Future economy plays

While the results were somewhat surprising, they were not entirely unexpected. The year had begun on a low after a depressing end to 2018. Experts are not needed to point out that prices of most — if not all — major asset classes had ended lower last year. This rare positive correlation among the major asset classes had made it difficult for investors to adjust their portfolio.

“Because of various reasons, markets are now highly correlated, whether it is bonds or equities, across countries. It means that when they move, they all move together [in the same direction]. That makes diversification very difficult. What are you going to diversify into?” Jeffrey Jaensubhakij, chief investment officer at GIC, pointed out at an investment seminar organised by Fullerton Fund Management on Jan 16.

It is with this backdrop in mind that The Edge Singapore has assembled the annual portfolio of 10 stocks, done in conjunction with the Lunar New Year. Our portfolio is traditionally limited to locally listed counters and based on our reporting and observation of the market. We aim to beat the Straits Times Index over the course of the year, and we will not replace any of the holdings. In effect, the portfolio is an expression of our editorial team’s view on the local corporate sector for the year ahead. (The value portfolio in our Capital section is a real-money portfolio of global stocks and its holdings may be adjusted on any given week.)

Macroeconomic headwinds

That said, there are significant challenges ahead. For starters, there are signs of slowing global growth this year as the major economies face headwinds. This would typically have a detrimental effect on equities, as they tend to underperform amid decelerating growth.

In the US, most experts agree that the world’s largest economy is in the late phase of economic expansion. And the prolonged economic cycle could be coming to an end faster than expected due to several reasons. For one, the positive effects from the US corporate and personal income tax reductions, a highlight of Donald Trump’s presidency thus far, will be wearing off this year.

Secondly, the partial shutdown of the US government that lasted most of January, though it has temporarily ended with a stop-gap bill until Feb 15, is a negative. “It is still likely to weigh on US growth in the first quarter and add to political uncertainty, as this situation isn’t fully resolved, and discussions over the debt ceiling are coming up soon too,” Esty Dwek, senior investment strategist at Natixis Investment Managers, writes in a Jan 30 market commentary.

While the US Federal Reserve has kept its policy rate unchanged, as widely expected, the delay in raising the Fed funds rate could be disastrous later in the year. Rob Carnell, Asia-Pacific head of research and chief economist at ING Bank based in Singapore, says if the current US macroeconomic data is conducive for further normalisation of monetary policy, the Fed’s decision not to do so now could mislead the market. “Such inconsistent guidance sets us all up for an awkward correction later on. This could be particularly nasty, as the higher inflation and wages backdrop might coincide with a weaker projection for future growth, and that is a tough one for risk assets, especially equities, to digest. Summertime blues then?” he writes in a Jan 31 commentary.

And of course, the unresolved trade tensions between the US and China continue to dominate the headlines. The 90-day truce signed by both countries in November last year has yet to culminate in a deal. The situation may have worsened, following criminal charges brought by the US against Huawei Technologies. “The US’ accusation against Huawei — China’s telecommunications technology giant — of stealing technology and bank fraud set a complicated context for the trade negotiations. US treasury secretary [Steven] Mnuchin expects ‘significant progress’ to be made this week, while [the] China side remains fairly silent,” CMC Markets analyst Margaret Yang writes in a Jan 30 market commentary.

In China, there are worries too. The trade war is starting to weigh on the world’s second-largest economy. According to official data, China grew 6.4% in 4Q2018, down from 6.5% in the preceding quarter. This was the third consecutive quarterly decline. For the whole year, China expanded just 6.6%, a far cry from the near-double-digit growth that everyone has got used to, and marking the slowest pace since 1990. “We expect Beijing to adopt more supportive policies in a bid to cushion the slowdown in 2019, which will likely be driven by a poor external outlook and its knock-on effects on private consumption,” says Fitch Solutions in a Jan 23 report.

Singapore, caught between the US and China, its two largest trading partners, is expected to suffer. “Singapore’s growth momentum continues to wane, hurt by the US-China trade war and slowing global electronics demand. Manufacturing growth eased in December, with most clusters declining. PMIs [Purchasing managers’ indices] in Asia, Europe and, more recently, the US are all heading south,” Maybank Kim Eng economists Chua Hak Bin and Lee Ju Ye write in a Jan 25 report. “We are forecasting GDP growth to slow to 2.2% in 2019, down from the expected 3.2% in 2018.”

Earnings could dip, but valuations cheap

So, what does this mean for equities? According to Bank of Singapore, the private banking unit of OCBC, analysts are downgrading their corporate earnings forecast for 2019. The consensus forecast is for global earnings per share to grow at 7%, down from 10% three months ago. “As trade uncertainties and tighter financial conditions continue to drag on economic growth, downgrades to consensus earnings growth expectations are picking up speed across major regions,” Bank of Singapore’s head of investment strategy Eli Lee and investment strategist Conrad Tan write in a Jan 28 report.

However, given that global equities had retreated last year, valuations have reached favourable levels. “At current valuations, we believe that equity market returns are skewed towards the upside, and we have a constructive stance on risk assets,” they add.

Similarly, some local stocks are looking cheap. “Singapore equity market valuation is pricing in weaker macro conditions and earnings, although downside risks to estimates remain. We recommend that investors stay invested in a portfolio of quality, high-yield stocks and stocks with low, embedded expectations to ride out any volatility in 2019 while positioning for a market recovery,” says Kum Soek Ching, head of private banking research at Credit Suisse in Southeast Asia.

While a low base works in our favour, it may be harder to outperform the STI. Therefore, the key challenge now is no longer valuation, but picking stocks that would deliver a better return than the benchmark index within two fixed points in time.

This year, we have taken a top-down approach, by picking stocks that could be beneficiaries of the future economy. By future economy, we mean companies that are ready to innovate and adapt to new ways of doing business as technology disrupts the status quo, as well as those able to ride the wave of digitalisation. According to Gartner, worldwide IT spending is projected to total US$3.76 trillion ($5.08 trillion) in 2019, up 3.2% from 2018.

“Despite uncertainty fuelled by recession rumours, Brexit and trade wars and tariffs, the likely scenario for IT spending in 2019 is growth,” says John-David Lovelock, research vice-president at Gartner. “However, there are a lot of dynamic changes happening in regard to which segments will be driving growth in the future. Spending is moving from saturated segments such as mobile phones, PCs and on-premises data centre infrastructure to cloud services and Internet of Things devices. IoT devices, in particular, are starting to pick up the slack from devices. Where the devices segment is saturated, IoT is not.”

We also take into account the region’s demographic factors, for instance the rapidly ageing population in Asia-Pacific. This means that companies that operate in the old economy sectors are not necessarily excluded, nor are those that operate in the new economy sectors necessarily included.

Ultimately, we are trying to pick the winners of tomorrow to capture the upside potential today. Our selections this year are CapitaLand, DBS Group Holdings, iFast Corp, iX Biopharma, Mapletree Industrial Trust, MindChamps Preschool, NetLink NBN Trust, Raffles Medical Group, SATS and Silverlake Axis. In the following pages, we explain why.

The Edge Singapore’s 2019 stock pick

• CapitaLand
• DBS Group Holdings
• iFast Corp
• iX Biopharma
• Mapletree Industrial Trust
• MindChamps Preschool
• NetLink NBN Trust
• Raffles Medical Group
• SATS
• Silverlake Axis

This story appears in The Edge Singapore (Issue 867, week of Feb 4) which is on sale now. Subscribe here