% of the amount of loans made to Eurozone non-financial corporates and households (excluding mortgages) as of 31 January 2016 from the ECB at the prevailing main refinancing operations rate for 4 years, which currently stands at 0%. Should banks whose net lending increases by 2.5% by January 2018, they will receive the difference between the main refinancing rate and the deposit facility rate which translates into banks being paid a maximum of 0.40% by the ECB to lend!
Meanwhile in the US, the Federal Reserve kept interest rates unchanged but cited that "global economic and financial developments continue to pose risks" to the US economy while lowering its projections for the Federal Funds rate from a prior 1.375% in December 2015 to 0.875%, in effect communicating that it expects to hike the benchmark rate by 2 times instead of 4 times (assuming a 25 bps hike in each meeting where a hike would be announced). Markets cheered the latest FOMC announcement, interpreting the news rather dovishly, with equity markets rallying and the USD weakening against many currencies despite its growth forecast likewise being cut.
As we head into the second quarter, we take a closer look at some of the top-performing markets for the first quarter of this year (Brazil, Russia and Thailand) as well as those on the bottom of the performance table (India, Hong Kong and China), identifying some of the key reasons for their performances and providing our outlook for each market.
[All returns in SGD terms unless otherwise stated as of 29 March 2016]
Top Performing Markets
Brazil (+22.4% in 1Q 16 in SGD Terms)
The Brazilian equity market was sent into a frenzied rally, with the benchmark Bovespa Index surging 22.4% in SGD terms over 1Q 16 to top the list of equity markets under our coverage as speculation over President Dilma Rousseff's ouster gained momentum. Given their heavy weightage in the Bovespa Index, local banks Banco Bradesco SA and Itau Unibanco Holding SA delivered the largest contribution to the index's stellar performance, with their preference share prices staging a spectacular rally by 42.3% and 20.9% respectively in 1Q 16. The beleaguered Petrobras, which was at the centre of a sprawling corruption scandal in 2014 that sent shockwaves through the Brazilian economy, also attracted substantial investor interest over the course of the quarter, with its preference and ordinary share values rising 26.9% and 24.0% respectively. After falling to its lowest level in two decades last year, the Brazilian real (BRL) has rebounded, with its 3.9% appreciation against the Singapore dollar (SGD) contributing to overall gains in 1Q 16.
Political developments dominated the headlines in Brazil over the past quarter, with more than a million Brazilians taking to the streets to protest against Rousseff, the detention of former President Lula for questioning over his suspected involvement in the corruption scandal, and Brazil's largest party announcing that it was abandoning the ruling coalition, all of which have sharply raised the odds of Rousseff's impeachment. In other news, Moody's became the third major ratings agency to strip Brazil of its prized investment grade rating. While a negative development, the downgrade came as no surprise and has been largely priced into markets. The earnings outlook of the Bovespa Index remained subdued over 1Q 16, as estimated earnings for 2016 were slashed by -15.0%, while earnings for 2017 and 2018 were also revised downward by -8.2% and -1.6% respectively, with notable revisions seen in commodity-related sectors. Mining giant, Vale SA, saw its estimated earnings downgraded into negative territory following a Brazilian court's decision earlier this quarter to temporarily suspend trading activity at its main Tubarão port, which moves about 35% of Vale's iron ore and is one of the world's largest iron ore terminals, due to alleged environmental breaches.
While the Bovespa Index turned in a spectacular performance in 1Q 16, the economic data rolling out of Brazil has not been encouraging. Brazil saw its economy sink deeper into recession in 4Q 15, with GDP declining -5.9% year-on-year after a downward-revised -4.5% year-on-year fall in the previous quarter, the largest contraction since 1996 when Brazil started measuring GDP by the current system. For the full year, Brazil's economy shrank by -3.8% in 2015. Retail sales in Brazil saw a broad-based decline for the tenth consecutive month by -10.3% year-on-year, while industrial production also extended its decline by -13.8% year-on-year in January 2016. Meanwhile, inflationary pressures remain elevated, with the benchmark IPCA consumer price inflation index above the government's official target range of 2.5 – 6.5% at 10.36% year-on-year in February 2016. The Copom maintained the Selic rate at 14.25%, citing inflation prospects, economic concerns abroad and at home as arguments behind its decision. The Copom's dovish stance is likely to continue, given the greater focus policymakers have placed on the risks to Brazil's economic growth. Economists have forecasted Brazil's GDP growth for 2016 and 2017 to come in at -3.7% and 0.4% respectively, as the country's economy struggles to regain traction amid poor consumer and business confidence.
