Position for better end to 2023
• Catalysts for a better end to 2H are inflation cooling further, FED stopping rate hikes, and China’s recovery resuming
• 2 notable developments; El Niño and AI demand picking up
• Positive: Hong Kong and Indonesia; Neutral: Singapore, Thailand and Philippines
Catalysts in play for a better end to 2H. We are more sanguine about how equities may end the year despite ongoing concerns of a global slowdown and higher-for-longer rates. Market valuations have fallen. Equity markets can overcome the seasonally volatile 3Q to finish the year on a better note if Inflation cools further, the FED stops hiking rates and China’s recovery resumes.
El Niño is back! El Niño conditions have developed. 3 potential positive implications are that (1) higher CPO price benefits First Resources, Bumitama Agri and London Sumatra (2) higher beverage consumption benefits Budweiser APAC, CR Beer, Thai Bev and Uni-President while higher sales of cooling-related electronic appliances benefit Home Products (3) demand shift towards fossil fuels favours upstream oil names CNOOC, PetroChina and PTT Exp. & Prod while higher electricity demand is positive for SembCorp Industries. Thankfully, we see little/no impact on tourism despite heightened risk of transboundary haze.
AI breathes new life to tech recovery. Demand of AI-related segments is expected to pick up strongly. Potential beneficiaries along the hardware value chain include front-end equipment manufacturer UMS Hldgs and Lenovo. Alibaba Group also stands to gain through its search engine business and AI Cloud services.
Positive on Hong Kong and Indonesia. We stay positive on Hong Kong with the market’s attractive valuation and policy efforts to drive demand. Top 4 picks are Trip.com, Tencent, Li Auto and China Mobile. We turn positive (prev. neutral) for Indonesia as interest rate look to fall and pre-election spending boosts consumption. Top 4 picks are – BBCA IJ, ICBP IJ, ISAT IJ and LSIP IJ.
Neutral Singapore, Thailand and Philippines GDP growth for Singapore (prev. positive) is cut to 1.7% (prev. 2.2%). Top 4 picks are Keppel Corp, Yangzijiang, ST Engrg and UMS Hldgs. Thailand’s (prev. positive) forward PE valuation vs. GDP growth is the least attractive among EMs under our coverage. YE SET Index target is 1,650. Top 4 picks are Airport of Thailand, AMATA, CPALL and Central Pattana. The Philippines (prev. negative) market looks the most attractive from a GDP growth to forward PE valuation perspective. Top 4 picks are Bank of Philippine Islands, RL Commercial REIT, MREIT, Inc and Century Pacific Food Inc.
Macro Outlook
El Niño is back!
El Niño conditions have developed and are expected to continue for the rest of 2023 and beyond, according to the latest June update by US government agency the National Oceanic and Atmospheric Administration (NOAA). There is an 84% chance that this will be a moderate El Niño event, and a 56% chance that it will be a strong one.
Here are three potential implications of El Niño:
1) Positive for CPO price. Warmer temperatures and/or drought would lead to higher agri-commodities prices (e.g. water-intensive crops like CPO, rice, sugarcane, soybean) on tighter supplies and output. As some of these agri-commodities serve as key inputs or staples for consumers in this region, a possible resurgence of food inflation is a risk that bears watching.
The onset of El Niño, coupled with an already bottoming trend for CPO, bodes well for CPO price and plantation stocks going forward. We see a conducive backdrop for CPO price to stage a recovery as (i) output remains tight under El Niño, (ii) CPO prices bottoming, as noted by our plantation analysts, and (iii) expectation for brent oil prices to be supported this/next year at US$82-87/bbl. CPO stock picks under our coverage are First Resources (FR SP), Bumitama Agri (BAL SP), and London Sumatera (LSIP IJ) for upstream; Wilmar International (WIL SP) for integrated exposure.
2) Positive for beverage consumption and cooling devices. An ice-cold beverage, be it alcoholic or non-alcoholic, is a good way to beat the heat, which benefits beverages makers – especially those that can pass through rising input cost to customers. We prefer breweries. Our picks are Budweiser APAC (1876 HK), CR Beer (291 HK), and Thai Beverage (THBEV SP). We pick Uni-President (220 HK) for non-alcoholic beverage manufacturers.
