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As stock indices in Asian markets climb on improving economic data and quantitative easing programmes, the Singapore market has been left behind. Year-to-date, the benchmark Straits Times Index is up 15.1% against the stronger showing by regional markets such as the Philippines (24.4%) and Thailand (26.9%). The Philippines Stock Exchange PSEi Index has surpassed its pre-crisis high by 40.4%. The Stock Exchange of Thailand Index is 42.2% above its previous peak. The STI, on the other hand, is currently 20.5% below the 3,831.2 points it touched on Oct 11, 2007.

  To be sure, Singapore is no longer a developing market and doesn’ t enjoy the same rate of GDP growth as its neighbours. Yet, even in the US, where GDP growth was an anaemic 1.3% in 2Q2012, benchmark stock indices have recovered more quickly. The Standard & Poor’ s 500 Index, for instance, is now just 7% away from its October 2007 peak. The Dow Jones Industrial Average is 4.3% away. What ails our stock market?

A closer look at the data suggests that Singapore’ s stocks are moving, but there has been a wide variance in their performance. Unlike the universal bounce that the market experienced in 2009, when it would have been hard to pick a loser on the STI, or for that matter on any other index in almost any major market around the world. The present stock market recovery has seen some heavyweight stocks deliver massive outperformance and others sag dramatically.

At the top of the table are CapitaMalls Asia and CapitaLand, up 55.3% and 47.6% respectively. Previously seen as undervalued, these stocks have finally caught up with the strength of the physical property market and now reflect expectations of further growth locally and in the region, going forward. At No 4 is Fraser and Neave (F& N), which has risen 43.2% on the back of M& A interest. At the other end of the spectrum and weighing down the index are commodity-related names such as Wilmar International (down 35.4%), Golden Agri-Resources (down 11.2%) and Olam International (down 5.6%). Global growth concerns and volatile commodity prices have hit these companies hard. (See Table for Performance of the STI relative to other indices.)

This stark disparity shows up in the performance of the Dow too. Currently, Bank of America and Home Depot lead with gains of 70.1% and 44.8%, respectively. Hewlett- Packard and Intel, however, are down 43.3% and 7.8%, respectively. Such wide variances in performance make a good case for active stock-picking rather than passive index funds. But should investors stick with stocks that have already outperformed? Or, should they rotate into those that have lagged behind? Are there any potential winners that have been overlooked by the market?

TAKE A LESS RISK
On the face of it, the principal theme in the market now is risk. This year, money has flowed into perceived safe havens and income- yielding assets such as real estate investment trusts, telcos and emerging market bonds. Some of the best performers on the STI this year are investor favourites for their steady cash flow generation and diversified business portfolios. Investors have also gravitated towards large companies with steady, visible and diversified sources of revenue.

ST Engineering, for instance, has a healthy dividend yield of close to 5% and significant earnings visibility, thanks to a strong order book (see “ ST Engineering’ s MRO orders bounce back” on Page 8). Jardine Strategic Holdings, meanwhile, has steady income generators such as supermarkets and convenience stores, as well as interests in the property, hospitality, commodities and automotive segments. Even CapitaLand which, as a property stock can’ t rightfully be counted in the low-risk basket, is a favourite for its broad property scope. Credit Suisse, for instance, says CapitaLand is its top pick in the developer space as it is “ much more diversified with a strong recurring income stream from its office, retail and fund management businesses” .

Romain Boscher, global head of equities at Amundi Asset Management, says the risk aversion that we see today is not only natural, but also suitable for the period of deleveraging and lower growth that we are facing. “ In the past, we were in a high-growth and quite low-risk environment. Then, the relationship between risk and reward was quite clear: Higher risks would mean higher rewards,” Boscher says. “ Today, our view is the opposite. We are facing a new market environment with more risk and less returns. That means we have to manage an equity portfolio differently. If we are able to dramatically reduce the risk, we will significantly improve the return.”

His focus of late is less on beating a benchmark index by seeking alpha or adding risk. Rather, he believes that the least risky options will likely generate the best performance. “ In such an environment, you have to first think about return of investment rather than return on investment,” Boscher adds.

