While our Key Investment Themes & 2019 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 2018.
[All returns in SGD terms unless otherwise stated as of 31 December 2018]
Brazil (+15.0% in 4Q 18, +0.4% in 2018 in SGD terms)
The Bovespa index which represents Brazil's equity market, rose 0.4% for the full year of 2018 (15.0% in local currency terms) but recorded a stellar 15.0% increase in 4Q 18 (10.8% in local currency terms). Much of 4Q 18's gain can be attributed to the market's positive reaction regarding October's general elections which saw ring-winged pro-business candidate, Jair Bolonaro, emerging as the victor. State-owned companies such as Petrobas, Banco do Brasil and Cia Energetica de Minas Gerais as well as private companies like Magazine Luiza and Suzano Papel e Celulose are amongst the best performers in the Brazilian market in 2018. In particular, Magazine Luiza and Cia Energetica de Minas Gerais are the top two best performing plays within the period, their share price rose 126.3% and 119.3% respectively within the year, contributing to 3.5% and 3.9% of the index's gain respectively. Itau Unibanco rose 33.9% and contributed to 22.6% of the index's gain, the most of all Bovespa's plays.
Over the quarter, earnings of Brazilian corporations was dealt with mix revisions, with 2018's earnings estimates revised -1.8% lower while 2019's estimates got upgraded 1.2%. Most sector, apart from materials and financials, saw a downgrade in earnings. The materials sectors received the strongest earnings upgrades lead by Gerdau and Cia Siderurgica Nacional as revenue derived from Brazil continues to surge northwards, driven by a recovering economy. The Brazilian consumer staples saw significant earnings downgrade as a whole. Earnings revisions for the financials sector, in particular Brazilian banks, remain mixed while the nation's stock exchange, B3, enjoyed the largest earnings upgrade within the sector.
In terms of economic data, leading indicators have reflected an upturn in economic growth. Manufacturing and services PMI have risen sharply in 4Q 18. In particular, the service sector, which is a pillar of strength for Brazil's economy, rebounded to an expansionary territory as services PMI shot up from 46.4 in Sep 18 to 51.3 in Nov 18. Confidence levels for both consumer and business (as represented by the FGV Consumer confidence and CNI Industrial confidence) have also swiftly swelled after October's general election. Moving into 2019, we expect corporate earnings growth to be supported by better economic growth, confidence levels and sentiments, accommodative monetary and a relatively low inflationary environment.
The crux for Brazil in 2019 will be the ability of the new presidential administration to pass fiscal reforms. Investors are expecting major reforms to fix Brazil's overwhelming fiscal deficit as promised by Bolsonaro. He is expected to face opposition when passing reforms on the pension system, especially from left-wing parties and the public. If such policies were to be implemented successfully, we expect Brazil to have a strong growth and investment prospect backed by restored investors' confidence.
As of 28 December 2018, the Bovespa index is trading at a 10.7X and 9.8X estimated PE ratio for 2019 and 2020 respectively, a discount compared to our fair ratio of 11.5X. We maintain a 3.0 Stars "Attractive" rating for the Brazilian equity market..
India (+3.4% in 4Q 18, -1.0% in 2018 in SGD terms)
India started 2018 on a positive note with the benchmark index, S&P BSE Sensex, scaling 36,000 levels for the first time in January. Volatility persisted through the year, although the market touched a new high of 38,000 levels in August 2018. The factors that contributed to a good 2018 included the drastic improvement in the macro-economic indicators with improving oil prices, strengthening of the Rupee, falling inflation and improving industrial production numbers. During the course of the year, the market experienced a tensed few months due to rising oil prices and weakening INR, along with RBI increasing the policy rate citing upside risk to inflation. However, a reversal in these trends helped the market pare losses as the year came to an end.
The markets were in for a rude shock in September, on account of the downgrade of Infrastructure Leasing & Financial Services (IL&FS), one of India's leading infrastructure development and finance companies. The markets were spooked further when a Fund House sold Commercial Paper 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. As banks slowed down lending due to bad loans, the non-banking financial companies (NBFCs) had stepped in to meet the demand for credit. In this context, the fears of defaults in this space along with the liquidity freeze in the NBFC space caused additional stress to market participants.
The ruling party's failure to form government in Karnataka and three other states in North India has created uncertainty on the outcome of the general election in 2019. The resignation of the RBI Governor also dampened sentiment. However, the market recovered after the announcement of the election results and the Government's decision to appoint Shaktikanta Das at the helm of the central bank.
Our view on the fears around NBFC defaults is that there are still good companies in this space; although they will take a more cautious route to continue lending, the RBI's decision to release liquidity will be positive for this segment. One of the biggest stress factors on the market in 2019 will be the general election and in this scenario, we are advising our investors to stay away from the noise and continue to take an exposure into the markets via dollar-cost averaging (RSP). A victory for the ruling party would mean that there will be continuity in the policies and this will positively aid the growth momentum of the economy.
As of end-December 2018, the Indian equity market trades at 21.4X and 16.7X FY2019's and FY2020's estimated earnings respectively. We maintain an "Attractive" rating of 3.5 stars for the Indian equity market.
