As global financial markets are embracing for an inevitable third US Federal Reserve interest rate hike since December 2015 this week, Singapore’s Straits Times Index (STI) is also joining the market frenzy closing at record high levels at close to 3,140 to 3,160 for the past three sessions since last Friday, March 10, 2017. The index’s main drivers have been the banks and property counters which soared after the government introduced some market friendly property cooling easing measures which were generally well received by many investors.
However, the markets entered the new week with uncertainties over Wednesday (early Thursday, Singapore time) US Fed announcement of a potential interest rate hike, the British parliament approval for Prime Minister Theresa May to invoke Article 50 to begin divorce negotiations with the European Union, and French Presidential Elections with candidates like the far-right Le Pen, and moderate Macron leading neck to neck. Oil prices tumbled on Tuesday with the West Texas Intermediate (WTI) falling close to US$47 per barrel. The fall in crude oil prices, on top of the conclusion of the Chinese parliamentary sessions have also featured quite prominently this week. Investors have more than a plateful to digest amid the uncertainties and market volatilities.
How did the STI perform mid-week
The STI was last traded at 3,138 on Wednesday, March 15, 2017, and was down by 0.25 per cent mid-week as markets entered the eve before the highly anticipated official US Fed interest rate hike announcement. The Federal Funds Futures as monitored by the Chicago Mercantile Exchange (CME) Group FedWatch tool last stood at 93 per cent probability of a 75 to 100 basis points (bps) rise in interest rates. There is a unanimous expectation among investors that the US Federal Reserve is likely to be act aggressively in hiking interest rates.
Looking at the one-year daily STI chart above, we noted that the index is trending up with the average directional index (ADX) flattening. We believe that the flattening of the ADX could suggest that momentum has stabilised in anticipation of the expected interest rate hike. The rate of change (ROC) (not shown) has also shown some consolidation and flattening, suggesting market action is mild among the traders.
3-month SIBOR rates
The long-term 3-month Singapore Interbank Offered Rate (SIBOR) has been trending down, and at one point was flattened. It rose slightly this year, but is still below 1.0 per cent despite the impending interest rate hikes from the US Fed. According to Tradingeconomics.com, the 3-month SIBOR last stood at 0.88 per cent on March 13, 2017.
Why are local interest rates generally low despite a rising interest rate environment
Good question! Some answers by most market experts include the generally low inflationary environment in Singapore where consumer prices last hovered at a positive 0.6 per cent in January 2017 relative to December’s 0.2 per cent. The consensus estimates for January figures also matched with the actual figures. Prices are largely held down by the low housing rental costs.
However, most market watchers do not expect low interest rates to continue in Singapore as the economy is generally open, and is still impacted by imported inflationary pressure coming abroad. China, for example has lowered its 2017 gross domestic product (GDP) growth target to 6.5 per cent from last year’s 6.7 per cent. The European Union (EU) is also facing a challenging election season. For the US, the economic policies adopted by the Trump administration appear to be insular, and nationalistic in nature. Moving forward, with the increased infrastructure spending coupled with tighter monetary policies, interest rates in Singapore would generally rise in the long run.
The first rate hike of 2017
The US Federal Reserve announced on Wednesday afternoon (early Thursday morning, Singapore time) that the benchmark Federal Funds Rate has been increased by 25 basis points to 0.75 per cent to 1 per cent, and was in line with widely held expectations. The Federal Open Market Committee (FOMC) has reached a near unanimous decision with only one dissent vote coming from Minneapolis Fed President, Neal Kashkari. The Fed has also indicated that it expects two more rate hikes, and in the statement, it noted that business investment has “firmed somewhat”, a slight upgrade from the characterization of “soft” after the January 31 – February 1 meeting.
Looking at the Federal Fund Futures on the second trading day after the meeting, investors are still expecting the Federal Reserve to raise rates aggressively in the upcoming May meeting with current probability of a 75 to 100 bps hike in rates at 95.7 per cent as compared to 93.6 per cent previously.
Looking at the US Fed projections for the pace of interest rate increases, it appears that by end of 2017, the Federal Funds Rate is slated to head higher to around 1.25 per cent to 1.5 per cent with two rate hikes being factored in. On a longer term, the Federal Funds Rates could end up at around 3 per cent to 4 per cent.
