As we move into the fourth quarter and the end of the year, we take a closer look at some of the top-performing markets in 3Q 18 (Thailand, US, Japan) as well as those at the bottom (India, Hong Kong, China A) to understand some of the drivers of performance and provide our outlook for each market.
[All returns in SGD terms unless otherwise stated as of 28 September 2018]
Thailand (+12.9% in 3Q 18, +3.2% Year-To-Date in SGD terms)
Thailand's equity market, as represented by the SET Index, outperformed many of its Asian peers over 3Q 18, clocking returns of 12.9% in SGD terms (10.1% in local currency terms). Year-to-date, the SET Index has delivered a return of 3.2% in SGD price terms. While Asian and emerging market equities’ movements were affected by concerns on Turkey and Argentina coupled by the US-Sino trade tension, Thailand's healthy and sound fundamentals (positive current account surplus and stable political backdrop) have emerged as a bright spot for foreign investors to look at.
Over 3Q 18, earnings estimates for listed companies in Thailand were revised downwards by -0.9%, led Consumer Staples (-0.8%), Industrials (-0.1%) and Real Estate (-0.1%). On the other hand, Financials (+0.2%), Materials (+0.1%) and Energy (+0.1%) have witnessed upward revision in their earnings forecast. On a year-to-date basis, Thai companies have had their earnings forecast slashed by -1.4%. As of 28 September 2018, the SET Index registered an earnings growth of 7.3% over the year of 2018, and is expected to deliver earnings growth of 10.0% for the year of 2019.
In terms of economic data, Thailand's GDP grew 4.6% year-on-year in 2Q 2018, beating consensus forecasts of 4.4% year-on-year growth, but softened from previous quarter's 4.8% year-on-year growth. The kingdom's growth was underpinned by a recovery in the agriculture sector and private consumption as well as a boost from government expenditure. On the global trade front, export activities were resilient despite the trade tensions, which continues to fuel expansion within the manufacturing sector throughout 1H 2018. Looking towards tourism, tourist arrival growth figures were slightly lower than 1Q 18, but stood at high single-digit nonetheless. Hotel and restaurant, transportation as well as communication sectors were among the beneficiaries of higher tourism receipts.
Moving forward, decent agriculture yields and prices may contribute to higher farmers’ income, thereby supporting domestic consumption, which remains as a dominant driver of Thailand’s economy. Exports and tourism activities, however, are expected to moderate as the recent surge in the THB could deter demand for Thai goods and services. As of 28 September 2018, the SET Index is trading at PE ratios of 16.3X and 14.9X for 2018 and 2019 respectively. At this juncture, we remain positive on Thailand, but opine that valuations for Thai equities are not appealing compared to its North-Asia counterparts. While earnings figures lacked encouraging momentum, we believe market participants have priced-in a political stability premium, which has left Thai equities at a relatively unattractive level. With that, we maintain a star rating at 3.0 Stars “Attractive” for Thailand.
US (+7.5% in 3Q 18, +11.5% Year-To-Date in SGD terms)
The US equity market continued to climb higher and clock new-highs in 3Q 18, delivering a 7.5% gain in SGD price terms (7.2% in USD terms). The 2Q 18 earnings season results were strong as a whole, with 72% of the S&P 500 companies beating sales targets and 84% of them beating their earnings targets. Some of the best performing stocks over the quarter were Advanced Micro Devices, HCA Healthcare and Illumina Inc., while Twitter, Western Digital Corp and Wynn Resorts have been some of the bottom performers.
Earnings estimates of American corporations have been revised higher over the quarter, with 2018's and 2019's estimates upgraded by 1.1% and 1.3% respectively. The information technology (IT) sector was one of the largest contributors to overall earnings upgrades, as it enjoyed a 3.7% upward revision for its 2018 earnings estimate. The financials, health care, industrials and consumer staples sectors also saw slight earnings upgrades over 3Q 18. Year-to-date, earnings increases have reflected the windfall US corporations have enjoyed from the change in the fiscal tax code implemented by the Trump Administration.