US (-14.2% in 4Q 18, -4.4% in 2018 in SGD terms)
US equities underwent one of its worse quarters in Wall Street's history in 4Q 18, with the benchmark S&P 500 Index plunging more than -14.0% in December alone before ending the quarter with a -14.0% loss in USD price terms (-14.2% in SGD price terms). This brings 2018's performance to a -6.2% loss in USD terms (-4.4% in SGD terms). Cyclicals underperformed defensive sectors in the fourth quarter, and the sell-off was not only seen in large-cap stocks but across the mid-cap and small-cap space. Some of the best performing stocks in 4Q 18 include Newmont Mining, Starbucks Corp, Procter & Gamble and CME Group, while bottom performers include the likes of NVIDIA Corp, Nektar Therapeutics, Michael Kors and many energy-related companies.
Earnings estimates of American corporations for 2018 have been revised higher over the quarter by 0.5%, while earnings estimates for 2019 have been revised lower by -1.3%. Focusing on 2019's estimates, the bulk of the downgrades have been seen in the energy and the materials sectors, as lower energy-related and industrial commodity prices weigh on the two sector's prospects. Upgrades have been seen only in the US health care and information technology (IT) sectors over 4Q 18 (as of 28 December 2018).
The US Federal Reserve went ahead with its well-telegraphed hike in its December policy meeting, bringing the Fed Funds rate up by 25 basis points to a range of 2.25% – 2.50%. The Fed reaffirmed that the labour market 'has continued to strengthen and that economic activity has been rising at a strong rate', and that 'risks to the economic outlook are roughly balanced'. The Fed committee also updated its forecasts for both the economy and inflation for 2019 as well as the Fed Funds rate trajectory, with the median line suggesting roughly two 25 basis-points hikes next year. In the press conference, Fed chair Jerome Powell acknowledged that 'financial market volatility has increased over the past couple of months, and overall financial conditions have tightened', but that 'these developments have not fundamentally altered the outlook'. Powell added that the balance sheet runoff remains on 'automatic pilot' and that the Fed is maintaining a data-dependent approach for its guidance for 2019 and beyond. Markets did not take the announcement kindly, with further risk aversion seen as bond yields decline and equities sold off on concerns that the Fed will continue to tighten monetary policy further in 2019.
As of end-2018, US equities trade at estimated PE ratios of 14.0X and 12.6X for 2019 and 2020 respectively, as compared to its fair PE ratio of 15.0X. Overall valuations have improved, but for the moment, we are maintaining our rating of 2.0 Stars "Unattractive" for the US equity market.
Europe (-13.4% in 4Q 18, -15.7% in 2018 in SGD terms)
European equity markets continued their drift lower from the third quarter, with the benchmark Stoxx 600 Index declining -11.9% in EUR terms in 4Q 18 to end the year with a -13.2% loss (-15.7% loss in SGD terms). The sell-off was seen across the continent, with investor sentiment weighed down by Brexit-related concerns as well as the back-and-forth bickering between Brussels and Rome over Italy's proposed budget deficit plans. Some of the best performing stocks in 4Q 18 include the likes of Randgold, Proximus, Vestas Wind Systems and Endesa, while Metro Bank, Royal Mail, Commerzbank and Fresenius Medical Care were found at the bottom this time round.
Earnings estimates of European corporations as a whole were revised lower over the fourth quarter, with 2018's estimates lowered -1.4% while 2019's and 2020's earnings estimates were lowered -2.1% and -2.0% respectively (as of 28 December 2018). European industries such as automobiles, financial services, industrial goods and chemicals saw earnings estimates for 2019 lowered, while revisions among retailers, banks and the construction industry were more muted. The oil and gas industry initially enjoyed earnings upgrades for 2018 and 2019, but projections were lowered by sell-side analysts in December following the plunge in crude oil prices worldwide.
The European Central Bank (ECB) proceeded to wind down its monthly asset purchases in December, and announced in its December policy meeting that principal payments from maturing securities will continue to be reinvested. Leaving benchmark interest rates unchanged, the ECB continues to expect them to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term’. In the press conference, ECB President Mario Draghi reaffirmed that latest economic data ‘have been weaker than expected’, but that overall growth momentum remains supported as labour markets remain robust and domestic demand is supporting business investment. The central bank also remains cognisant of uncertainties related to geopolitical factors, protectionism and recent financial market volatility.
Consequently, European equities trade at 11.9X and 10.9X 2019's and 2020's estimated earnings respectively, as compared to its fair PE ratio of 13.5X, with valuations now lower than where they were before relative to where we deemed them to be fair. Growth momentum has cooled thus far but we do not expect overall growth to fall off the cliff. For the moment, we are maintaining a 2.5 Stars "Neutral" rating for Europe.
