SINGAPORE (Aug 17): Two positive pillars of Singapore’s seemingly-strong equities market have weakened, according to equity strategists of financial services firm Morgan Stanley.

This comes even as MSCI Singapore’s next 12 months (NTM) P/E nears a four-year high at 14 times, and is up 14.5% in the year to date (YTD) to lead Asean markets though underperforming MSCI Asia ex-Japan (AxJ) by 370 basis points (bps).

In a Thursday report, equity strategists Sean Gardiner and Aarti Shah recall the past year as a positive one for the Singapore market, with return of earnings growth and positive estimate revisions after five years of expectations erosion.

Despite seeing upside to earnings estimates and strong high-frequency indicators in the near-term, they have highlighted two potential fragilities for the local equity market.   

Firstly, Gardiner and Shah point out that the trend in reflation trade – which started around Oct 2016 and has served as a “clear tailwind” for Singapore ever since, particularly for banks with the expected return of pricing power – may be petering out.

The strategists however note that the market has continued to soar even with inflation expectations peaking in Jan this year, and say this could be explained by rising domestic expectations for both the local economy and earnings.

Nonetheless, they emphasise the possibility of a rise in market volatility and downside risk in the case of inflation expectations continuing their decline.

The other risk lies in the downtrend in global trade, as reflected by recent data from the Morgan Stanley Global Trade Leading Indicator (MSGTLI) which declined to 0.19 in July, the lowest reading since late 2016 and a material decline from its peak of 0.9 in Feb.

“MSCI Singapore lacks direct exposure to global trade-linked stocks, but we believe the trajectory of global trade is an important driver of market sentiment and domestic demand,” explain the strategists.

“Despite a further fall [in the indicator], the absolute decline was more modest than in the past four months. That said, our macro team expects MSGTLI to moderate further in coming months because of base effects,” they add.

Morgan Stanley is thus maintaining its “equal weight” rating on Singapore’s market with an estimated 2% downside to its index target, as it believes the more elevated multiples are currently pricing in most of the ‘good news expectations’ around the better earnings outlook.

A tangible rise in Singapore Interbank Offered Rate (SIBOR) to support net interest margin (NIM) expansion expectations; increased domestic developer participation in more profitable land banking to boost revalued net asset valuation (RNAV) growth; as well as a translation of export or macro recovery into domestic consumption recovery would bring about more conviction in the upside to their view, add Gardiner and Shah.