What strategies should investors use in the new market paradigm? Over the last five years or so, since the deleveraging cycle began,

Boscher has been implementing some principles for what he calls “ next-generation equities” at some of the funds he manages. These include buying stocks with the lowest levels of volatility and downside risk versus their peers in a sector, using options to increase equity market participation on the upside and introducing a bias towards stocks with high dividend yields.

 


BUY BIG BRANDS
Another broader market theme that has distinguished the outperformers from the underperformers in global equity markets is brand power. Mark Ong, chief investment officer and partner at boutique fund manager Barker Investment Management, points out that although Asia’ s GDP growth has been much stronger over the last 20 years, its equity market returns still lag the US. One important reason for this, he says, is that although much of the world’ s goods are produced in Asia, the profits still mostly accrue to the Western players.

To illustrate, Ong points to the US-listed electronics maker Apple. “ Apple designs products and markets them. But the products are made in Asia, largely China. Apple has the creativity and innovation, critical for design and marketing. Asian companies have cheap labour, cheap space and cheap energy. That seems like a reasonable split of specialisations, right? But what is of most interest to us here is how the spoils are divided.”

Ong notes that Apple enjoys a net margin of 25%. Meanwhile, its Taiwan-listed supplier Hon Hai Precision Industry Co has a net margin of less than 2%. This difference trickles through to the net return: 36% for Apple since the release of the first iPhone, versus -7% for Hon Hai. “ The takeaway should be clear: The brand owner takes most of the cake and Asia doesn’ t own many of the top brands. We need to own the companies that own the intellectual property.”

Of course, having a world-class brand is not a sure-fire formula for success because competition can change brand equity. Just look at where the shares of former hot-brand owners such as Research In Motion and Hewlett-Packard are today. Home-grown Singapore Airlines, widely acknowledged as one of the world’ s top airline brands and the only Singapore brand to regularly make it into Fortune magazine’ s list of top international brand names, is languishing today. It is up just 4.4% year-to-date as it wrestles with higher fuel costs, travellers’ propensities to opt for low-cost carriers and strong competition from Middle Eastern brands in its traditional area of strength: luxury and business travel.

Perhaps one reason that the Singapore market has lagged recently is that it lacks heavyweight companies with ascending brand names, despite being a developed economy. Indeed, some of the home-grown consumer brands that do exist have recently become takeover targets by acquirers who are betting they can grow them faster.

This year, Tiger beer maker Asia Pacific Breweries has been acquired by Heineken, while Thai Beverage and some of its affiliates have made a bid for F& N. Meanwhile, shares in Yeo Hiap Seng have rocketed on talk of a takeover, while other forgotten consumer brand-name companies such as Auric Pacific and Super Group have seen active trading interest.

To be fair, Singapore does have a handful of companies that are recognised as being globally competitive in their fields. Shipyard operators Keppel Corp and Sembcorp Marine, for instance, have been winning orders this year from faraway Brazil. In fact, SembMarine and its parent Sembcorp Industries are both on the list of outperformers this year, up 32.1% and 36.3% respectively.

Boscher of Amundi says despite the riskier investing environment, this is no time for investors to sit on the sidelines. “ We can’ t expect a normalisation in the short term [so it would be a] wrong solution to be patient and wait for a comeback to the previous situation,” he says. Rather, investors should try to identify new winners in the months ahead.

Who might these winners be? One relatively safe sector that looks likely to continue outperforming is real estate investment trusts (REITs). Quality names such as CapitaMall Trust (CMT), Keppel REIT and Frasers Centrepoint Trust have outperformed the STI this year as investors turn to them for yields. At current levels, these REITs have yields of 4.7%, 6.2% and 5.1%, respectively. While they are no longer as undervalued as they were a year ago, they have continued to touch new highs because of the relative attractiveness of their assets.

Another low-risk industry is healthcare. Here, Singapore companies also tend to enjoy some brand cachet regionally as well as internationally. The recently-listed IHH Healthcare has a relatively high price-to-earnings multiple of 43.8 times but Raffles Medical Group is slightly more affordable at 25.6 times earnings and it is expanding overseas.