How did the STI react post Fed meeting
Looking at the one-year daily chart of STI, we note that the stochastic indicator is moving higher suggesting momentum is heading upwards. This could be an indication of investors’ bullishness in stocks, and with an open economy like Singapore, the local markets are expected to benefit from a strong US economy. Indeed, in an MAS survey of private economists’ estimates for full-year 2017 gross domestic product (GDP) growth, a majority of them have projected growth of 2.3 per cent, up from the previous forecast of 1.5 per cent. The upgrade was largely due to their optimism of continued manufacturing growth, and better non-oil domestic exports which are projected to rise by 6.1 per cent in 2017, as compared to the 0.3 per cent forecasted in the previous survey in December.
Could STI persist in heading up higher
This is a good question. Frankly, nobody knows. The STI has risen by about 17 to 18 per cent since the trough in June 2016. This is the ninth month of the so-called ‘bull’ market since the STI recorded its lows in June 2016 at 2,703.48 on June 27, 2016. Using the Fibonacci Retracement Tool, we note the following:
The STI is slowing inching itself close to the 100 per cent line on the Fibonacci Retracement line of 3,176.17. If it manages to break this level, we believe the next level to test is 3,180. However, if it does break below, we think we could go down lower to the 78.6 per cent line at 3,073.14. The STI is currently hovering 3,176 at the time of this writing, and is up by around 0.9 per cent for the week since Monday, March 13, 2017.
Biggest beneficiaries during a rising yield environment
Similarly, with the rising momentum of the STI, the FTSE ST Financial Index has also hit its all-time high 864.92, along with a positive momentum reading of 15.79. The rising yield environment has provided some impetus for the increase in the index. One of the reasons banks might benefit from the rising yields is the interest margin spreads are expected to widen, and most banks generally perform better in such conditions. However, some may disagree as in the case of Jefferies, a sell-side brokerage house, reported in a recent Business Times article post rate hike on March 15. The Jefferies report noted that weak domestic private consumption, lower annual job growth than the historical trend, as well as high leverage, domestic rates are likely to stay low and uncorrelated with the US dollar rates, amid ample Singapore Dollar liquidity.
Hang Seng on the move
With the recent rate hikes in US, Hong Kong’s Hang Seng Index (HSI) has also risen significantly and was touted by Reuters.com as the best weekly gain in six months. Although the HSI ended flat, up by 0.1 per cent at 24,309.93 points, the entire week saw a gain of 3.1 per cent. The week has also saw a live televised debate among the candidates for the chief executive position for the Special Administrative Region (SAR) in which television pundits picked John Tsang, the former financial secretary as the clear winner over Ms. Carrie Lam, a former Chief Secretary for Administration. Retired judge Woo Kwok-hing was far behind the lead during the television debate. The Chinese government currently favours Ms. Lam. However, the elections which is scheduled for March 26 is still a tussle among the main contenders, Mr. Tsang and Ms. Lam.
As to how the local elections impact the Hong Kong financial markets, we think that it is quite subtle as seen by the continued push upwards of the Hang Seng Index. However, looking at the negative downtrend shown by the Average Directional Index (ADX) shown below the chart, it appears that the momentum to carry the HSI further upwards is fast diminishing. This may change post elections given that there is still some positive catalysts including China’s trade flows, and continued growth in the US economy might bring about increased commerce and finance-related activities in the territory.
S&P 500 continues to march upwards
The US stock markets got a massive boost on Wednesday (early Thursday morning Singapore time) when the US Federal Reserve hiked rates by 25 bps to 0.75 per cent to one percent. It also indicated that interest rates going forward are likely to be gradual, and they expect two more hikes this year. The stock reacted with much euphoria, with the S&P 500 index closing the week at 2,378.25, up by 0.24 per cent. On a year-to-date (YTD) basis, the index rose 6.23 per cent, while since the elections on November 08, 2016, the index now stands at a positive 11.34 per cent. Although in a rising interest rate environment, one might expect financial stocks to outperform, but it is not the case with US financial stocks falling by 0.9 per cent for the week and was the worst performer in the S&P 500. A possible explanation might be the less than expected aggressiveness in the rate hike expectations coming out from the US Federal Reserve, and this impacted the expected interest margin spreads for bank stocks going forward.
Looking at the ADX, there seems to be a slight fall off in the chart below, and trade volume topped at around 9.4 billion, the most since December 16, 2016, according to CNBC.com. However, there is question on the sustainability of the daily increases in the index, as the current price earnings (P/E) ratio has risen to about 26 to 27 times, compared to the median P/E multiple of 14 to 15 times.