With Brazil's economy undergoing a relatively tough shape, the road ahead is certainly not easy for the nation, given that growth drivers have weakened significantly and the economy is only expected to rebound in 2017. Despite Brazil's economic woes, the Bovespa Index trades at forward PE ratios of 14.2X, 10.3X and 8.3X projected earnings for 2016, 2017 and 2018 respectively (as of 28 March 2016), offering investors a total potential annualised return of 16.2% by end-2018, with dividends reinvested. A star rating of 4.0 Stars "Very Attractive" for Brazilian equities continues to be warranted at this juncture.
Russia (+6.9% in 1Q 16 in SGD Terms)
Russian equities, represented by the RTSI$ index, posted a 6.9% gain in SGD terms over the first quarter of 2016, landing near the top of the performance ladder this time round. In local currency terms, the index posted an 11.4% gain over the quarter, as the RUB rebounded and strengthened against many currencies from its lows seen in early-January (the RUB has strengthened 2.3% against the SGD in 1Q 16). This rebound in performance has come on the back of a return of risk-appetite in equity markets worldwide, as well as a rebound in crude oil prices from mid-January that saw Brent crude price rise from USD 27.8 per barrel to USD 39.0 per barrel (a 40% increase in USD terms). In 1Q 16, energy companies like Rosneft, Bashneft, Surgutneftegas, Lukoil and Gazprom saw gains in their share prices, while companies like Russian airliner Aeroflot, as well as Novolipetsk Steel and Severstal were the top performing stocks over the quarter. Yandex, VTB Bank and hypermarket chain Lenta were some of the underperformers this time round.
Earnings estimates of Russian companies on aggregate for 2016 were revised -5.4% south over the quarter, while 2017's estimated earnings were revised 4.4% higher (as of 30 March 2016). As a whole, earnings are expected to grow by 1.4% this year, before growing by 28.5% in 2017 and 1.8% in 2018 (in RUB terms as of 30 March 2016). Among some of the notable revisions over the quarter, securities trading operator Moscow Exchange saw its EPS gradually revised higher by 6.9%, while Sberbank saw recent EPS upgrades in late February and March, as sell-side analysts continue to turn favourable on the Russian bank on expectations of a peak in NPL formation and improving asset quality. On the other hand, natural gas producer Novatek continued to see EPS downgrades (-4.1% over 1Q 16).
Various data points continue to suggest sluggish economic conditions in Russia. Industrial production and exports growth remained weak over the quarter, while recent retail sales data suggested that domestic consumption still remains weak in the country. The real disposable income of consumers continued to trend downwards, falling -6.9% year-on-year in March from a prior -6.3% year-on-year decline. The Markit Manufacturing PMI readings continued to stay in contractionary territory over 1Q 16, while services rebounded into expansionary territory in February. On the other hand, inflation data have been on a downtrend over 1Q 16, but it is primarily due to a high base effect. Russia's central bank has held rates at 11.0%, stating that its "moderately tight" policy may last longer than previously expected, and is reluctant to shift to a more dovish stance on the prospect of inflation risks intensifying. Going forward, policymakers are expected to ease monetary policy once they are confident on the trend of disinflationary pressures – time would be needed before economic conditions in the country start to turn around.
