While our Key Investment Themes and 2018 Outlook covers our expectations for the year ahead, in this end-of-quarter update, we take a closer look into the top and bottom three performing markets under our coverage over the course of 2017.
[All returns in SGD terms as of end-December 2017 unless otherwise stated]
China (+7.2% in 4Q 17, +27.9% for 2017 in SGD terms)
The HSML100 index which represents China's H-share market, rose 27.9% for the full year of 2017 (39.5% in local currency terms). Tencent Holdings, banks and insurance companies are the major contributors behind the market's splendid performance. Tencent and Ping An Insurance are the top two market leaders within the period, their stock prices rose 114.5% and 114.2% respectively within the year, representing 24.8% and 10.5% of the index's gain respectively.
Strong earnings results have been the backbone of the recent stock rally. Tencent managed to deliver exceptional growth in its gaming business with the help of "Honour of Kings", which in turns lead to above 40.0% earnings growth on a year-on-year basis for three consecutive quarters, fuelling investors' optimism. Large Chinese banks generally enjoyed higher Net Interest Margins (NIMs) and lower bad debt costs than in 2016, helping them to finally deliver earnings growth after two years of stagnation. As for insurance companies, they benefited from both the continued consumption upgrade in the mainland and their investment in technology, which boosted their earnings within the year.
Moving into 2018, we believe these companies will continue to deliver consistently strong earnings growth. For Tencent, the company now invests heavily into survival shooter genre of games, with cooperation of Bluehole Studio, developer of the popular title "Player Unknown's Battlegrounds"; Tencent may manage to extend their high growth rate in the gaming section with contributions from new titles.
As for banks and insurers, we reckon that the strict financial regulations are here to stay for 2018 as authorities further stress the importance of "financial stability", the PBOC may continue to raise the money rate further following the Federal Reserve's rate hike actions in an attempt to stabilise the RMB. Market interest rates therefore shall be generally higher in 2018 compared to 2017, helping banks' business revenue and insurers' overall investment yield. Other than the interest rate environment, continuation of debt quality control and bad debt write-off in 2018 could also help banks' earnings by releasing loan loss provisions, while insurance companies could enjoy stronger earnings growth by utilising technology innovation so to further boost user growth and user's monetisation rate.
As of 29 December 2017, the HSML 100 index is trading at a 9.9X estimated PE ratio for 2018, a discount compared to our fair ratio of 13.5X. We believe the estimated PE ratio may go even lower within the year with upgrade on estimated earnings, leaving room for the H-share market to rally higher. We maintain our star ratings of 4.5 Stars "Very Attractive" for the Chinese equity market.
Korea (+8.5% in 4Q 17, +26.6% for 2017 in SGD terms)
The KOSPI index which represents South Korea's equity market, rose 26.6% for the full year of 2017 (21.8% in local currency terms), coming in second after China among the markets under our coverage this time round. The equity market itself did not deliver the very strong returns relative to its other Asian peers, yet as the KRW strengthened against many currencies including the USD and the SGD within the same period, the market's total return climbed to the top-three positions among the markets under our coverage.
Semiconductor manufacturers and banks are the two main sectors behind the market's gain. For the former, fast growth for Chinese smartphones' shipment and rapid expansion of data centres created strong demand for memory chips when supply lagged; manufacturers therefore witnessed a surge in their products' price and quantity demanded, leading to spectacular earnings seasons and share price gains.
We currently believe the under-supply scenario for DRAM will be here to stay for roughly two more quarters, as demand for memory chips from smartphones remain vivid in recent quarters, demand from servers remain elevated since cloud service providers stay the course on further expansion, and that major expansion on DRAM's production capacity will only start to feed into the global market by second half of 2018. We therefore expect strong earnings result for relevant companies to be in place until third quarter of 2018, potentially supporting companies' stock price by dragging back investors' confidence, which is now dampened by a drop in NAND's price level. As for the banks, their stock prices have been supported by rising Net Interest Margins (NIMs) and a falling Non Performing Loan (NPL) ratio for the whole of 2017. With exports maintaining its strength and expectations high for another rate hike by the Bank of Korea (BOK) in the later part of 2018, NIMs and the NPL ratio may improve further in 2018, paving the way for banking stocks to go even higher.
