Market & Economy (1 Feb 2006)

SG-AM: Market & Economy (1 Feb 2006)
By Carmen Lee
Wed, 01 Feb 2006, 08:57:20 SGT

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MARKETS

Farewell to Greenspan. While the Singapore market was closed for the Chinese New Year break, the US Federal Reserve met and raised interest rates once more by another 25bp, bringing it to 4.5%, and starting off 2006. Apart from raising US interest rate to 4.5% under Chairman Alan Greenspan for the final time, US Federal Reserve policy makers also indicated that interest rate hike is not over though there is less certainty now. There was no use of the usual "measured" pace, instead the FOMC said that some "further policy firming may be needed" to curb inflation. During the past few days, the US markets fell, while most Asian markets were closed (Taiwan, Hong Kong, Malaysia and Singapore) for the Chinese New Year holiday. The Nikkei remained traded during this period and clocked up its sixth straight day of gains.

STI benefited from gains for oil-related stocks. Since our last Strategy report in Dec 2005, the Singapore market has seen several interesting developments. Of key interest is that the Straits Times Index (STI) started off the year on a positive note and touched a closing high of 2425.99 on 9 Jan 2006, up 3.4% for the year. Since the early heady gains, the STI has been on a downtrend before recent gains for oil-related stocks managed to give the STI another boost, lifting the STI to last Friday's closing level of 2412.18, up 2.8% for the year.

With four consecutive days of gains before we closed off the year of the Rooster, what can the market expect for the first trading day of the year of the Dog?

Interest rate is moving higher. With the US Federal Reserve indicating possibly more rate hikes ahead and with oil prices up 10% for the year (based on crude oil for March delivery, which hit a recent high of US$68.35 per barrel on Monday), we expect further oil price increases to be limited, pending no major worldwide catastrophes that could potentially cripple oil supplies. If oil prices stay within 10% of last year's levels, we expect the upside for Singapore oil-related stocks to be fairly limited as the key oil stocks have already moved up significantly and even the second-tier oil-related stocks have similarly surged in recent days. While rotational interest could move to some of the other sectors, we expect interest to remain fairly muted pending the Singapore Budget on 17 Feb 2006. Once again, the corporate wishlist is likely to include more corporate incentives and of course, lower corporate tax rate. However, with property incentives announced in 2005, we expect any corporate incentives to target other industries, especially growth segments like Biomedical, pharmaceuticals, etc. The much talked-about Singapore general election has, we believe, been factored into the market and potential government initiatives are likely to be more family-oriented with mass appeal.

STI is starting to show some signs of lethargy. Based on our Strategy report, our STI target was 2465, and the STI at current level is showing limited upside potential. However, mitigating this is that yield is still good at about 4.3%. However, PER for the STI is edging higher. It is currently at about 15.2x 2006 earnings and based on this, it is edging closer towards the 13-year average of 19.5x, and higher than the recent range of only 10-14x. While the STI is facing some resistance, the broader market is still fairly undemanding. Valuation for the broader market is lower at about 12.3x 2006 earnings with 9% EPS growth. In recent days, we have seen the other segments doing some catching up. For example, the UOB Sesdaq Index hit a high of 92.73 on 16 Jan 2006, up 5.3% for the year - a creditable performance after having been lacklustre for a long time (with a puny gain of only 1.3% in 2005 versus 13.6% for the STI). Overall, we expect the STI to demonstrate limited gains as market watchers await the Singapore Budget, but for value investors, ex-STI, oil and property stocks, the rest of the Singapore stocks are still fairly undemanding at current prices. (Carmen Lee)

Economy: As widely expected, the US Federal Reserve yesterday raised its key overnight Fed funds rate by 25bps to 4.50%. This is the 14th consecutive rate hike and one of the most extended gradual tightening cycles in recent history. Yesterday's FOMC meeting was also Alan Greenspan's last, with a new chairman Ben Bernanke taking over from today. The post-meeting statement was essentially the same as the last one on 13 Dec 05, underscoring the Fed's confidence on economic outlook and inflation expectations. However, the phrase "some further measured policy firming is likely to be needed..." was altered slightly to "some further policy firming may be needed...", with the words "gradual" dropped (in use since May 2004), and "likely to" changed to "may".

With the minor change in wording, the risk of further rate hikes appears to be less visible than before, especially taking into account last week's slower-than-expected US 4Q05 GDP report (1.1% annualized vs. 2.8% consensus). This also leaves open the room for the next chairman to spell out his policy direction, who has an opportunity on 15th February to deliver the semi-annual monetary policy report to Congress. In terms of the "neutral policy zone" that we mentioned earlier, the current rate of 4.50% is closing on to our 4.7% to 5.6% range. This means at least another 25bps hike to go, although our 5% target appears to be lofty now depending on data going forward, after taking into account the new incoming US Fed Chairman, less-than-certain post-meeting statement, and weak 4Q05 GDP. This suggests limited headroom for domestic interest rates, as we had mentioned before. We continue to reiterate our end-2006 target of 3.50% for the 3-month interbank rate (SIBOR) from current 3.25%. The US Fed will next meet next month, on 28 Mar 06. (Suan Teck Kin)