Cooling devices such as air conditioners becomes more necessity than luxury when the temperature rises, even without El Niño. The International Energy Agency expects 10 new air conditioners sold every second between now to 2050. These benefit (i) manufacturers of these appliances, and (ii) energy providers given the high electricity-consumption of these devices. Home Product Centre (HMPRO TB) is a potential beneficiary through higher sales of electronic appliances such as fans, aircons, cooling-related products, or even dehumidifiers.
3) Energy generation. Ceteris paribus, hotter and drier conditions lead to higher-than-expected power demand in countries in the Asia Pacific region, in turn raising fossil fuel demand and supporting energy commodity prices. Reduced rainfall and lower windspeed during El Niño is negative for hydropower and wind power generation in affected countries that should also shift demand towards fossil fuels. Our regional energy team continues to favour upstream oil names CNOOC (883 HK), Petrochina (857 HK), and PTT Exploration and Production (PTTEP TB) but do not necessarily ascribe any key catalysts from the El Niño event to share prices. Sembcorp Industries (SCI SP) should benefit on sustained electricity prices/demand amid the tight power market in Singapore, coupled with its “brown-to-green” transformation strategy.
4) Little/no impact on tourism. We see little to no impact on tourism despite the heightened risk of transboundary haze due to the combination of higher temperature and reduced rainfall. One consequence of the previous major El Niño event that spanned Oct-14 to May-16 was the severe haze situation in 2015 that engulfed many parts of Indonesia (except Java), Singapore, Malaysia, and Southern Thailand.
Singapore’s Institute of International Affairs has warned about a high risk of transboundary haze this year. The transboundary haze affects Singapore the worst, because there’s nowhere to hide given Singapore’s tiny land area. Thankfully, data shows that Singapore’s tourist arrivals stayed resilient during the haze years of 2015 (severe), 2016, and 2019 (moderate).
Looking back at the period from August to October when the haze risk is highest, the y-o-y drop in 2014 visitor arrivals was due to Chinese travellers boycotting the Southeast Asia region following the MH370 disappearance. However, this figure started to recover from 2015 onwards as Chinese tourists returned despite the haze situation.
The steady return of Chinese visitors should further drive the recovery of regional tourism going forward.
Is Artificial Intelligence the tipping point of a new computer era?
The AI theme, while not new, found a strong second wind when OpenAI’s ChatGPT demonstrated the potential and wide-ranging use of generative AI. Microsoft’s US$10bn investment into OpenAI, the influx of competition like Google’s Bard/Baidu’s Ernie, and chipmaker Nvidia’s ‘blow-out’ guidance for huge AI-related demand amid the ongoing downturn, shows the potential that market players see in this space.
Forecasts from Bloomberg point to a strong pick-up in growth/demand for AI-related segments this year onwards, with generative AI expected to be a US$1.3trn market by 2032. First, companies involved in the hardware segment should benefit as it is poised to be the largest segment at US$642bil, representing about 50% of total spending in 2032. Second, the expectation for revenue to double and register the sharpest growth in 2024 was taken as a positive sign of recovery to come.
Positive share price performances amongst various global semiconductor companies suggest that investors are looking beyond obvious AI-plays (e.g., Nvidia) to other potential beneficiaries along the value chain. Positive spill-over from the AI boom may benefit other parts of the value chain including foundries and equipment makers in the front end, to outsourced semiconductor assembly and testing (OSAT) players in the backend.
Potential beneficiaries along the hardware value chain include front-end equipment manufacturer UMS Holdings (UMSH SP), and Lenovo (992 HK) given its exposure to AI servers in this region. Baidu (9888 HK) also stands to gain from the proliferation of AI, which enhances efficiency and revenue for its search engine business and increase demand for its AI Cloud services and solutions in China.
Overcoming China’s uneven recovery
Recent data releases from China have thrown the sustainability of its post zero-COVID recovery into doubt, especially for the manufacturing sector. But while the manufacturing sector’s 1Q recovery looks to have slowed in recent months, China’s services sector recovery remains resilient. Furthermore, the PBOC has various tools on hand to bolster economic recovery. Rather than a warning sign that China’s economic rebound that started in January has stalled, we believe this is a more uneven recovery that will take time to smooth out. DBS economic research is keeping our 5.5% GDP growth forecast for 2023.