The latest leading indicators such as the ISM's headline PMIs still suggest expansionary activity in the US, with sub-components such as new orders and backlogs registering increases in readings. The responses from manufacturers indicated that they remained concerned over rising trade tensions with China, but there is little evidence at this juncture to suggest that the impact of tariffs are affecting overall business confidence and derailing growth. In terms of the labour market, job creation has been robust and wage data continued its overall uptrend over the past few months, which, alongside strong consumer sentiment survey readings, is supporting the outlook for domestic consumption and its contribution to overall growth momentum.
The Federal Reserve went ahead with its well-televised 25 basis point rate hike in its September meeting, bringing the Fed Funds rate up to a range of 2.00% - 2.25%. Fed chair Jerome Powell retained its positive assessment of the US economy, and maintained its ‘Dot Plot’ forecast, indicating that another 25-basis point hike in December is on the cards. GDP growth forecasts for both 2018 and 2019 were raised by 30 basis points (to 3.1%) and 10 basis points (to 2.5%) respectively, while core PCE inflation was kept unchanged.
As of end-September 2018, US equities trade at estimated PE ratios of 18.1X and 16.4X for 2018 and 2019 respectively, as compared to its fair PE ratio of 15.0X. We acknowledge the near-term benefits of the recent fiscal package (supporting investment and spending), but are cognisant of still-stretched valuations that limit the potential upside to any long term investor. Thus we maintain our rating of 2.0 Stars “Unattractive” for the US equity market.
Japan (+5.9% in 3Q 18, +7.5% Year-To-Date in SGD terms)
As at 28 September, Nikkei 225 index rose by 5.95% in local currency terms year-to-date to 24,120.04, reaching its highest since November in 1991. Market sentiment appears to remain positive on Japan's market. The Bank of Japan (BOJ) announced in the Monetary Policy Meeting held earlier in September that BOJ will maintain its stance on the loose monetary policy, coupled with other factors such as the continuing depreciation of the JPY against the USD, reduced corporate taxes and increases in sales revenue, have generally enabled Japanese companies to increase their business confidence and profitability for the year ahead, leading to an increase in market's optimism for improvement in macro economy and in corporate earnings.
In terms of economic data, exports and core machine orders look like the main driver for recent growth. Over the quarter, we saw both exports and core machine orders picking up momentum. We believe Japan will continue benefiting from current trade tensions between the US and China over the near-term. With regards to the economic outlook in the Monetary Minutes, Japan is likely to continue its moderate expansion to reach the inflation target of 2.0%. In the medium term perspective, Japan should still be able to maintain its growth momentum.
Corporate earnings estimates of Japanese companies on aggregate has been revised upwards in 3Q 18. As at 28 September, 2018's and 2019's earnings estimates for the third quarter (July - September) have been revised upward by 2.46% and 1.30% respectively. As compared with the earnings revision for 2018 and 2019 since the start of its financial year (dated at 1st April), earnings upgrade was 2.76% and 1.99% respectively, with Banks, Energy, Raw Materials and IT being the main contributors to the earnings upgrade. There is an upbeat in earnings for the companies in Japan, coupled with the current attractive valuation profile of the Japanese market, Japanese equities has the potential to reach a higher level in the medium term perspective.
Lastly, Nikkei 225 Index’s estimated PE for FY2018 and FY2019 were 16.8X and 14.9X respectively, which is below our fair value target of 18.0X. It is trading at a PE ratio lower than most of the other developed markets and we can see improving revenue and positive producer sentiment that suggests continued expansionary conditions. We therefore maintain a 3.5 Stars “Attractive” rating for the Japanese market.
India (-3.2% in 3Q 18, -4.3% Year-To-Date in SGD terms)
India has turned out to be one of the worst performing markets analysed in 3Q 18. Despite starting the month of July on a very positive note, the market could not sustain the momentum through the entire quarter. July started well with some positive events: good monsoons, the decision to hike the minimum support price (MSP) for Kharif crops, fall in oil prices, approved capital infusion of INR 11,336 cr for 5 public sector banks, the GST council's decision to cut tax rates on 88 items, the no-confidence motion won by the ruling party in the Lok Sabha, and some impressive results from corporate India. August saw continued momentum with the benchmark index (S&P BSE Sensex) crossing 38,000 levels for the first time, aided by RBI's decision to pay the government dividends to the tune of INR 50,000 cr. Macroeconomic data released during the month, like a fall in the year-on-year inflation rate from 4.9% in June 2018 to 4.2% in July 2018, and rise in IIP to 7.0% in June 2018 vis-a-vis 3.2% in May, supported the positive sentiments in the market.
