As we head into 2H 2017, we take a closer look at some of the top-performing markets for the first half of the year (South Korea, India, Taiwan) as well as those on the other side of the fence (Thailand, Brazil, Russia) to identify some of the key reasons for their stellar or disappointing performance as well as our outlook for each market.
[All returns in SGD terms unless otherwise stated as of 30 June 2017]
South Korea (+18.3% in 1H 17 in SGD terms)
As of 30 June, KOSPI index which represents the South Korean equity market, rose 18.3% year-to-date (18.0% in local currency terms). In 2Q 17 alone, Korean equities rose 6.7%; in local currency terms the market delivered a 10.7% gain. Most companies' 1Q 17 earnings came out in April, semiconductor and non-insurance banking companies announced outstanding earnings figures with Samsung electronics, SK Hynix and KB Financial group reporting 35.3%, 327% and 47.5% earnings growth on a year-on-year basis. A favourable trend continues for the semiconductor businesses. Exports for semiconductors maintained its momentum with both year-on-year and month-on-month growth, while overall exports continues to demonstrate higher than 10% growth in year-on-year terms, with the Asia region contributing most of the demand.
Chinese mobile phone players still provide strong demand for memory chips in the medium term, with short term demand subject to inventory adjustment practises. As first quarter shipment for major players mostly showed double digit-growth, recent data for Chinese phone exports also points to continuous year-on-year growth. Another source of growth comes from increasing number of data-centres to support big data and cloud computing businesses, China and Europe are two of the regions that continues to demonstrate demand for server facilities throughout 2017.
One delighting feature of Korea's market is that the financial sector managed to earn more amid the economic upturn, with market interest rates higher since the end of last year under a positive economic forecast – net interest margin (NIM) expansion helping the sector as a whole. Markets have begun revaluing the sector as of April, with recognition that an economic upswing can benefit such cyclical industry, share prices have risen alongside earnings upgrades, and we are witnessing some persistent positive momentum up to now. We believe the growth in financial sector helps strengthen the longevity of the current equities upturn, with investor now expanding their pool of feasible investment, diverting some of the inflow away from semiconductor sector. The conduction also confirms investor's optimism towards the underlying market, which could provide the market with more room for valuation expansion.
In 1H 17, corporate earnings estimates have been gradually revised upwards, with 2017's earnings upgraded 14.7% higher and 2018's earnings estimates revised 14.1% higher thus far. Factoring in 30% earnings growth to last year's earnings figure (market consensus being 30.5%, achievable if Samsung managed to maintain its performance throughout the later year), the market then is trading at a 10.3X estimated PE ratio for 2017 and 9.5X for 2018, as compared to its fair PE ratio of 11.5X. We maintain our current star ratings of 4.5 Stars "Very Attractive". We continue to be positive on the market, given its high earnings growth prospects and its low estimated valuation if the strong earnings estimates are realised.
India (+16.2% in 1H 17 in SGD terms)
India is one of the top performing markets for the first half of 2017 with the current valuations making investors think twice about taking an exposure into the equity market. However, the market continues to move northwards while the forward PE ratio looks attractive from a 2 to 3 year perspective. Our first quarter, which was expected to be the worst on account of demonetisation, turned out to be one of the best for the Indian markets. The fact that the earnings of corporate India turned out to be better than analysts' expectations and GDP grew at 7.0% (year-on-year) during the last quarter of 2016, gave confidence to market participants that the impact of demonetisation was not as severe as was expected. The Budget presented on 1 February 2017 had given due emphasis in reviving the growth momentum of the rural economy along with more reform measures for other sectors (like infrastructure, financial sector, digital economy, etc). Market participants were also relieved as the Finance Minister decided to leave the current long term capital gains tax on equities unchanged. The BJP winning a majority in India's largest state that is Uttar Pradesh spread positive cheer in the market as it gave the confidence that the Modi Government would be able to pass more reforms in the Upper House of Parliament.
If in the first quarter of the year, the government had made sure that all the hurdles in implementing the country's biggest tax reform that is Goods and Services Tax (GST) was cleared, then in the second quarter, the finalisation of rates was done and as of the time of writing, the GST is in place since 1 July 2017.
Another positive which helped the market during 2Q 17 was the prediction of a normal monsoon by the Indian Meteorological Department (IMD) along with the good quarterly results of India Inc for the first quarter of the year. During the second quarter of 2017, both the indicators of inflation that is WPI and CPI fell below 3.0% and this has been giving the market participants the confidence that it is only a matter of time before the central bank reduces the policy rate. It also seemed like after a few months of silence on Non-Performing Assets (NPAs) of Banks, Dr Patel and team has decided to clean up the mess in the banking system. In accordance with this resolve, the RBI decided to implement the Banking Regulation (Amendment) Ordinance 2017, wherein the central bank is empowered to issue directions to banks to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC). The huge inflows from foreign institutions and domestic investors also provided liquidity to the markets.