Exports recovery turned down in April and fell 7.5% y-o-y by May, a consequence of weakening global demand. Imports contracted for a second month, down 4.5% y-o-y. These were despite the low-base comparison given the two-month Shanghai lockdown in April and May 2022. Shanghai ports contributed around 19% of China’s total freight back in pre-COVID. The official manufacturing PMI has also sunk back to contraction territory in April and May after a brief 1Q expansion.
However, it’s not all doom and gloom. The Caixin manufacturing PMI that surveys small and mid-size companies returned to expansion territory in May. Services PMI continued its expansion with the strong 57.1 reading for May. This is similar to the experience of other countries that have shifted to the COVID endemic.
The uneven recovery between the manufacturing and services sector was also evident in the dull industrial production recovery vs. the strong retail sales expansion.
On a positive note, DBS Economic Research sees various tools available to the PBOC to keep monetary conditions accommodative and bolster economic recovery. The PBOC cut its one-year mid-term lending facility (MLF) from 2.75% to 2.65% amid signs of fading recovery. Our China economist sees another 10bps hike in 3Q. The deposit rates cut could help unleash some spending power held by the record-high new saving deposits. The recent lowering of the banks’ deposit rate ceilings allows banks to cut loan prime rates in the months ahead. The PBOC may also trim the required reserve ratio (RRR) in 2H23. Finally, the Chinese government may deploy structural tools complementing fiscal policy to bolster credit growth, such as re-lending programs for infrastructure financing.
Inflation is cooling off. Firstly, supply chain disruptions from the Russia-Ukraine war, and China’s strict zero-COVID policy last year, have eased. This sets a favourable high-base effect compared to y-o-y CPI numbers going forward. Secondly, the global manufacturing slowdown has affected demand for metal, energy, and freight services. As a result, food and energy prices – as well as freight rates that drove inflation last year – have fallen considerably on a y-o-y basis by 20%, 40%, and 82% respectively.
While inflation is moderating, it will take time to return to the pre-COVID level. Most countries under our coverage continue to see above-trend inflation this year. A further downside to inflation may also be limited at this point, as it takes a substantial demand shock or major global economic downturn to bring US inflation down to below 3%, in our economists’ view.
Sticky, elevated service inflation is one reason why core inflation should stay firm. Services demand and spending in the US remain robust on historically low unemployment and positive real wages growth, putting services PMI firmly in the expansionary territory. While less pronounced for the region, service inflation should stay firm on the continuing recovery/reopening of economies.
Oil prices are also likely to find support around the US$80/bbl mark, as demand-supply dynamics look balanced for now. Positive factors going for oil demand and prices – period of seasonally higher oil demand regardless of recession, China’s reopening, latest OPEC+ production cuts and US restocking its strategic petroleum reserve – are nevertheless balanced by (fears of) slowing global economy.
A strong pick-up in China’s rebound and return of food inflation are potential drivers of inflationary risk. Food inflation is another to watch – prices of key input/agricultural commodities can rise if El Niño’s warmer conditions weigh on their output and supply.
The current weakness in industrial metals, due to China’s lacklustre and/or service-led recovery, can quickly reverse as manufacturing/construction activities resume significantly on policy easing and improving sentiments. Equity markets will welcome a pickup in industrial metal prices though, especially if it is driven by China’s manufacturing recovery.
Nearing the end of current rate hike cycle
The FED’s pause in June may not spell the end of the current rate hike cycle. DBS Economic Research sees one more hike in July given the US economy’s resilience thus far, before this rate hike cycle ends with FED funds rate at 5.5%. While not the base view, our economist raised the possibility of a second hike in 4Q if China and Europe are able to lead a recovery in external demand.
Be it one or two more hikes, what’s important is that the current rate hike cycle is nearing the end. US real interest rates rose to the highest level since 2010. We believe equity investors will not get nervous if a second hike does materialize in 2H23, driven by China’s and Europe’s recoveries, which will be positive for regional economies.
While rates are peaking, it’s likely to stay higher-for-longer given the sticky inflation expectation. DBS Economic Research continues to see no rate cuts through 1H24 with 100bps cut only in 2H24.