Indian equities, represented by the Sensex Index, fell -2.7% in SGD terms over 3Q 2018 (+2.6% in local currency terms). Earnings estimates for 3Q 2018 were revised downwards by -1.7% and -1.5% for the year 2018 and 2019 respectively. In contrast to August, investors were in for a rude shock in September when volatility returned. Although market participants have primarily been worried about the depreciating INR and rising oil prices, the biggest factor that pulled the market down was the downgrade of Infrastructure Leasing & Financial Services (IL&FS), one of India's leading infrastructure development and finance companies. IL&FS was downgraded from AA+ to BB and finally to D during the course of the month. What spooked the market more was the fact that a Fund House sold Commercial Paper worth INR 300 cr of another prominent housing finance company (HFC) at a higher than previous yield. This caused panic selling in the market as investors assumed the Fund House's deal at a higher yield implied more expected defaults, which in turn would lead to a liquidity crisis in the economy. With banks slowing lending on account of their bad loans, NBFCs are stepping in to meet the demand for credit – in this context, fears of defaults and the resulting liquidity freeze in NBFCs therefore assume a lot of importance. Our view here, however, is that there are still good companies in this space; in the next few months, they will take a more cautious route to continue lending, and the market's fears will be addressed soon.
As of end-September 2018, Indian equities trade at 19.5X and 16.2X FY2018 and FY2019’s estimated earnings, relative to its fair PE ratio of 15.0X. We retain a star rating of 3.5 Stars - “Attractive” for the Indian equity market.
Hong Kong (-3.5% in 3Q 18, -4.3% Year-To-Date in SGD terms)
As at 28 September, the Hang Seng Index (HSI) dropped by -4.3% year-to-date to 27,788.52. In the third quarter alone, the HSI declined -3.5% - the worst quarterly performance since the fourth quarter in 2016. Although this year has seen a number of big IPOs from Chinese technology firms, it didn't inject lead to much positive momentum 3Q 18. Market concerns over the China's economic outlook, trade tensions, the weakening of the Renminbi (RMB) and the increase in the prime rate have negatively impacted HK's equity market and overall market sentiment.
In terms of economic data, overall economic data in Hong Kong for 3Q 18 was relatively weak. The seasonally adjusted Nikkei Hong Kong PMI has recorded a fifth straight month of contraction in private sector activity, we believe the contraction was mainly due to the weak demand from mainland China, resulting a decrease in both output and new orders. Given current trade tensions and China's economic outlook, we believe the aforementioned situation will continue to remain.
Following the US Federal Reserve, Hong Kong Monetary Authority (HKMA) has also raised its base lending rate. Then HSBC, the largest bank in HK became the first commercial bank to raise the prime rate, Hong Kong's low interest rate environment may soon come to an end. With the increased interest rate, mortgage loans and bank loans are now less affordable and companies earnings in Hong Kong are also likely be affected. We believe Hong Kong's housing market and equity market (in terms of valuation) will be affected accordingly, there might even be a possibility that the banks’ interest rate in HK will increase at a rate faster than the HKMA in order to close down the gap in the interest rate spread with US banks.
The sharp weakening of RMB against the USD was attributed to several factors, including USD appreciation, widening interest rate spread between US and China, the trade war, and the slowdown in China’s economic growth. The weakening of the RMB has an effect on the HK equity market, as there were clear signs of capital outflow from the Hong Kong equity market into USD-denominated asset classes inside or outside of HK. Moreover, the RMB’s depreciation affected the earnings prospects of Chinese companies listed in HK. Chinese policy-makers have reintroduced the “Counter-Cyclical Factor”, but it remains to be seen if RMB stability could be achieved via this measure.
Corporate earnings estimates of HK companies on aggregate has been revised downwards in 3Q 18. As at 28 September, 2018's and 2019's earnings estimates have been revised downward by -2.26% and -2.03% respectively. During the period, most of the companies in HK have recorded an earnings downgrade, of which, sectors such as financials and healthcare were the largest contributor to the earnings downgrade.