In spite of all the positives, the market has been on tenterhooks whenever there geo-political tensions flare up and the continued monetary tightening by the Fed has also not been taken lightly. On the domestic side, worries continue as the central bank has asked banks to increase the provisioning for bad loans which is going to impact the earnings of this sector in the next few quarters. The street is virtually on a wait and watch mode to see if the GST transition is smooth and what impact this tax reform would have on the overall economy.
The market continues to cheer a reform-oriented government along with a central bank who is making all efforts to clean up the mess in India's banking system so as to spur growth in the long term. As of 30 June 2017, the Sensex Index is trading at estimated PE ratios of 19.0X and 15.5X as compared to its fair PE ratio of 15.0X. We maintain a 3.5 Star "Attractive" rating on India.
Taiwan (+15.7% in 1H 17 in SGD terms)
As of 30 June, TAIEX index which represents the Taiwanese equity market, rose 14.0% year-to-date (in local currency terms it was a 12.3% return), with 2Q 17's return coming in at 4.4% (5.9% in local currency terms). Much like that of the South Korean equity market, Taiwanese equities' recent surge continued to be based on a rise in exports and a booming semiconductor business, with further positive influence coming from expectations towards strong sales for iPhone's new, celebratory model. Related companies, including TSMC, Hon Hai Precision and Catcher Technology, all witnessed further gains throughout 2Q 17.
Regarding exports, although growth remains at a relatively high level in year-on-year terms, monthly increments decelerated in the months of April and May. However, as the semiconductor business remains strong, the recent slow-down seems more like a short term correction than a trend reversion, especially when growth in export orders remains in an upward trend and points to stronger support for exports in the future. Despite market spreading suspicions that iPhone would need some delay for its release date, most remain optimistic on its sales, especially when recent design "leakage" all points to renovate the phone 's front design, display screen, button arrangement and body materials. The markets are therefore pricing in strong orders for all related components suppliers, and we believe such optimism can be met when the phone is truly released.
Over the first half of the year, corporate earnings estimates on aggregate have seen upgrades in the first quarter, but a somewhat flat trend in the second. 2017's earnings estimates have been revised 1.5% higher in 1H 17, while 2018's earnings estimates have been upgraded 2.0% higher. The Taiwanese market is now trading at a 14.7X estimated PE ratio, lower than its fair PE ratio of 15.0X, with estimated earnings growth of 14.6% for 2017. Equity prices could go higher when the new iPhone cycle feeds into earnings in the second half of the year: we are still optimistic towards the market on the ground due to the strong prospects of the semiconductor businesses and on robust iPhone sales. Comparatively, the financial sector has failed to catch-up amid the recent economic upswing, where its actual earnings have been flat in recent terms and there is a lack of earnings upgrades and capital inflow at the moment. We maintain our star ratings of 4.0 Stars "Attractive" for the Taiwanese equity market.
Thailand (+2.6% in 1H 17 in SGD terms)
Thailand's equity market, as represented by the SET Index, slid into the red territory in 2Q 17 (-0.3% in SGD terms, flat in THB terms). For 1H 17 as a whole, the SET Index has delivered a return of 2.6% (2.1% in THB terms). Despite delivering positive returns over 1H 17, the decent performance from both its regional peers and developed market counterparts have dwarfed its return in comparison, causing Thai equities to emerge as one of the bottom performing markets under our coverage.
Despite the lacklustre equity market performance, Thailand's economy grew 3.3% year-on-year in 1Q 17, coming in stronger than consensus forecasts' 3.1% and 4Q 16's 3.0% growth. In expenditure terms, domestic spending remains as a prominent driver for Thai Kingdom's economic growth, which has robust growth on the back of a higher farmer income plus a better confidence within consumer segment. Sector wise, apart from higher crop prices, better weather conditions post-El Niño have also improved crop yields, thereby spurring decent growth for the agriculture sector. Meanwhile, growth slowed within non-agricultural sectors such as manufacturing and construction. For the external sector, exports growth has been robust on the back of global economic recovery and higher oil price. We saw strong external demand for Thai goods, particularly for electronics and rubber-related products
Earnings forecast for the SET Index was revised upwards by 0.9% over the second quarter of 2017, led by the better earnings prospect in the Materials (1.4%) and Energy (0.5%) sectors. On the other hand, the consumer-related sectors such as Consumer Discretionary and Consumer Staples saw their earnings forecast downgraded by -0.2% and -0.3% respectively (1.4%). For 1H 17, Thai companies have had their earnings forecast slashed by -0.4%, with most of the downgrades attributable to the Industrials (-0.7%) and Consumer Staples (-0.4%) sectors. As of 28 June 2017, the SET Index registered an earnings growth of 6.1% over the year of 2017, and is expected to deliver earnings growth of 11.1% for the year of 2018.