As of 30 March 2016, the RTSI$ index trades at estimated PE ratios of 6.5X and 5.0X for 2016 and 2017 respectively as compared to its fair PE ratio of 7.0X. On a price-to-book basis, Russian equities are trading at 0.7X book value, reflecting it's relatively beaten down valuations. Sentiment still remains poor as markets remain concerned on the overall direction of crude oil prices, as well as political tensions between Russia and the West. We maintain a 4.5 stars "Very Attractive" rating for the Russian equity market.
Thailand (+5.8% in 1Q 16 in SGD Terms)
Thailand's equity market saw a turnover in 1Q 16, delivering a decent return of 8.1% in local currency terms (5.8% in SGD terms) as compared to previous quarter's -4.3% loss. Part of the reason for the surge can be attributable to foreign capital flowing back into Thailand's equity market amid market expectations of a relatively gradual monetary tightening exercise by the US Fed going forward.
On the economic front, the Thai economy has grew resiliently in 4Q 15, posting a 2.8% year-on-year growth that is slightly lower than 2.9% expansion registered in previous quarter. While external trade continued to be sluggish (exports and imports registering year-on-year contractions of -3.5% and -1.3% respectively), the quarterly GDP number is supported by commendable growths in segments such as investments (9.4%) and consumption (2.5%). The kingdom summed up 2015 with an annual growth of 2.8% year-on-year, significantly better than the upward revised 0.8% expansion in 2014. Another major driver for the kingdom's economy is the thriving tourism sector, which make up approximately 10% of the nation's economic growth. Despite minor disruptions in 3Q 15 due to a booming incident, the tourism sector saw significant growth in terms of its tourist arrivals (20.4% year-on-year growth) in 2015 largely because of the weakening THB. Going forward, increased public spending, accommodative monetary policy and the booming tourism industry should continue to support the kingdom's economic growth. Nonetheless we remain cautious, keeping in mind the weak exports segment of the kingdom, noting that continued weakness in this segment might weigh on the nation's GDP growth.
Earnings downgrades continued to prevail in 1Q 16. Over the quarter, Thai corporate earnings were heftily revised downwards, with 2016's and 2017's earnings being slashed by -4.8% and -5.2% respectively. This is largely due to earnings downgrades in sectors such as Telecommunications (-20.8%), Energy (-14.4%) and Consumer Discretionary (-4.9%) respectively. Given the challenging external environment and the nation's bleak economic outlook, corporate earnings in Thailand are expected to continue its downtrend going forward, which implies that there is a possibility for the market's expensive valuation metric to trend even higher.
Looking at the valuation metric, the Thai equity market is by no means attractive. As of 30 March 2016, the SET Index is trading at a PE ratio of 15.0X, well above our fair PE estimate of 12.5X. For Thai equities, its upside potential is estimated to be one of the lowest among the markets under our coverage, standing at 5.0% (as of 30 March 2016) expected annualised returns for the following 3 years, mainly attributed to the expected annualised contraction in valuation multiples (-6.6%). As such, we retain the star rating for this Asian kingdom at 2.5 Stars "Neutral".
Bottom Performing Markets
India (-8.8% in 1Q 16 in SGD Terms)
One of the worst performing markets – India, had a bad quarter on uncertainties on both the domestic and global fronts. The concerns over a slowdown in global growth and the consequent sell-off by foreign institutional investors had an adverse impact on the markets. The uncertainties regarding the Reserve Bank of India's (RBI) policy meet that was to be held in February; the Union Budget and uncertainties over the US Federal Reserve's guidance had been weighing on investment sentiment over the quarter.
In the Sixth Bi-Monthly policy review 2015-16 held on 2 February 2016, the RBI had maintained a status quo on policy rates. Dr. Rajan seemed to be in a wait and watch mode as he wanted to see how inflation data would pan out. He was also keeping an eye on the structural reforms that were to be introduced in the Union Budget along with the fiscal prudence that would be followed by the government. However, the government did not disappoint the central bank as it not only promised to maintain fiscal discipline despite the increase in the plan expenditure, but also made provisions made for the Seventh Pay Commission. The Budget was pro-agriculture with due emphasis to some of the other sectors of the economy such as infrastructure, banks, the social sector and education. There were no big bang reforms and the Finance Ministry made it very clear that the measures laid down in the Budget would supplement the on-going reform agenda of the government.
