Singapore's economy is facing unfamiliar headwinds. Historically, the city has been a beacon of financial strength, averaging 5.4 per cent GDP growth over the past decade. But now, as global economic conditions improve, Singapore's growth runs the risk of remaining stuck in low gear.
Case in point: The Government recently downgraded its official projections for 2016 GDP growth from 1-3 per cent to 1-2 per cent, the lowest since the 2009 global financial crisis.
More indicative of Singapore's economic difficulties is the recent uptick in corporate bond defaults and a poor showing in the recent earnings season. With the credit sector in dire straits and the equity market underperforming - the Straits Times Index has lost 2.7 per cent year-to-date in local currency terms - Singaporean investors should look beyond local investments and diversify globally in their hunt for returns.
FALLOUT FROM SWIBER ROCKS THE BOND MARKET
Singapore-listed Swiber Holdings sent shockwaves through the local bond market when it filed for liquidation on July 28. The offshore oil and gas company was overcome by the prolonged downturn in oil prices - a potentially far-reaching development considering the offshore support industry makes up 5 per cent of Singapore's GDP.
In the aftermath of Swiber's fall, banks have anticipated the rising likelihood of future credit events and are tightening their grip on lending. They are likely to demand collateral or impose more stringent lending criteria as troubled issuers struggle to secure financing.
About S$18 billion of Singapore's corporate bonds are due over the next 18 months, of which about 28 per cent are from sectors facing structural headwinds such as oil and gas, industrials, transportation, and metals and mining. And the upward creep in non-performing loans by the domestic banking industry will be a weighty burden; already, Moody's has placed Singapore banks under negative rating outlook due to concerns about asset quality.
We expect default risks and SGD corporate bond yields to rise in the next six to 12 months. Investors should focus on credit quality and on issuers that can generate good, stable operating cash flows with sufficient liquidity and asset coverage. Defensive sectors such as telecoms, large property developers, banks and government-linked corporations offer low yields but are relatively safe investments.
For SGD yield pick-up, investors should look to perpetual bonds issued by Singapore Reits and overseas corporate issuers which have SGD issues.
CHINA'S LOCAL GOVERNMENT FINANCING VEHICLE BONDS
Amid lacklustre economic growth, credit fundamentals are weakening not just in Singapore but throughout Asia. Since the beginning of the year, there have been more than 20 onshore defaults in China, already exceeding last year's tally. This rise in default cases is not unexpected as the structural reform led by the central government deepens to clean up the over-capacity sectors of coal, steel and mining.
The Chinese property sector also remains bifurcated: developers in lower-tier cities continue to de-stock inventory amid weak demand, while those in higher-tier cities face stringent tightening measures as the government seeks to rein in overheating markets.
In general, there is increasingly less credit differentiation in the Asian credit market as investors continue to hunt for yield. Overall, the asset class has a tepid return outlook and is largely limited to coupon carry, given low US Treasury yields and tight credit spread valuations.
Investors should stay defensive and remain selective in their bond picks across the region.
Bucking the trend are China's local government financing vehicles (LGFVs).
Issuance of LGFV USD bonds has grown - to US$12 billion (S$16.3 billion) in the second quarter this year from US$2 billion in 2014. These entities are tasked with financing and operating important public projects, making them indispensable tools of developmental progress amid China's economic slowdown.
LGFV bonds are expected to become a key sector in China's USD credit space as robust issuance continues into next year.
IMPACT ON EARNINGS (AND EQUITIES)
For the Singapore equity market, the second-quarter results season was the most disappointing in recent years. Of the companies we track, none exceeded expectations; 55 per cent were in line with expectations and 45 per cent missed expectations. On aggregate, the MSCI Singapore index's constituents suffered a 9 per cent contraction in revenue and a 14 per cent decline in net profit. Consensus earnings-per-share forecasts have been cut by 11 per cent for 2016.
Energy, consumer staples, consumer discretionary and industrials fared the worst. Earnings fell while the energy sector slipped from profits a year ago to losses this year. The most significant earnings cuts were in consumer staples, consumer discretionary and industrials. The outlook for Singapore banks is also weak following Swiber's liquidation. Defensive sectors that can sustain their dividends, such as telcos and Reits, offer the most reliable options in the current environment.
A depressed corporate sector could, in turn, weaken Singapore's labour market and further reduce domestic demand. With nominal GDP growth already negative year-on-year, some easing in the Singapore dollar exchange rate policy cannot be ruled out. So, with the US Federal Reserve on the cusp of hiking rates, which would lift the greenback, USDSGD (exchange rate) should drift towards S$1.41 over the next six to 12 months.
Several overseas markets and assets offer more attractive investment opportunities. Asian equities, up more than 20 per cent from their February lows, should continue to be bolstered by low yields, ample liquidity and unwavering fiscal support. India, China and South Korea are positioned favourably and should offer decent returns in the coming months. Chinese Internet players, selected Asian financials, high-quality blue chips and dividend-yielding stocks are among the most appealing.
Investors should also pay attention to key regional events like the launch of the Shenzhen-Hong Kong Stock Connect, expected in December, which should buoy eligible H-shares with high dividend yields, high-quality blue chip companies with sustainable return-on-equity, and leading "new economy" players trading at a discount to their A-share counterparts. This event should also pave the way for MSCI to include A-shares at its next review, which would be a boon for high-growth small and mid-cap stocks in China's onshore equity market. Outside Asia, US and emerging market equities are looking good, should the expected recovery in earnings transpire.
- The writer is the Apac regional head at the chief investment office of UBS Wealth Management.