Equities tend to do well when rate hike cycle ends
The US rate hike cycle paused four times in the past 30 years. History shows that equity markets have a high tendency to reward investors with positive returns through the period that the FED stopped its rate hike cycle and held rates steady. Except for 2000 – during the Dot.com bubble burst – the US and regional equity markets enjoyed positive returns, supported by factors such as trade optimism, M&A activities, benign economic conditions and strong earnings.
Taking this as a guide, a pause to the current rate hike cycle could see the YTD rally in US equity markets holding up well in 2H23, which can provide a positive backdrop for regional markets.
Regional equity indices under our coverage were down YTD – except for the Jakarta Composite Index. Investor sentiment was affected by (1) China’s manufacturing recovery faltering amid the weak property market, (2) hawkish central banks, (3) the US’s regional banking crisis, and (4) concerns about impending recession in the developed markets of the US and Europe.
Regional equity indices start off 2H23 with a subdued forward PE valuation as equity markets worked to price in the negatives over the past six months. The 12-month forward PE valuations of the Hang Seng Index (HSI), Jakarta Compositive Index (JCI), Straits Times Index (STI), and the Philippines Stock Exchange Index (PSEI) are all well below their respective historical 10-yr average. The PSEI looks most attractive from a GDP growth to forward PE valuation perspective. Forward PE valuation for the Stock Exchange of Thailand Index (SET) looks relatively least attractive trading at its historical average. Singapore has the lowest GDP growth outlook among our coverage but the low forward PE valuation of the STI relative to its 10-year average suggests that much of the negatives may already be priced in.
While concerns about a global slowdown, technical recession risk, and higher-for-longer rates remain, we are more sanguine about how equities may end the year for the following reasons:
1) The PBOC has various tools available to keep monetary conditions accommodative (e.g., lowering MLT, deposit rates, and RRR) and bolster economic recovery (e.g., re-lending programmes for infrastructure financing)
2) Inflation is cooling, albeit at a gradual pace. Energy, food, industrial metals, and freight rates have fallen amid slower global demand and the easing of supply chain disruptions from the Russia-Ukraine war and China’s zero-COVID policies.
3) The worst of the manufacturing slowdown was passing away, with 2Q23 being the low point. The strong pick-up in growth/demand for generative AI may well speed up the semiconductor sector recovery.
4) The current FED rate hike cycle was nearing the end, with an anticipated final hike at the July FED meeting. We believe equity investors will not get nervous if a second hike does materialise in 2H23 driven by China and Europe recovery, which has a positive implication for regional economies.
5) Equity markets tend to enjoy positive returns when the FED pauses its rate hike cycle, which can provide a positive backdrop for regional markets in 2H.
6) Regional markets have been pricing in slowdown, or even technical recession worries, YTD. Forward index PE valuation for Singapore, Hong Kong, and the Philippines have sunk close to -2SD of their historical average. This opens the rerating potential if the China’s slowdown stabilizes and recovers, or the anticipated global slowdown is shallower or shorter than feared.
3Q is a seasonally volatile period for equities. But 1H’s performance of regional equity indices has been disappointing, and valuations have retreated closer towards trough. We do not rule out regional equity indices heading towards our anticipated YE target to end the year on a better note if inflation continues to cool, the FED stops raising rates and China’s recovery resumes.
Positive on Hong Kong and Indonesia
We stay positive on Hong Kong despite the Hang Seng Index’s 4.5% decline YTD. Stocks of mainland companies listed in Hong Kong have the most attractive PEG valuation and highest yield compared to our regional coverage. Policy efforts should underpin consumer demand and provide support to strategically important industries such as new energy vehicles (NEV), semiconductor and high-end manufacturing. Large-scale fiscal support for infrastructure will be a positive surprise. China-US relations are also stabilizing, which could partially restore foreign investors’ risk appetite. But higher-for-longer US interest rates remain a source of volatility. Our year-end HSI target is 23,400 based on a 11.3X 12-mth fwd PE. Our themes are (1) fundamental recovery post-reopening Samsonite International (1910 HK), Trip.com (9961 HK), Alibaba Group (9988 HK), Tencent (700 HK) (2) Beneficiaries of policy stimulus Longfor Properties (960 HK), Hua Hong Semiconductor (1347 HK), Li Auto (2015 HK), ANTA Sports (2020 HK), Ping An Insurance (2318 HK), and (3) SOE China Mobile (941 HK) which offers stable return.