As of 31 December 2017, KOSPI index is trading at 9.1X estimated PE for 2018, a discount compared to the index's fair PE ratio of 11.0X, we believe market has been stressing too much on the recent drop in NAND's price and analysts' downgrade action on Samsung electronics, the upcoming earnings season could potentially help revert some of the pessimism and drive up stock prices if the semiconductor manufacturers indeed deliver satisfactory earnings result as we expected. We maintain our star ratings of 4.5 Stars "Very Attractive" for the Korean equity market.
India (+9.8% in 4Q 17, +25.8% for 2017 in SGD terms)
India has turned out to be one of the best performing markets in 2017 after China and South Korea. The beginning of 2017 saw the news of the union budget and the government making all-out efforts to clear hurdles coming in the way of implementing Goods and Services Tax (GST), which was implemented on 1 July 2017. Investment sentiment was buoyed by the incumbent party's (BJP) majority victory in Uttar Pradesh and in subsequent areas like Gujarat and Himachal Pradesh, as the Modi government would be able to carry on more of its intended reforms without much hassle from the Upper House of Parliament.
Despite concerns of adverse impacts on account of Demonetisation, the anti-corruption move launched by the government back in November 2016, the economy stabilised quicker than expected, and the equity market rebounded strongly. The earnings of India Inc turned out to be better than analysts' expectations and GDP grew at 7.0% during the last quarter of 2016, giving confidence to market participants that the impact of demonetisation was not as severe as was expected. Another positive that enabled the market to cross 30,000 levels for the first time was the fact that after a few months of silence on Non-Performing Assets (NPAs) of Banks, Dr.Patel and team decided to clean up the mess in the banking system. In accordance with this resolve, RBI decided to implement the Banking Regulation (Amendment) Ordinance 2017, wherein the Central Bank is empowered to issue directions to banks to initiate an insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC). The government decided to supplement RBI's efforts to help Public Sector Banks (PSBs) suffering from NPAs by announcing a huge recapitalization package and infusing a capital of INR 2.11 Lakh crore into PSBs. Along with this, Jaitley and team announced a huge spending in the infrastructure sector like improvement of rail and road connectivity, affordable housing for lower income families in both rural and urban areas and universal electrification by March 2019.
The Indian market also went through some rough patches during the year on account of factors like RBI changing its monetary policy stance from accommodative to neutral, citing upside risks to inflation. Consumer Price Index (CPI) which had remained below 4.0% since demonetisation fell to a 1.46% rate in June, after which it started increasing and touched 4.88% in November, which meant that the central bank would maintain status quo on policy rates for some more time. The slowdown in the growth momentum of the economy in the second quarter of 2017 to 5.7%, its lowest level since the quarter ended March 2014, mixed quarterly results of India Inc, the tensions across the Indian borders, rising oil prices and the worry that that the government will miss the fiscal deficit target of 3.2% in FY18 also negatively impacted the market sentiments. To add to this, the geopolitical tensions between US and North Korea also kept the markets on tenterhooks for some time.
According to consensus estimates, as on December 22, 2017 the estimated PE ratio for India's stock market (Sensex) are 22.7X, 17.8X and 14.8X for FY18, FY19 and FY20 respectively. Estimated earnings growth is 13.64%, 27.59% and 20.02% for FY18, FY19 and FY20 respectively. We maintain an "Attractive" rating of 3.5 stars for the Indian equity market.
Indonesia (+5.2% in 4Q 17, +10.5% for 2017 in SGD terms)
The Indonesian equity market, as represented by the JCI Index, performed fairly well in 2017. It registered a 10.5% gain for the full year (20.0% in local currency terms). Despite achieving positive returns over the year, the decent performance from its regional peers and developed market counterparts have outshone its return in comparison, making the Indonesian equity market to end the year as one of the bottom performing markets under our coverage.
Regarding macro data movement, we saw the Indonesian economy expand 5.1% year-on-year in 3Q 17, slightly faster than 5.0% in 2Q 17, but below consensus estimates of 5.2%. Growing investment expenditure, higher government consumption and surging exports continue to be the positive contributor to the growth of Indonesian economy. In addition, Indonesia's Nikkei Manufacturing PMI grew to a reading of 50.4 in November, slightly improving from 50.1 in the preceding month. The production in Indonesia's manufacturing sector was sustained by further gains in new orders at the strongest pace in three months on the back of rising demand from domestic demand and export orders.