Finally, United Overseas Bank (UOB), although it doesn’ t operate in a low-risk industry, is a relatively safe stock. As a bank, it is well-known for its conservative position. That doesn’ t mean, however, it isn’ t growing. UOB has a strong brand presence in Southeast Asia. It currently trades at 1.4 times book value and has a dividend yield of 3.2%.

For investors seeking outperformers with either a relatively low-risk profile or a strong brand, these companies could be interesting opportunities. (See Table for The best and worst performers on the STI.)

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The recent move by China to boost fiscal spending, as well as the purchase of bonds and mortgage-backed securities by the European Central Bank (ECB) and US Federal Reserve respectively should provide support for equities in the near term. However, Lorraine Tan, vicepresident of research, Asia, at S& P Capital IQ, cautions that the underlying risks have not changed. She says investors should stay neutral with a defensive stance when it comes to equities.

  “The two key known risks are slowing global economic growth and financial market stability,” says Tan, adding that risks will continue to emanate from the eurozone as Greece and Spain look likely to miss debt targets and seek more funding.

She sees the risk of a deeper recession in Europe to be “relatively high at 40%, a US recession at 25% and a hard landing in China at 10%”. The worst-case scenario will most likely stem from the eurozone debt crisis if one of the troubled countries is locked out of the debt market.

However, with the ECB having taken steps to defer this risk, Tan expects the US to grow 2.1% this year, the eurozone to contract 0.6% and China to manage a soft landing at 7.8% to 8% growth. Next year, she expects the US, the eurozone countries and China to grow 1.8%, 0.4% and 8.2% respectively.

“While we think these moves should help restore some confidence for the near term in the financial markets, the uptick to the real economy may take some time to filter through,” says Tan.

ASIA’S EXPORT WOES
Meanwhile, Asian governments are expected to take steps to boost domestic confidence as regional trade data continues to disappoint, says Tan. However, they will be prudent to maintain a targeted policy owing to inflation risks.

“We don’t see the region’s manufacturing activity picking up much in September as companies continue to defer expenditure,” she says, adding
that restocking and pre-Christmas activity are also looking relatively lacklustre.

“As such, we think a sign of improving domestic spending will be a key positive for Asian markets, but do not expect to see this come through until end-October.” In August, manufacturing and external activity in China continued to moderate. Industrial production growth eased to 8.9% y-o-y, the slowest since May 2009, while exports grew just 2.7% y-o-y.

Singapore’s non-oil domestic exports fell 10.6% y-o-y in August, led by a drop in electronics exports. This is a much bigger drop than a Reuters market poll estimate of a 4% decline. Tan attributes this weakness to exports to Europe.

Japan’s data also remained generally lacklustre, although a betterthan- expected 4.6% m-o-m pickup in machinery orders in July helped boost sentiment. This came after 2Q GDP growth was lowered to 0.7%
q-o-q from the preliminary figure of 1.4% q-o-q while the fall in July’s industrial production was revised to 1% y-o-y from 1.2% y-o-y in the preliminary reading. According to Bloomberg consensus, the market is looking at Japan growing 2.5% in 2012, but the recent data has lowered this expectation, says Tan.

 


STAYING DEFENSIVE
Despite the series of disappointing macro data and earnings results in July and August, selling pressure has been somewhat contained as markets underperformed last year and stayed weak in 2Q, says Tan.

After the latest earnings releases, the regional market has lowered its earnings per share (EPS) growth estimates for this year to 5.1% from 7.5%. However, Tan thinks this has already been reflected in most valuations, although it should be noted that China stocks bore the brunt of the macroeconomic and earnings worries. The Shanghai Composite Index is down 3.2% YTD, losing 8% since end-July, making it the worst performing market in Asia.

In terms of sectors, the key change for S& P over the past month was the lowering of real estate to “market weight” after being “overweight” since end-2011. This move follows the industry’s relative outperformance and S& P Capital IQ’s view that the risk of further policy restrictions would rise with transactions rebounding sharply in Hong Kong.

S& P has also shifted industrials and materials to “underweight” on signs that companies are deferring capital expenditure. “The slower recovery in capacity utilisation likely spells pressure on cash flows for the two sectors and, therefore, added financial risk,” says Tan. However, S& P is “overweight” on the energy, IT and utilities sectors.

