Source : Business Times - 1 Oct 2008
Need of the hour is to invest in a global balanced portfolio complemented by a portfolio of high-yielding Singapore stocks
THE financial chaos engulfing Wall Street has left investors and market observers breathless and shaken by the capitulation of once venerable global financial institutions. Though banks in Singapore have avoided the worst of the credit crunch, with little exposure to the sub-prime crisis, the Singapore stock market has not been spared the carnage ripping through global equity markets since July 2007.
Since the start of the credit crisis in July last year, the Straits Times Index has lost 30 per cent. And on a year-to-date basis as at Sept 16, the index was down 28.7 per cent. The UOB Singapore Government bonds index has also experienced unusually high volatility this year. And with real yields negative thanks to persistently high inflation and low interest rates, Singaporean investors are clearly not having the best of times.
The collapse of Lehman Brothers and takeover of Merrill Lynch by Bank of America in September have left many market participants perplexed and shocked at the scale and speed of the de-leveraging that is unravelling in spite of the US government’s exceptional response to contain the credit crisis. In short, a comatose credit market, combined with massive asset de-leveraging, has caused global capital markets to experience a level of volatility not seen in a long while.
Unfortunately being conservative and staying in cash via fixed deposits may not be the best course of action. Over the 12 years from 1997 to 2007, with an average inflation rate of 0.9 per cent and the average 12-month fixed deposit rate at 1.9 per cent, local investors were getting positive returns of one per cent.
However, that scenario changed drastically towards the end of last year when inflation in Singapore shot up to 25-year high levels. From January 2007 to July 2008, inflation in Singapore (as measured by the Consumer Price Index) averaged 5.3 per cent, while 12-month fixed deposit rates averaged 1.3 per cent. Thus, real yields in Singapore were a hefty -4 per cent.
The message is, therefore, very clear: you need to make certain investments to try to generate returns higher than inflation. Otherwise, your cash in the bank will slowly erode away. Assuming a negative real yield of 3 per cent - inflation at 4.5 per cent and interest rates at 1.5 per cent - $100 today will be worth only $85.90 in five years.
So we need to invest - but what do Singaporeans usually invest in? Until recently, the property market was foremost on many people’s minds. However, a deeper analysis would reveal that investing in property is not attractive as it would seem. For instance, property prices as measured by the URA Residential Property Index yielded a total return of 24.2 per cent, or an annualised return of 1.9 per cent for the period from 1996 to 2007. This return excludes property taxes, stamp duty, commission for selling the property and legal fees that usually add to the expense of investing in physical real estate.
Currently, the local Sing-dollar bond market is not liquid enough for most retail investors, leaving the stock market as the only other realistic alternative for local investors. Despite the local equity market going through a slump from 1996 to 2002, except for a technology-driven rally in 1999, the market, as measured by the MSCI Singapore index, returned an average of 8.2 per annum.
To achieve achieve higher returns than inflation in Sing-dollar assets, we may need to invest in the local stock market. However, with the current spike in uncertainty and resultant volatility, the market has been sold down sharply, and investing in it is not for the faint of heart. Singapore has one of the most open economies in the world and is, therefore, vulnerable to any global economic slowdown. As such, any systemic threat to the world economy is likely to have an impact on Singapore and may affect the stock market. This recent sell-off in the stock market presents some interesting opportunities.
In a highly globalised economy, downturns sparked by asset sales and loan disposals reinforcing one another cannot be contained. As my UBS colleague and US economist George Magnus had pointed out, economic downturns sparked by de-leveraging are not self-correcting and are measured empirically in years and not quarters. Exceptional circumstances like the one we are going through require unorthodox solutions.
To this end, the proposed US$700 billion mortgage bailout package is a step in the right direction. A systemic downturn of the scale we are currently witnessing requires a systemic approach from policy, including intervention via recapitalisation and the establishment of structures to manage a more orderly disposal of assets.
The crux of the problem is now shifting to the fact that even interbank lending has come to an almost complete halt. Despite strong, concerted efforts by central banks globally to continue to pump liquidity into the system, most refinancing operations between banks are currently concentrated on the very short end of the curve, with most of the liquidity traded on weekly maturities.