Earnings forecasts for the JCI Index was revised upward by 2.8% over the last quarter of 2017. Most of the upgrades are attributable to the Financials and Energy sectors, where the former is expected to benefit from the improving operating environment and higher profitability due to lower credit cost as well as higher loan loss coverage ratios. The Industrials and Information Technology (IT) sectors were among other sectors that saw upgrade in their earnings estimates. Meanwhile, the consumer sector (both discretionary and staples) have had their earnings estimates revised downwards by analysts over the quarter, as a recovery in private consumption recovery on the domestic front remains modest. As of 29 December 2017, the JCI Index registered an earnings growth of 14.2% over the year of 2017, and is expected to deliver earnings growth of 12.0% for year of 2018.
Looking forward, economic growth in Indonesia is expected to stay strong with the support of a gradual recovery in private consumption and infrastructure spending. The easing measures undertaken by Bank Indonesia also provide a material lift to lending activities, which could stimulate investment and consumption activities in the coming months. In terms of valuations, the Indonesian equity market now trades at an estimated PE of 16.4X and 14.7X for 2018 and 2019 respectively, as compared to its fair PE ratio of 16.0X. Given that Indonesia's economic outlook continues to be favourable as the conducive external environment persists and domestic conditions become more positive, a star rating of 3.0 Stars (Attractive) remains warranted at this juncture.
US (+4.6% in 4Q 17, +10.3% for 2017 in SGD terms)
The US equity market (as represented by the S&P 500 Index) rose 4.6% in 4Q 17 to end off with a full year price return of 10.3%, lagging its developed and emerging counterparts and landing up as one of the bottom performing markets under our coverage this time round. The US equity market continued to climb higher and register new highs as investors warm up to the prospects of a favourable fiscal plan coming out of Capitol Hill. Some of the best performing stocks in 4Q 17 include mining giant Freeport-McMoran, Michael Kors, Twenty-First Century Fox, Seagate Technology and Caterpillar, while Allergan, Advanced Micro Devices, Expedia and Regeneron Pharmaceuticals are some of the bottom performers. Overall, we saw that the technology sector was the top performing sector in 2017, followed by the consumer discretionary, financials, and industrials sectors, while the telecommunications and energy sectors were the laggards.
Corporate earnings estimates for American companies on aggregate have been upgraded over 4Q 17 and year-to-date, with 2018's and 2019's estimates revised 1.9% and 2.0% higher over the quarter (as of 29 December 2017). The tech sector saw the strongest upgrades, while the US energy sector was the runner-up as global oil prices rose over the past three months: a positive development as energy-related companies have for most part of the year, incurred downgrades to their earnings estimates. Additionally, the materials sector also saw broad-based earnings upgrades as a whole, reflecting the current situation of improving demand dynamics from both emerging and developed markets.
Leading indicators like business surveys and consumer sentiment studies reveal that confidence in the US is robust, supporting the outlook for private investment and domestic consumption in 2018. In its December meeting, the US Federal Reserve raised the benchmark Fed Funds rate by 25 basis points to a 1.25% - 1.50% range – a decision that was well communicated previously and widely expected by markets. The Fed retained its assessment of an upbeat outlook, commenting that "averaging through hurricane-related fluctuations, job gains have been solid, and the unemployment rate declined further." The central bank also reiterated that despite the effects of the hurricanes, they "have not materially altered the outlook for the national economy." The current policy for its balance sheet normalisation was unchanged, but the Fed did raise its GDP forecast for the US economy, with 2018's growth rate expected to come in at 2.5% (from a prior 2.1%), while 2019's 2.0% rate was upgraded to 2.1%. Inflation forecasts were unchanged however. Moving forward, attention will be on the leadership transition as chairwoman Janet Yellen prepares to hand over the reins of the Fed to Jerome Powell.
At current levels, the US equity market trades at 18.1X and 16.4X 2018's and 2019's estimated earnings, as compared to our estimated fair value of 15.0X. Earnings growth would be a key driver for US equity returns moving forward as valuation multiples remain relatively stretched. The potential upside of the US market is now the lowest among the markets that we cover, and as such, we maintain our star ratings of 2.0 Stars "Unattractive" for the US.