“We continue to believe the former two will benefit from a potential pick-up in the economy while the latter is relatively defensive and is seeing stable cash flow, particularly with interest rates declining or staying low,” says Tan. She prefers stocks with industry-leading margins and market positions. “The performance across sectors has not been that uniform, so some have done much better than others and that’s a reflection of how efficient a company is and how effective it is at cost-cutting.”

She likes CapitaLand for its multi- sector property exposure to the residential, commercial and hospitality segments as well as geographical diversification. “This diversification enables the group to weather the volatility of property cycles as well as policy risks, particularly in the residential sector,” she says. CapitaLand also has a growing real-estate fund management business, which has $36.1 billion of assets under management. As at end 2QFY2012, the company’s healthy balance sheet — cash and cash equivalents of $5.07 billion and a net gearing of 0.54 times — will enable it to make opportunistic acquisitions, says Tan.

Meanwhile, DBS Group Holdings’ loan pipeline remains decent. Tan expects the completion of its purchase of Bank Danamon to remove an overhanging uncertainty. With steady earnings delivery, she expects the return- on-equity gap between DBS and its peers to close by 2014, at about 11%. DBS offers dividend yields of 4% to 5%.

Tan’s top pick within the operations and maintenance space is Sembcorp Marine, as she expects the company to be a major beneficiary of a pickup in exploration and production spending, particularly by Petrobas. The group’s technological advantage, execution track record and strong balance sheet with net cash of $1.95 billion as at end-2011 will help it through any short-term soft patch, adds Tan.

While Tan does not have an explicit call on Dyna-Mac Holdings, she believes it bears watching as there may be upside potential to its earnings estimates. She predicts that Dyna-Mac’s aggressive expansion into new yard capacity reflects the healthy tenders currently, which may translate into stronger contract replenishments in 2H2012. She is also positive on its floating production, storage and offloading order flow over the medium term as upstream focus shifts more towards deep water production. (See Charts.)

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Singapore’s industrial production unexpectedly fell in August from a year ago, raising fears the trade-dependent economy will slip into recession this quarter, and increasing the chances of monetary easing by the central bank next month.

The city-state’s manufacturing sector fell 2.2% last month from a year ago, dragged down by slumping demand for its key exports of electronics, the Economic Development Board said on Wednesday.

Economists polled by Reuters had expected industrial production to rise 1.1% year-on-year but stay unchanged month-on-month after seasonal adjustments.

“Unless we see industrial production rebound by at least 6% year-on-year in September, Singapore will probably fall into a recession in the third quarter,” said CIMB regional economist Song Seng Wun.

On a seasonally adjusted basis, industrial production declined by 2.3% in August from July when output fell a revised 8.7% month-on-month.

Manufacturing accounts for about a quarter of Singapore’s gross domestic product. Other Asian nations have also reported slowing factory output because of weak export orders from the United States and Europe.

The U.S. dollar rose against the Singapore dollar after the data, rising to $1.2308 from $1.2305.

Singapore’s economy shrank 0.7% in the second quarter on an annualised and seasonally adjusted quarter-on-quarter basis as manufacturing and services both shrank, and a quarterly contraction in July-September will put the city-state in technical recession.

In that case, the central bank will be under greater pressure to ease monetary policy at its meeting next month.


DIFFICULT TO PREDICT
Singapore’s industrial production is difficult to predict because pharmaceuticals and oil rigs tend to be highly volatile from month to month.

CIMB’s Song said while the drop in marine and offshore engineering output was “computational”, given the strong order books of rig builders Keppel Corp and Sembcorp Marine, the electronics sector faced serious difficulties.

Output from the electronics cluster fell 7.3% year-on-year while the marine and offshore engineering segment, which includes oil rigs, contracted 27.2%.

Singapore’s non-oil domestic exports fell a more-than-expected 9.1% in August from July after seasonal adjustments and the Purchasing Manager’s Index (PMI) stayed below the 50-point level for a second straight month in August.

“We have not really tapped into these product launches that are occurring in North Asia right now, like iPhone 5 and so on. We are more of the secondary component suppliers and that’s hurting us,” said Barclays economist Leong Wai Ho.