This disruption in the interbank market is resulting in much tighter credit conditions from the banks, translating into a sharp increase in funding costs not only for banks but also for corporations and leverage-hungry hedge funds. For instance, the average of the Singapore Overnight Rate went from 0.49 per cent on Sept 1, 2008, to 1.7 per cent on Sept 25, (figures from Monetary Authority of Singapore).
As a result of this sharp rise in short-term rates, Singapore Reits have been sold down drastically over the past week on fears they will suffer from higher refinancing costs. But S-Reits do not typically finance on the short end. Current yields now average 9.5 per cent per annum, or +660 basis points spread to the 10-Year Singapore Government bond, based on FY09 estimates. In an environment where there is deep risk aversion, high inflation and low interest rates, the recent sell-off in S-Reits presents a unique opportunity for investors to get exposure to some good-quality, liquid and large-cap trusts such as Parkway Life, Macquarie Prime, CapitaMall Trust and CDL Hospitality Trust.
Other high-yielding, defensive stocks that are likely to post inflation-plus returns based on 2009 earnings include Singapore Press Holdings, which is currently yielding 8 per cent, Singapore Exchange at 6 per cent and SingTel, which is currently yielding 4.24 per cent.
We believe the macroeconomic environment in Singapore is unlikely to deteriorate to the extent of that in 1998 during the Asian Financial Crisis or in 2003 during Sars. We expect the global slowdown to affect Singapore, but it may lead to a slowdown and not a major contraction. At the beginning of the year, we were projecting GDP growth for Singapore at 6.8 per cent for 2008 and 7.9 per cent for 2009. Now our forecasts are 3.5 and 5.9 per cent respectively.
But will the current crisis turn out to be worse than the Asian Financial Crisis or Sars? Where do we stand in relation to these past crises? As noted by my colleague Tan Min Lan, UBS research strategist for Singapore, the STI now trades at 10.1X, all time low on trailing PE. Compared with the worst of the Asian crisis (at 11.2X) and the worst of Sars (at 10.9X), the market is now trading some 7-10 per cent below past crises.
If we use price-to-book value (PB), the trailing PB of key stocks is at 1.8x, close to the -1 Standard Deviation level, but approximately 70 per cent above the worst of the Asian crisis and 22 per cent above the worst of Sars. Note that corporate profitability (ROE) has structurally improved since then, thanks to sale of non-core assets, consolidation, and stronger capital management. ROE was 4.7 per cent in 1998, 7-8 per cent in 2002-03 and 12 per cent in 2008. For ROE to reach the 1998 or 2003 levels, earnings have to fall 60 and 35 per cent respectively from here. In volatile markets where there is a high level of uncertainty, a well-diversified portfolio may help investors lower their risks. Unfortunately, the Singapore capital markets do not provide much depth for local investors to diversify. Besides selective exposure to high-yield stocks in Singapore, investors may also consider diversifying into international capital markets.
For instance, a balanced portfolio with 50 per cent exposure to global equity markets as typified by the MSCI World Equity index and 50 per cent exposure to the global bonds market as typified by the Citigroup World Bonds Index would be down 11 per cent (in Sing-dollar terms) since the crisis started in July last year, much less than the 30 per cent slide the STI has suffered in the same period. Such balanced portfolios generally deliver between 6 and 8 per cent per annum (Sing-dollar terms) over a five-year investment period, with less than half the volatility of the STI.
Depressed investment markets such as we are currently going through often offer good opportunities for investors to build portfolios geared towards the medium to long-term periods. We suggest investing in a global balanced portfolio complemented by a portfolio of high-yielding Singapore stocks with strong balance sheets and a sustainable cashflow business, as mentioned earlier.
On a near-term basis, the markets might be in a range-bound trading environment due to ongoing uncertainty. But over a medium to longer-term basis, the rationale for such a portfolio will become clear.
By KELVIN TAY, deputy head of products & marketing, UBS Wealth Management
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