2016 has been a year
of political surprises in the United Kingdom and the United States. The UK
voted to leave the European Union in a referendum on 23 June and Donald
Trump won the US presidential election on 9 November.
Financial markets
were totally wrong-footed in both instances and everything seemed to plunge in
the immediate aftermath. Yet there was also a quick turnaround, which was
equally unexpected.
The Straits Times
Index (STI) ended the year nearly flat or just 0.07% lower at 2,881, which is
quite remarkable considering all the bad news it has been hit with throughout
the year.
Exactly a year ago,
I had predicted that despite the challenging economic outlook, the
downside for the STI would be limited due to its attractive valuation.
For 2017, the main
risk for global financial markets is, in my opinion, souring international
relations, especially between the US and China.
The fragile global
economy can little afford its two biggest economies engaged in diplomatic,
trade or even armed conflicts. In spite of this, there are still reasons for
the STI to perform better.
Improving
macroeconomic environment
First of all, the
global macroeconomic picture is generally better. Going by official GDP data,
China has been able to avoid a hard landing thus far, growing at about 6.5%.
The US economy
continues to improve, so much so that the Fed is now projecting to raise
interest rates three times instead of twice in 2017.
Commodity prices
have recovered significantly from their lows in early 2016. Oil prices are currently
hovering at above US$53/barrel, 70% higher than its lowest price level of about
US$30/barrel.
Strengthening
US greenback is actually a good thing
Secondly, there is a
great deal of nervousness surrounding the Fed raising interest rates and a
stronger USD, which is unwarranted.
Rising interest
rates from near-zero level should be viewed in the context of normalization,
made possible by a stronger US economy. Even so, interest rates would still be
historically very low.
Similarly, the
rising USD is really nothing to fret about if we remember that the greenback
had fallen a lot during and after the global financial crisis of 2008.
For example, US$1
was worth about S$1.70 around the year 2000 before trending all the way down to
below S$1.25 around the year 2013. A stronger USD is also beneficial for
exporting countries such as Japan and Singapore.
The Great Rotation
Thirdly, there is
abundant liquidity in the form of cash waiting on the sidelines or cash
misallocated in assets such as bonds with very low or even negative yields.
With rising interest rates, investments in bonds are no
longer safe.
In the last few
years, financial commentators have talked about a great rotation from bonds
into equities. Perhaps this is already happening in the US, which recently
experienced a spike in 10-year treasury yields alongside a strong stock market
performance.
Plenty of
room for upside
Fourthly, valuation
of the local index remains attractive. While US stock indices have climbed
about 10% in 2016 and repeatedly reached new record highs in November, the STI
is still a far distant from its 2007 record level of above 3,500.
Its
price-to-earnings (P/E) and price-to-book (P/B) ratios are about 14 and 1.1
respectively, compared to 19 and 2.9 for the S&P 500, according to The
Business Times.
Another indicator of
cheap valuation is the noticeable number of majority shareholders taking their
companies private in 2016, such as Osim, Eu Yan Sang, Tiger Air, Sim Lian and
ARA.
Economy still ticking along
Finally, despite the
many challenges in 2016, the local economy averted recession and still managed
to grow, albeit slowly, at about 1%. The economy is expected to grow 1% to 3%
in 2017, says The Sunday Times. Slow economic growth is probably the new normal
going forward and it’s not such a bad thing.
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