UOB Kay Hian analyst Jonathan Koh is keeping his “overweight” recommendation on Singapore REITs (S-REITs) as he sees “resiliency” in the sector.
Externally, Koh says the Russia-Ukraine war creates heightened uncertainties and has pushed bond yields higher, adding that a peace agreement remains elusive.
Koh’s report dated April 5, also comes at a time where the risk of the US economy slipping into a recession has increased with an inversion of the US yield curve since April 1.
According to the analyst, the inverted yield curve is the “most reliable indicator of recessions”, with the inversion of the yield curve predicting all nine recessions in the US over the past 60 years.
“An inverted yield curve is followed by a recession within two years. The time lag between the inversion of the yield curve to the beginning of a recession ranges from six to 24 months,” he says.
“According to Federal Reserve Bank of San Francisco, the inverted yield’s ability to predict
recessions have not diminished despite the recent low-interest-rate environment,” he adds.
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In addition, the 10Y-2Y (or 10 year - two year) term spread has also slipped into negative territory, signalling a potential recession six to 24 months down the road, notes Koh.
He is referring to the difference between the 10-year treasury rate and the two-year US Treasury rate, where a 10-2 treasury spread that approaches zero signifies a flattening yield curve, while a negative 10-2 yield spread has historically been viewed as a precursor to a recessionary period.
In Singapore, the slope of the yield curve has flattened but remains upward sloping. The 10 year - 2-year term spread stayed marginally positive at 0.5%.
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The inverted yield curve had predicted the last two recessions in Singapore, during the 2008 Global Financial Crisis and Covid-19 pandemic.
“The inversion of yield curve took place on Nov 23, 2006 and Aug 15, 2019 and, coincidentally, occurred for only one day,” Koh writes.
For S-REITs, Koh notes that they started to underperform earlier, about three quarters after the inversion, and the Global Financial Crisis eventually erupted seven quarters (about 18 months) after the inversion.
“S-REITs corrected 56.4% and underperformed by 18.4% during the two years after the yield curve has started to invert,” the analyst says.
This was during a time where banks faced stress after the collapse of Lehman Brothers and S-REITs had difficulty accessing funding for refinancing due to the ensuing credit crunch.
At the time, the US Federal Reserve fund rate was elevated and reached a high of 5% during the cycle.
As for the Covid-19 pandemic, it hit three quarters (about nine months) after the inversion in the yield curve. However, this time, S-REITs, being defensive yield plays, outperformed most of the time during the pandemic.
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“The banking sector was resilient and consistently supported the funding requirements of S-REITs for acquisitions and refinancing throughout the Covid-19 pandemic. The US economy weathered a mild rate hike cycle and the peak US Fed fund rate was lower at 2.25%,” says Koh.
Despite risks of the US slipping into a recession, Koh observed that the US labour market is remaining resilient. The economy saw the addition of 431,000 jobs in March as retailers, restaurants and manufacturers hired more workers.
The unemployment rate dropped from 3.8% to 3.6%, which is near pre-pandemic levels and the 50-year low of 3.5% in February 2020.
An increase in average hourly earnings remains elevated at 5.5% y-o-y, and the “red hot” job market will continue to support growth in domestic consumption and sustained recovery for the US economy.
Retail and hospitality S-REITs to benefit from easing of measures and border reopenings
In Singapore, Koh thinks that retail and hospitality REITs will benefit from the domestic easing of safe management measures and border reopenings respectively.
The improvement in physical occupancy at office buildings as more employee return to work from their offices will lead to higher shopper traffic at downtown malls for the retail REITs
Meanwhile, the move to allow fully vaccinated travellers with no quarantine restrictions, especially from Malaysia, is likely to “kick-start” Singaporeans and Malaysians taking short trips between the two neighbouring countries, boosting hospitality REITs.
Koh’s top picks for the S-REITs sector are Ascott Residence Trust (ART), Frasers Centerpoint Trust (FCT), Mapletree Commerical Trust (MCT) and Mapletree Industrial Trust (MINT).