We turn positive (prev. neutral) for Indonesia as domestic inflationary pressure eases and Bank Indonesia (BI) is seen cutting rates by 75bps rate by year-end. Dovish policies and stable currency generally supports foreign inflow, which has been positive YTD. We expect pre-election spending to help domestic consumption, advertising, and services sectors as well as market sentiment, especially in 4Q23. The Indonesian market currently trades at just over 13x FY23F forward PE multiple, which is the lowest in the last five years except during the pandemic in 2020. Our year-end 2023 JCI index target is 7,500, pegged to a 15.3x blended forward PE multiple or c.10-year average. Themes are (1) domestic economy resilience Bank Central Asia (BBCA), Indofood CBP (ICBP), and Indosat Hutchinson (ISAT), (2) Election beneficiaries Indofood CBP (ICBP), Matahari Dep Store (LPPF), and XL Axiata (EXCL) that are election-spending proxies, (3) El Niño beneficiaries London Sumatera (LSIP), Indofood Sukses (INDF), and Mitra Adiperkasa (MAPI).
Neutral on Singapore, Thailand and Philippines
We turn neutral (prev. positive) for Singapore. YE target was lowered to 3,450 (prev. 3,600) pegged to an 11.5X (-1.5SD) FY24F PE. 2023 GDP growth was lowered to 1.7% (prev. 2.2%) amid uncertainty over the manufacturing sector’s recovery and normalizing service sector recovery. STI earnings revision has been stable over the past six months and dividend yield was attractive vs. regional peers. While the STI has been the second-best performing country index under our coverage YTD, NIM expansion for banks is poised to end while loans growth and non-interest income recovery was maybe weaker-than-expected. The services sector is expected to stay resilient with the travel-related cluster benefiting from the continued recovery in Chinese visitor arrivals. We like (1) industrial names like Keppel Corp (KEP), Seatrium (STM SP) and Yangzijiang (YZJSGD SP) that can benefit from firm oil prices and the ongoing transition towards renewable energy (2) rate pause beneficiaries Far East Hospitality Trust (FEHT SP), ST Engineering (STE SP), and UMS (UMSH SP) (3) potential El Niño beneficiaries First Resources (FR SP), Bumitama (BAL SP), Wilmar (WIL SP), ThaiBev (THBEV SP), and Sembcorp Industries (SCI SP).
We turn neutral (prev. positive) for Thailand considering that SET Index’s 12-mth fwd PE of 15.2X vs. blended 2023/24 GDP growth of 3.6% is the least attractive among Ems under our coverage. Thankfully, we expect clarity on the political front from 3Q23 as a new government comes into place that should be positive for the stock market. Growth should still be supported by the tourism upswing and resilient private consumption. Exports face global external headwinds, but the pace of decline appears to be easing and should start to recover next year. Themes are (1) Accelerated tourism recovery such as Airports of Thailand (AOT), Bangkok Dusit Medical Services (BDMS), and Siam Wellness Group (SPA), (2) Production relocation from China that benefits Amata Corporation (AMATA), (3) Beneficiaries of falling inflation Berli Jucker (BJC), CP All (CPALL), Central Pattana (CPN), and Central Retail Corporation (CRC), and (4) El Niño that positively impacts Home Product Center (HMPRO).
We turn neutral (prev. positive) on Philippines considering that the PSEI is the most attractive from a GDP growth to forward PE valuation perspective. Concerns about an end to easy money, attractive bond yields, uncertain inflation outlook, deteriorating fiscal health, weakening external trade dynamics and negative operating as well as financial leverage at the corporate level is keeping PSEI upside at bay despite improving economic data and robust earnings forecast. But with an index valuation approaching trough, we advocate accumulating on weakness towards PSEI 6,150 or slightly above. Themes are (1) the improving trade-off between monetary policy and financial stability objectives that benefits Bank of the Philippine Islands (BPI PM) and Metropolitan Bank & Trust Company (MBT PM) (2) Approaching end of FED rate hike cycle RL Commercial REIT Inc (RCR PM), MREIT Inc. (MREIT PM), AREIT Inc. (AREIT PM) and PLDT Inc (TEL PM) (3) Earnings resilience Century Pacific Food Inc (CNPF PM), Universal Robina Corp (URC PM) and Jollibee Foods Corp. (JFC PM).