Going forward, we foresee domestic consumption activities to continue its modest recovery path, and investment activities to pick-up following the commencement of various infrastructure projects. The disbursement of government funding for the mass rapid transit (MRT) projects in 2H 17 is likely to provide a boost to economic growth, and acting as a stimulus to both private and foreign investment. The recent Royal endorsement of the 2017 constitution back in April have also set the path for the next election, which provides clarity for the domestic political scene and may boost business confidence further. As of 28 June 2017, the SET Index is trading at estimated PE ratios of 15.5X and 14.0X for 2017 and 2018 respectively. While there is little change to Thailand's macroeconomic backdrop since we upgraded the nation's star rating back in December 2016, we are of the view that the economic development and social improvements on Thailand's front remain on track and should continue to support earnings growth in the coming quarter. With that, we maintain the star rating of the Thai equity market at 3.0 stars "Attractive".
Brazil (-2.5% in 1H 17 in SGD terms)
Brazilian equities, represented by the Bovespa Index, fell -2.5% in SGD terms over 1H 17 to end the first half of this year as one of the bottom 3 performing of markets under our coverage. In local currency terms, the index was up 4.4% in 1H 17. The release of the economy's 4Q 2017 GDP growth in March (which showed the economy to have underperformed expectations on a year-on-year basis for the second consecutive quarter) as well as news regarding the newly elected president's cover-up bribery in May fed negative sentiments amongst investors. Furthermore, investigations in the days that followed the corruption allegation in May, also revealed the country's president, Mr Temer to have taken about USD 150,000 in bribes from the former chairman of meatpacking giant JBS SA in exchange for financing from state banks and favourable regulatory actions, which further deepened investor concerns with regards to the country's political stability.
Through 1H 17, the earnings estimates of Brazilian companies for 2017 and 2018 were revised upwards by 10.0% and 1.2% respectively. As of 30 June 2017, expectations are for the earnings of Brazilian companies to grow by 35.6% and 10.6% in 2017 and in 2018 respectively. Amongst the top four most heavily weighted sectors in the Bovespa Index, the consumer staples (15% of index) and materials (13% of index) sectors have seen mixed, both upward and downward, earnings revisions of companies through the first half of the year, while little was changed with regards to the earnings estimates of the financials sector (35% of index). The energy sector (12% of index) saw the largest earnings downgrades, alongside the fall in oil prices since end-February.
A look into the economic fundamentals of the recovering economy revealed the economy to have contracted -0.4% year-on-year in 1Q 17, up from 4Q 16's -2.5% contraction. On a quarter-on-quarter basis, the country registered a positive growth of 1.0% for the first time in 2 years. Much of the slowdown in the country's economic contraction can be attributed to private consumption in the economy (contracted a smaller -1.9% year-on-year versus 4Q 16's -2.9% year-on-year decline); as well as the economy's fixed capital investment (contracted a smaller -3.7% versus the -5.4% decline in 4Q 16). Apart from the country's growth in 1Q 17, which did not disappoint, data pertaining to economic performance in 2Q 17 continued to reflect a gradual shift towards a turnaround. On a year-on-year basis, Brazil's growth in retail sales had turned positive for the first time in 2 years in April, while inflation continued to trend downwards and unemployment rate had dipped for the first time since beginning 2015, although the dip was small (13.6% in April from 13.7% in March). While industrial production had declined -4.5% year-on-year in May, the figure had exceeded expectations of a -5.5% decline. Meanwhile, manufacturing PMI, had continued to climb, and came in above the 50.0 neutral reading in both April and May, signalling continued manufacturing expansion.
As of 30 June 2017, the Bovespa Index trades at estimated PE ratios of 11.7X and 10.5X for 2017 and 2018 respectively as compared to its fair PE ratio of 11.5X. Valuations have fallen significantly in the past recent months despite earnings estimates having remained around the same level, signalling a better price for the earnings presented by the market. Additionally, while there is near-term political uncertainty, economic fundamentals have improved alongside an expected monetary easing cycle by Brazil's central bank. Economic momentum remains supported in the Latin American economy. While we retain the star rating of 3.5 Stars "Attractive" for the Brazilian equity market, we keep a lookout for trends in the market and would do the necessary changes to the market's star ratings should there be changes in valuations that are not matched with an equivalent change in fundamentals.
