The year began with a sombre warning from the International Monetary Fund, that 2023 would be a tougher year. The US, European and Chinese economies are slowing down simultaneously. The US economy may have weakened more and earlier than data are showing, going by a report by the Federal Reserve bank of Philadelphia on 13 Dec 2022. The report, entitled ‘Early Benchmark Revisions of State Payroll Employment’, estimated that 10,500 net new jobs were added in Q2 2022. This sharply contrasted with two other figures: the first by the Bureau of Labor Statistics that 1,047,000 net jobs were added; the second is net adds of 1,121,500, by the sum of the states.
The Fed is likely to move its fed funds target to 5.0% in early 2023. Higher cost of funds curbs corporate spending and asset values. We expect job losses, further declines in housing affordability, and a hard landing for the US economy. Manulife US REIT, which owns office commercial assets in the US, has warned that its aggregate leverage may rise to 49%. The culprits? A higher cap rate for its portfolio assets, a higher discount rate for valuing these assets, and reduced occupancy rates as a result of hybrid work. The REIT may dispose of some assets or raise new capital to keep its leverage within the 50% limit imposed by the MAS.
Inflation is still sticky. This is notwithstanding easing energy prices and improving supply chains, which have brought down freight rates. As the tailwind of COVID reopening fades, prices for broader range of items have increased. This was unlike the early phase of the COVID recovery, when price hikes were mostly concentrated in energy, cars and travel. That said, we expect inflation to level off with a weaker economic outlook. Corporates with pricing power could enjoy margin expansion in a dis-inflationary environment.
Lenders would demand a higher risk premium in a recessionary environment amid monetary tightening. Hence, interest rates are likely to stay elevated. This would lower housing affordability. We also expect more credit defaults in 2023.
In Singapore, highly-geared construction companies and developers are more vulnerable. Costlier labour and materials will erode margins. Cash flow generation has become ever more important in this environment. Although margins for banks might expand into Q1 2023, our optimism is capped by concerns over asset quality. Reflecting this, we are neutral on the banks.
The tech sector may cut back capex spending aggressively. US semiconductor players will be focusing on reducing inventories. Valuations for the sector corrected for this in 2022, and we might see an earnings trough in Q1 2023. Cloud computing, auto innovations, AI and smartphone upgrades will be the key demand drivers in 2023. The US is pouring money into developing chip resilience that will benefit companies in the chip equipment value chain. All these factors could drive earnings higher in H2 2023.
We think China’s reopening is the single most important investment theme in Q1 2023. A thawing of relations with Australia will boost Australian exports ranging from wine to coal. In Asia, Thailand and the Philippines have the most to gain from the reopening. Higher tourism income will strengthen current account positions, alleviating the pressure to raise rates to stem currency weakness.
Indonesia benefitted from higher commodity prices in 2022. But coal prices have eased with weakening global economies. Furthermore, policy flip-flop is a perennial concern. Recent tighter export restrictions on crude palm oil are a case in point.
Singapore’s open economy is likely to mirror the slowdown in the developed countries. A major positive uplift for global markets is a rapid de-escalation in the Russia-Ukraine war. This could lessen price pressures significantly as energy and food prices fall.
Thank you for reading.
May you have a bountiful new year!
Yours sincerely,
Peggy Mak