South Korea (-13.3% in 4Q 18, -18.8% in 2018 in SGD terms)
As of 31st December, KOSPI index (which represents Korea's equity market) dropped by -18.8% in SGD terms for 2018 (-17.3% in local currency terms). In the fourth quarter alone KOSPI has dropped by -13.3% in SGD terms (-12.7% in local currency terms), the worst quarterly performance since the third quarter in 2011. As an export-oriented economy, it is sensitive to global economic developments. Market concerns over the global economic slowdown, Sino-US trade dispute and the slowdown in semiconductor industry have negatively impacted Korea's equity market as well as the market sentiment.
In terms of economic data, the overall economic data in South Korea for the fourth quarter was relatively weak, in particular for December. Exports in December fell by -1.2% year-on-year, with exports growth slowed down for two consecutive months. Manufacturing PMI came in at 49.8 in December, below 50 for two consecutive months. These were mainly due to global economic slowdown, especially in China, and uncertainty in the Sino-US trade dispute, which combined to exert downward pressure on the Korea market.
Corporate earnings estimates of Korean companies on aggregate have been revised downward in 4Q18. As of 31st December, 2019's and 2020's earnings estimates in the fourth quarter have been revised downward by -10.4% and -8.0% respectively. In particular, we found that the bloom in the semiconductor industry has started to slow down in 4Q 18. As a result from the oversupply of DRAM products, DRAM prices have started to drop, which consequently trimmed down the profit margin of producers. Furthermore, with the decrease in purchase from clients of major data center amid a low-demand season, the semiconductor industry is expected to remain sluggish in 1Q 19. Samsung Electronics, one of the major index constituents, is expected to have a -19% earnings drop in 1Q 19. However, we are still optimistic about the semiconductor business in the future as we believe that there will be a strong demand from 5G business and a possible recovery in 2Q 19 under the current market cycle.
Lastly, KOSPI index's estimated PE ratio for 2019 and 2020 were 8.57X and 7.73X respectively, which is below our estimated target of 12.5X. Although the current market sentiment is relatively weak given the risk factors mentioned above, valuations remain rather attractive compared with other markets. Thus, we maintain our star ratings of the South Korean market at a "Very Attractive" rating of 4.5 stars.
China A (-12.6% in 4Q 18, -27.7% in 2018 in SGD terms)
The China A-share market (as represented by the CSI 300 Index) fell by 12.6% in SGD terms through 4Q 18 and ended up with a return of -27.7% in SGD terms for 2018. It was the worst performer under our market coverage. Looking at sectorial returns in local currency terms, utility became the best-performing sector, albeit with a negative return of -7.2% in 2018. The remaining sectors performed even much weaker. Due to the Sino-US trade spat and the US' trade sanction against ZTE Corporation, the telecommunications sector became the worst-performing sector, generating a negative return of -38.3% in 2018. Investor's risk appetite, having affected by multiple market sell-offs in 2018, had fallen greatly as compared to the beginning of 2018.
The CSI 300 Index had suffered from volatile movements since 29th January, two months prior to the start of the Sino-US trade spat, which highlighted that the trigger of the market downturn was something else other than the trade spat. We believe the following to be those key factors. Financial deleveraging had an excessively negative impact on China's economy, leading to a spike in corporate debt default; implementation of new asset management rules affected off-balance sheet items of China's major commercial banks; recession period of China's real estate industry induced a shrinking demand which trickled down to affect items such as household appliance and urban media; continuous decline of China's total fixed-asset investment growth which was lagged by the sharp deceleration of infrastructure investment. Owing to the combination of the above factors, China's economy slowed as its overall GDP growth rate came in at 6.5% in 3Q 2018.
In addition to the GDP growth rate, other key indicators also reflected the deceleration of China's economy. The official manufacturing PMI dropped to 49.4 in Dec 18, the first time it fell below 50 in 34 months, indicating the manufacturing industry had struggled to expand due to weak demand. As for real estate investment growth, which used to be a huge driver of the Chinese economy, an upturn in the total floor space sold and infrastructural investment growth can be observed in mid-2018, albeit an overall upward trend was less clear and robust.
Regarding its valuation, we believe that the CSI 300 Index had fallen to its historical bottom range, indicating that the downside risks are minimal at the current juncture. According to the market estimation from Wind, the CSI 300 index was trading at a PE ratio of 10.2X as of 28th Dec 18, and its forward PE ratio is 9.8X and 8.7X based on the earnings forecast in 2018 and 2019 respectively, a drastic discount to its fair value of 14.0X. With such low valuation, we believe the China A-share has become very cheap for investors, and we believe the Chinese government will launch a series of fiscal and monetary counter-cyclical policies to stabilize the economy in 2019. As a result, we upgrade China A-share market from "attractive" with 3.5 Stars to 'very attractive' with 4.0 Stars.
Pockets of Opportunity Opening Up
Relative to fixed income markets, equity markets remain more attractive as earnings yields are higher than where we expect fixed income markets to trade at in 2019 and beyond. As mentioned in our Key Investment Themes & 2019 Outlook, we continue to be overweight equities vis-à-vis fixed income for our asset allocation.
With recent moves in financial markets, both bond and equity markets worldwide have seen a general improvement in valuations as a whole. Consequently, pockets of value and opportunities across market segments have appeared, and investors should take advantage of this fact moving forward.