Russia (+0.1% in 4Q 17, -7.4% for 2017 in SGD terms)
For the whole of 2017, Russian equities as represented by the RTSI$ Index, lost -7.4% in SGD terms, although, in USD terms, they ended the year at a level similar to where they were at the beginning of the year (0.2% gain). Much of the index's weak performance can be attributed to its -13.1% decline through the first half of the year, amid easing oil prices and unfavourable supply-side occurrences such as an increase in US shale oil production and a fall in the compliance rate of OPEC members with regards to their promised oil cuts. Additionally, the prices of other commodities such as that of industrial metals had also dipped, affecting the materials sector in the Russian equity market. While the Russian equity market had staged a strong comeback in the second half of the year (gained 15.3%) alongside the rebound in oil prices and seemingly improved supply-side factors, movements in currency markets resulted in 2H 17 gains (in SGD terms) which were insufficient to entirely offset losses (in SGD terms) incurred in 1H 17. For the whole of 2017, the consumer discretionary sector saw some of the largest price gains, while the utilities sector witnessed some of the largest price declines. Meanwhile, the performance of the dominant energy sector as well as the materials and financials sectors were mixed for the calendar year 2017.
Through 2017, the 2017, 2018 and 2019 earnings estimates of Russian corporations were revised downwards by -3.3%, -6.7% and -15.6% respectively. As of 31 December 2017, the earnings of Russian corporations were expected to have risen 9.7% in 2017 and are expected to grow a further 11.1% and 2.5% in 2018 and 2019 respectively. The financials sector saw some of the greatest earnings upgrades for the year 2017, while the utilities sector saw some of the largest earnings downgrades. For the whole of 2017, the energy sector managed to see earnings upgrades. It is worth noting, however, that over the coming quarters, notable supply-side uncertainties remain in the global oil market, presenting continued risks to the earnings of companies in the energy sector.
As revealed by the latest GDP figures, the Russian economy grew 1.8% year-on-year in 3Q 17 (final estimates), down from a prior 2.5% on the back of softer investment which had surged in the second quarter. Meanwhile, household expenditure, government expenditure and exports, had continued to improve, thus supporting growth in the quarter. As highlighted in IHS Markit's recent PMI reports on the Russian economy, business confidence in both the nation's manufacturing and services sectors had continued to be strong in December, with manufacturers reporting their strongest degree of optimism since September while service sector firms recorded their second-highest degree of optimism in five years. In addition to healthy business confidence levels, it is likely that a continued pickup in domestic consumption, which accounts for around half of Russia's GDP, supports growth over the coming quarters. For the month of November, Russia's CPI had come in at 2.5% year-on-year, extending its downward trend and lending continued support to consumption appetites. In addition, low borrowing costs over the coming quarters are likely to remain supportive of economic growth. In December, the Russian central bank slashed rates by another -50 basis points to 7.75%, greater than expectations of a -25 basis point cut, and had left open the option of further rate cuts in the first half of 2018.
As of 31 December 2017, the Russian equity market trades at estimated PE ratios of 6.3X and 6.1X for 2018 and 2019 respectively, compared to its 7.0X fair PE ratio. While Russia's good progress to economic recovery would likely continue to provide support to the aggregate earnings of Russian companies, notable uncertainties facing oil prices likely continue to present risks to the earnings of oil companies. At this juncture, we believe that a star rating of 3.5 Stars "Attractive" remains warranted for the market.
Overweight Equities Over Bonds; Do Not Underestimate The Value Of Active Management!
As mentioned in our outlook for 2018, we continue to be overweight equities-vis-à-vis fixed income, as the current environment of strong earnings growth coupled with accelerating economic momentum favour equity markets over bond markets as a whole. Additionally, investors should remain on the defensive for fixed income, given that aggregate yield levels still remain relatively low, and that risk-free rates are expected to gradually normalise higher moving forward, affecting riskier spread-related segments.
Additionally, we have noticed that following strong returns for both stock and bond markets over the past few years, investors have gravitated towards passively-managed styles of investing and instruments such as index and exchange-traded funds (ETFs). However, with bond yields still at relatively low levels and equity markets valued richer moving into 2018, we think that actively-managed vehicles are appropriate, with active stock pickers able to underweight or shun expensive stocks for more attractively-valued ones, while an era of rising interest rates coupled with historically-low rates means credit selection, flexible positioning and currency expertise will aid in driving overall fixed income returns to a greater extent. Do not underestimate the value of active management!