Lastly, Hong Kong’s equity market is currently trading at an estimated PE ratios of 11.2X and 10.1X based on estimated earnings in 2018 and 2019 respectively, which is below its fair value of 13.0X. It is also trading at a PE ratio lower than most of the other developed markets. We retain a 4.5 Star ‘Very Attractive’ rating on the Hong Kong market.
China A (-5.3% in 3Q 18, -17.4% Year-To-Date in SGD terms)
The China A-shares market, as represented by CSI 300 index, fell -17.4% over the past three quarters in SGD terms, and became the bottom performer under our market coverage. Looking at sectoral returns in local currency terms, the healthcare sector is the only one barely posting a positive return of 0.96%; the rest of the sectors delivered negative returns, the worst being the telecommunications sector with a -31.45% decline. Notwithstanding the catalysts such as the inclusion of A-shares in the FTSE Russell Index, investors risk appetite seems to remain subdued as a result of the escalation of the trade war between China and US.
The latest major market downturn happened at the end of July and continued through the first week of August, declining for a total of 8.6%. The announcement of a second tranche of Chinese goods that were subjected to US tariffs did not help either. However, the confirmed 10% tariffs gave a slight breather for the market and the index recovered 3.0% in September. For estimated earnings, they have been downgraded by -1.45% and -1.25% for 2018 and 2019 respectively.
Despite the external uncertainties, recent economic data such as industrial production and retail sales have been on an uptrend, suggesting solid fundamentals. In addition, China's economy grew 6.8% in the first half of 2018, which topped the government's annual growth target of around 6.5%. This will enable China to achieve relatively full employment. The Caixin China General Manufacturing PMI fell to a 14-month low of 50.6 in August of 2018 from 50.8 in the previous month and matching market consensus, which still remained above the boom-or-bust line of 50 that separates expansion from contraction. Another catalyst for upwards re-rating is the inclusion of A-shares in the MSCI and FTSE Russell indices. The move could trigger an inflow of around USD 24 billion, which would increase the participation of foreign institutional investors, and drive the A-share market valuation and the global market convergence in the long run.
Looking at valuations, we believe that the A-shares market is lingering at the bottom of its range, suggesting that the downside risk is possibly limited at this current juncture. For example, at the end of September, according to Wind database, 275 shares were trading at a Price-to-Book (PB) Ratio of lower than 1 with the number of shares being more than what we saw in 2016.
While China A-shares have underperformed global equities year-to-date, its underperformance translates into valuations that continue to be attractive to invest in. As at 28 September 2018, the CSI 300 Index was trading at estimated PE ratios of 11.8X and 10.2X based on estimated earnings in 2018 and 2019 respectively, a discount to its fair value of 15.0X. We believe that volatility could persist in the near term given factors such as poor investors’ sentiment currently, the ongoing deleveraging campaign and low trading volume. We maintain a 3.5 Stars “Attractive” rating for the China A-share market.
Varied Opportunities In Emerging Markets
The depreciation of various currencies will kick-start a series of macroeconomic adjustments; one of which is a potential improvement in the current account balance (especially for deficit countries). Weakening of currencies will lead to imports becoming more expensive, which discourages imports. Conversely, there will be a rise of export competitiveness, which could lead to an export-driven recovery. In this context, the currency's depreciation typically precedes an improvement in the current account.
Naturally, certain countries such as Turkey and Argentina may still experience a difficult time as policy-makers implement measures to rein on rising inflation pressures and to satisfy supranational organisations like the International Monetary Fund (IMF) (in the case of Argentina). These measures may weigh on overall growth prospects at least for another one or two quarters. On the other hand, the rest in fundamentally stronger positions may enjoy the benefit of a weaker domestic currency. Domestic consumption trends may also be relied upon for overall economic growth.
Despite the sabre rattling over trade between the US and China, the rest of the world remain keen on trade, and regional and bilateral trade deals are still maintained. Various emerging markets may benefit from these as supply chains adjust slowly should Sino-US trade tensions prevail. In such a market environment, an actively-managed strategy is imperative in order to mitigate risks and to capture the opportunities that will transpire moving forward.