Russia (-17.4% in 1H 17 in SGD terms)
Russian equities, as represented by the RTSI$ Index, fell -17.4% in SGD terms over 1H 17, coming in as the bottom-performing market of markets under our coverage for the period. In local currency terms, the index was down -13.1% in 1H 17. Alongside the dip in oil prices since end-February amid an increase in US's shale oil production, the share prices of several companies in the dominant energy sector had been adversely impacted and had thus weighed on the index's overall performance. Moreover, the drop in the prices of several soft commodities and industrial metals had weighed on the performance of the consumer staples and materials sector which in turn further weighed on the index's performance in 1H 17. Alongside the general sell-off in Russian equities, the financials sector too, saw a decline in its valuations over 1H 2017. Through 1H 17, geopolitical tensions had continued to fuel negative sentiments and adversely impact the index's performance. Over the first quarter of 2017, the earnings estimates of
Russian companies had continued be revised upwards, thus reflecting
continued optimism in the market’s earnings in the near future.
In 1Q 2017 (as of 30 March 2017), the estimated earnings of Russian
companies for 2017 and 2018 were revised higher by 6.5% and 4.9%
respectively. The financials sector saw some of the largest earnings
upgrades, with VTB Bank PJSC and Sberbank of Russia PJSC leading the
pack, while the materials sector saw some of the largest earnings
downgrades, with companies such as PhosAgro PJSC and Uralkali PJSC
ending the quarter as laggards in the sector. As of 30 March 2017,
the expected earnings growth of Russian companies are at 20.4% for
the year 2017 and 12.9% for 2018.
For the whole of 1H 17, the earnings estimates of Russian companies were revised downwards by -7.4% and -9.8% for 2017 and 2018 respectively. As of 30 June 2017, expectations are for the earnings of Russian companies to grow by 4.8% and 12.6% in 2017 and 2018 respectively. Due to the significant upward revision in the 2017 earnings estimates of several oil companies (for instance, that of Rosneft Oil Co PJSC, Surgutneftegas OJSC and LUKOIL PJSC) in 1H 17 where oil prices were comparatively more stable and remained above USD 50.00 per barrel in January and February, the energy sector managed to see an average upward revision in its 2017 earnings estimates for the whole of 1H 2017. The 2017 earnings estimates of many energy companies, however, were significantly revised downwards through 2Q 17, where oil prices had begun to fall and see increased volatility. For the whole of 1H 17, the consumer staples and utilities sectors saw the largest downward revisions in their 2017 earnings estimates. Meanwhile, the financials and materials sectors saw an average upward revision in 2017 earnings estimates.
Recently released economic data like industrial production rose in May, coming in at 5.6% year-on-year, and improving from a prior 2.3% year-on-year increase. Real retail sales data improved in April as well, coming in at a 0.7% year-on-year up from April's upward revised 0.1% year-on-year increase. Year-to-date, retail sales data have been on an uptrend, suggesting that the domestic economy in Russia has gradually improved from last year. This has been helped as well by disinflationary trends, with headline and core CPI continuously falling from 2016 and throughout 2017 thus far. In terms of leading indicators, Russia's manufacturing PMI rose to a 52.4 reading in May, up from April's 50.8 reading, extending its expansionary trend and has improved since the first half of 2016. The composite PMI came in at 56.0 in May, presenting an overall uptrend, and it remains likely that the country's economic growth would turn positive this year. Supportive of this view is the country's preliminary estimates of its 1Q 17 GDP, released earlier in June, which came in at 0.5% year-on-year up from 0.3% year-on-year in 4Q 16. On 16 June 2017, the Bank of Russia slashed its key rate by -25 basis points to 9.00%, resulting in a total of -100 basis points cut in interest rates since the start of the year. At this juncture, it is likely that the central bank would continue to cut rates in the remaining quarters of this year, albeit gradually, and this should continue to lend support to the recovering economy.
As of 30 June 2017, the Russian equity market trades at estimated PE ratios of 6.3X and 5.6X for 2017 and 2018 respectively, representing a discount from its 7.0X fair PE ratio. With oil prices expected to average higher in 2017 compared to that in 2016, it remains likely that the earnings of Russian oil companies would be supported over the coming quarters. Additionally, the earnings of Russian companies, in general, would likely be able to benefit from the country's improving economic fundamentals. While we retain Russia's star ratings at 4.0 Stars "Very Attractive", we keep a lookout for trends in the market and would do the necessary changes to the market's star ratings should there be changes in valuations that are not matched with an equivalent change in fundamentals.
A Decent First Half ...
Asian equity markets have once again outperformed their developed counterparts in the second quarter, helping to add to a rather strong 1H 17 return. We continue to see improvements in economic data as well as aggregate corporate earnings estimates, and reiterate our preference for the Asia ex Japan region as compared to the Western developed markets. Additionally, we have turned neutral on Europe, and may be reviewing our star ratings for the US market in the near-future. For our latest asset allocation views and changes, investors may view our update here.