As far as macro-economic indicators were concerned, the numbers released during the quarter were mixed. The Consumer Price Index (CPI), which is closely tracked by the central bank, increased by 5.69% year-on-year in January which was the highest year on year growth recorded since August 2014. This was on account of the rise in food prices, and here the main contributor was pulses which increased by a whopping 43.32%. However, this indicator has cooled to a 5.18% gain during the month of February 2016. On the other hand, the Index of Industrial Production (IIP) contracted by -3.4% year-on-year in November 2015 and the last time this indicator was negative was in October 2014. The IIP for the months of December 2015 and January 2016 were to the tune of -1.2% and -1.5%. The GDP for 4Q 15 showed that India grew at 7.3% year-on-year as compared to 3Q 15's 7.7% rate. The manufacturing sector posted a robust growth of 12.6% during the quarter. As per the advance estimates, India's GDP for the financial year 2015-16 was expected to grow by 7.6%.
However, the quarter did see some positive events as well which included the passage of a few crucial bills like the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Bill and the Real Estate (Regulation and Development) Bill, 2016. The Government also decided to reduce the interest rate on small savings schemes. This measure has increased the hope of a rate cut in the first Bi-Monthly Monetary Policy review to be held on 5 April 2016.
According to consensus estimates, as of 30 March 2016, the estimated PE ratios for India's stock market, represented by the SENSEX Index, are 18.57X, 15.73X and 13.61X for FY 2015-16, 2016-17 and 2017-18 respectively. Estimated earnings growth is 6.62%, 18.02% and 15.59% for F2015-16, 2016-17 and 2017-18 respectively. We maintain a 3.5 Stars "Attractive" rating for the Indian market.
Hong Kong (-11.0% in 1Q 16 in SGD Terms)
As the Chinese H-share market was one of the worst performers amongst markets under our coverage in 1Q 16, it is not surprising that the Hong Kong equity market, represented by the benchmark Hang Seng Index, was also amongst the worst performing markets as well. The market slumped in January over fears of a Chinese 'hard-landing', as well as a de-pegging of the HKD to the USD. However, market participants adjusted their expectations shortly after, with the index rebounding as the March earnings season approached.
Amongst the fifty constituents in the Hang Seng Index, only twenty were able to turn in earnings results that beat market consensus. Surprisingly, the industrials sector beat market consensus by the most, with the earnings of MTR Corp Limited, Cathay Pacific Airways Limited and CK Hutchison Holdings Limited all above consensus estimates. Internet giant, Tencent Holdings Limited, also exceeded market expectations with a strong growth in its mobile gaming segment. However, affected by the increase in provisions for non-performing loans (NPLs) in most of the banks, many of the companies in the financial sector had earnings results that did not meet market expectations. Only 7 out of 23 financial companies, most of them are real estate management companies, were able to beat consensus forecasts.
Looking forward, we expect Hong Kong companies to continue grappling with headwinds stemming from the global economic uncertainty, especially the trading and logistics services industry, which contributes the most to both GDP and employment in Hong Kong. As major economies around the globe suffer from a slowdown, Hong Kong's trade-reliant economy may also be subjected to negative influences from its external environment. At a time when Chinese industrial companies are undergoing structural reforms, companies with substantial trade links to China are also expected to remain mute. Furthermore, property prices in Hong Kong saw some adjustments, with the Centa-City Leading Index falling approximately -8.3% year-on-year, and that may lead to a higher level of provisions for NPLs for the local banks. However, at this current juncture, we do not foresee a property-related crisis unfolding in the banking sector.