We believe that there are many naysayers about the phenomenal rise in the US stock prices. I am personally one of them, and I do expect a falloff in the index in the magnitude of around 5 to 8 percent by year-end. I would also think that the US markets is relatively expensive, and there are many so-called ‘asset bubbles’ waiting to be burst. The most notable ones are financial stocks which are expected to drive up the premium of the US financial markets because most investors think that financial stocks were beaten hard during the financial crisis in 2008-2009, and are now slowly rising up. However, investors need clarity and understanding on how policy making impacts might impact the stock markets, and so far, there appears to be quite that is quite vague, and there are not a lot of economic plans have bene outlined by President Trump that have reassured investors, except the exit from the Trans-Pacific Partnership (TPP) agreement in late January after taking office.
How did our investment portfolio perform
The model investment portfolio which I have set up since end November 2016 is currently up year-to-date (YTD) at 8.8 per cent as compared to the benchmark STI return of 8.9 per cent during the same period to end at 3,163.52 on Friday, March 17, 2017. The calculation includes both capital and dividend returns. The stock picks which I have included in the portfolio are based on the combination of fundamental and technical analysis. The best performing stock on a capital return basis is Dairy Farm Holdings which rose by 29 per cent since end of last year, while the worst performing stock is Raffles Medical Group which fell by 4.4 per cent since the end of January 2017.
I am still keeping a watchlist of some stocks which regular readers might be familiar. These include Keppel Corporation, Ezion, and UMS Holdings. However, stocks like Keppel Corp. and UMS Holdings have since fallen out of favour as they have risen quite a bit since I have put on my watchlist. I am still keeping a close watch on Ezion, which I think many investors are still in fear, but the company is still generating positive free cash flows despite the continuing oil and gas (O&G) woes.
I am also adding my focus on exchange traded funds (ETFs) for international and regional exposures like the db x-trackers Euro STOXX 50 UCITS ETF, and the db-x-trackers MSCI Indonesia UCITS ETF. UCITS stands for Undertakings for Collective Investment in Transferrable Securities. Both ETFs have a 3-year annualized return of 2.3 per cent and 3.1 per cent respectively, according to SGX ‘My Gateway’ website. I believe that the various elections currently taking place in Europe, on top of ‘Brexit’ fears might be somewhat sensationalised by the press and giving rise to populist sentiments. However, I do believe that Europeans are rational and do not want to disintegrate the European Union (EU), or switch to their individual country currencies after having been in the Euro currency for about a decade or more. If they choose the drastic moves, this could stoke more uncertainties, and Europeans being pragmatic and rational people, are not expected to do away entirely out of the Euro currency and EU altogether.
For Indonesia, the economy has been rising and has one of the largest populations in the ASEAN region. The economy has a GDP growth of around 5 to 6 per cent and is enjoying relatively high birth rates. The population is young, and the government system is trying to introduce reforms. However, despite the optimism, there are challenges namely the slow infrastructure development, and the growing threat of terrorism. Despite these challenges, I believe the Indonesian government is trying to resolve these issues and policy makers are still encouraging foreign direct investments (FDI) into the country.
What to look out for next week
Closer to home, we are going to get the February 2017 consumer price index (CPI) prices on Thursday, March 23, 2017, and on Friday, the February 2017 industrial production numbers. The forecast for February CPI is 0.3 percent month-on-month (MoM), while the forecast for industrial production numbers is a slight decline of 0.8 per cent. We think that the weak industrial production forecast for February might have taken into account some of the production shutdowns happening in the first week of February due to the Lunar New Year.
After a superior yearly growth in February 2017 non-oil export numbers of 21.5 per cent for Singapore, we believe that there are signs of a recovery, and the latest reading from the survey of private economists which calls for a growth forecast of 2.3 per cent does embody some of the bullishness among many market watchers.
Elsewhere in the US, we will be getting existing home sales numbers on Wednesday, March 22, 2017 which calls for 5.69 million homes being transacted, and several Fed speakers who would be speaking. Market watchers will be tuning in to what their forecasts for interest rate hikes in the year, and their responses to the deliberations last week which led to the increase of the Fed Funds rate by 25 bps.
Disclaimer: The views/analyses expressed by the author in this article are based on public information sources, and individual analyses. These views do not necessarily represent the views shared by my principal firm. Investors seeking to trade in the stocks mentioned in this article are advised to seek the opinions from licensed financial advisers.