Despite a gloomy economic outlook for the year of 2016, the Hong Kong equity market is currently trading at cheap valuations, due to a downgrade in earnings and the headwinds faced by the local economy. Consensus estimates of earnings growth for the Hang Seng Index is now at a conservative -5.0% and 10.9% for 2016 and 2017 respectively as of 30 March 2016. In terms of valuations, the estimated PE ratio of the Hang Seng Index is at 11.1X and 10.0X for 2016 and 2017 respectively, and are well below our fair PE estimate of 14.5X. We maintain our 5.0 Stars "Very Attractive" rating for the Hong Kong equity market.
China (-11.6% in 1Q 16 in SGD Terms)
Dragged down by the -19.7% sell-off in domestic A-share equities in the first quarter of 2016, the offshore Chinese equity market came in as the worst performer amongst markets under our coverage, with the benchmark HSML 100 Index plunging -11.6% in 1Q 16.
Not only did investors express their concerns over the nation's economic outlook, their confidence in the equity market also took a hit following the introduction of the "circuit breaker" mechanism at the start of the year. The proposed mechanism, which is tied to the CSI 300 Index, will trigger a trade halt for 15 minutes if the index moves 5% in either direction from its previous close, while a 7% movement in either direction will halt trading for the rest of day. Instead of stabilising the market, the mechanism prompted a selling stampede as investors rushed to offload their holdings in anticipation of further declines, before the 7% threshold was reached. While the mechanism was soon scrapped by regulators, the Chinese A-share market remains a market characterised by heavy government intervention. Confidence in the equity market will take time to recover.
After a disappointing first two months for Chinese investors, the market has started to stabilise. Investors focused on arguably one of the most important events of the year, the Chinese 12th Annual National People's Congress (NPC) meeting, held from 5 March 2016 to 14 March 2016. The meeting was particularly important for Chinese investors to get a glimpse of the future direction of Chinese government policies. Not only did the government deliver its annual work report, the meeting also discussed about the country's social and economic development blueprints for 2016 and the 2016 – 2020 period.
Despite the lack of surprises from the meeting itself, the plan revealed measures to tackle China's slowing economy, and of particular importance was the government's economic growth target for the next five years. The government announced during the meeting that it was targeting an average growth rate of 6.5% – 7.0% over the next five years to a gross domestic product (GDP) of over 90 trillion Yuan. The tertiary sector is targeted to contribute more to the economy from a GDP weight of 50.5% in 2015 to 56% by 2020. This implies that the tertiary sector will have to grow at a compounded annual rate of 8.7% in the upcoming five years, while the growth rate of the primary and secondary sectors will continue at a slower rate of 4%.
Looking forward, we remain optimistic on the economic outlook of mainland China despite a continued slowdown in industrial activities that is expected to hinder growth, as the government has a strong track record of empowering its economy in the past. We remain positive especially on the industries within the tertiary sector (such as consumer discretionary, technology, and healthcare) as they are anticipated to grow rapidly in the coming years. As stressed in our previous view, we think rigorous stock picking would be the key to investing in China. As the divergence in sectoral performance may intensify in the year ahead, investors should pay extra attention to sector allocations when investing in Chinese equity funds as this will definitely make a noticeable difference in performance returns.
According to market consensus, estimated earnings growth for the HSML100 Index is -1.8% and 12.1% for 2016 and 2017 respectively as of 30 March 2016. The estimated PE ratios for the HSML100 Index is at 9.1X and 8.1X for 2016 and 2017 respectively, well below our fair PE of 13.0X. Due to its cheap valuations relative to other equity markets around the world, we maintain our 5.0 Stars "Very Attractive" rating for the offshore Chinese equity market.
For 2Q 16, we retain our neutral stance on equities vis-à-vis fixed income, as well as our preference for emerging and Asian equity markets relative to their developed market peers. Emerging and Asian equity markets with lower valuations provide a "margin of safety" for investors, helping to minimise the effect of a rise in the risk-free rate. Additionally, investors should also continue to remain diversified across asset classes and geographic markets, as various market segments may not move or respond similarly (in terms of direction and magnitude of move) to subsequent rate hikes by the Fed.