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1 July 212 Neel Sinha* Head of Research, Southeast Asia The Hongkong and Shanghai Banking Corporation Limited, Branch *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations 1

2 July 212 Introduction is a stable developed market. It traditionally trades at a premium to the rest of the region. It is concentrated, with financials dominating. This makes sector selection important. Market structure MSCI is concentrated, with financials constituting 47% of the index. The second biggest sector is industrials (25%), followed by telecoms (12%). Most of these companies, however, have a distinctly non- flavour. For example, Singtel owns assets in India and Indonesia, most industrials export equipment to oil producers globally or build ships for global buyers, while various financials have expanded across Asia (DBS) or ASEAN (UOB). Neel Sinha* Head of Research, Southeast Asia The Hongkong and Shanghai Banking Corporation Limited, Branch *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Market performance (Index levels) Jan-95 Feb-96 Mar-97 Apr-98 May-99 Jun- Jul-1 Aug-2 Sep-3 Oct-4 Nov-5 Dec-6 Jan-8 Feb-9 Mar-1 Apr-11 May-12 MSCI Rel to Asia ex Japan (RHS) market composition Sector Weights FINANCIALS 47% INDUSTRIALS 25% TELCOM SERVICES 12% CONSUMER DISCRETIONARY 9% CONSUMER STAPLES 6% INFORMATION TECHNOLOGY % ENERGY % MATERIALS % UTILITIES % HEALTH CARE % Indeed, five out of the 1 MSCI sectors are not present in MSCI. The top-5 and top-1 stocks constitute 49% and 65% of the index, respectively. After the ASEAN markets, it is the most concentrated market in the region. Despite this concentration in financials, does offer a number of well-regarded companies in sectors such as real estate, shipping, and telecoms. Some of these have global leadership in various niche products (think oil rigs). is classified as a developed market by MSCI. It is a liquid market with daily market cap about 32x cumulative monthly trading volumes. One of the government s investment arms, Temasek Holdings, has material shareholdings in a number of large caps (e.g. Singtel, Sembcorp Industries and ST Engineering). 2

3 July 212 : Stock market liquidity SG Note: Chart represents the number of months that the market takes to turn over. Source: Bloomberg, HSBC Largest stocks in Stock rank Stock name Index weight 1 SINGAPORE TELECOM 12% 2 DBS GROUP HOLDINGS 11% 3 UNITED OVERSEAS BANK 1% 4 OCBC 1% 5 KEPPEL CORPORATION 6% Top-5 49% 6 GENTING SINGAPORE 4% 7 CAPITALAND 3% 8 WILMAR 3% 9 SINGAPORE PRESS 3% 1 FRASER AND NEAVE 3% Top-1 16% Correlations Being a small, open economy, s GDP has a large export component. However, this does not directly translate into a high correlation with exports. Given the large dependence on financials, the equity market s correlation with exports (.54) is not very high. Thus, as in Korea, the market is not a good reflection of the underlying economy and the correlation of market sectors to global and domestic trends can vary widely. Equity returns also have a low correlation with the domestic money supply, implying that the market is still more dependent on global factors than domestic ones. This is also evident from the fact that has the highest correlation (.79) with MSCI World in the region. Thus, this is a market driven more by global than domestic factors, but less so than many other Asian countries. Correlations of MSCI Asia ex Japan Macro correlations Since 21 Since 21 ISM Exports.54.6 Money supply Fund flows.68 past 1 years past 5 years previous 5 years Indices Past 15 years Past 1 years Asia x Japan World.73.8 Geographic breakdown of corporate revenues (%) Asia Pacific 51 Domestic 19 Rest of the world 49 Source: MSCI, Bloomberg, Thomson Reuters Datastream, HSBC 3

4 July 212 Earnings and valuation earnings are currently trading below trend. Austerity measures to cool the real estate sector might be one reason for the drop in earnings momentum in 1H12. earnings are the most stable in the region. This is supported by the fact that earnings volatility in the last five years has been 16.9%, well below the regional average of 24.6%. Indeed, on a five-year historical basis, this is the least volatile market in Asia. For example, during the downturn of 28 Asia ex Japan EPS growth fell 27.8%, while s EPS registered negative growth of 12.7%. Actual vs trend earnings Nov-99 Sep- Jul-1 May-2 Mar-3 Jan-4 Nov-4 Sep-5 Jul-6 May-7 Mar-8 Jan-9 Nov-9 Sep-1 Jul-11 May-12 MSCI annual EPS growth* % y -o-y % 66.9% (1) (2) (3) (4) Actual Earnings Trend *The volatility in reported annual earnings growth is often due to exceptionals and oneoff items like asset disposals or write-offs. As the earnings momentum chart indicates, analysts earnings forecasts have closely tracked the market over the years. As companies earnings are more dependent on external factors, analysts have often turned positive on earnings when there were signs of the trade cycle improving. Investors have been more cautious on equities fell more than analysts earnings estimates as the market was derated (on a PE basis). Earnings momentum vs MSCI returns 12-month forward EPS growth* vs MSCI Index (%) (%) Momentum MSCI SG Index y-o-y (RHS) Note: Earnings momentum is defined as the 6 month % change in 12M forward EPS forecast EPS grow th MSCI SG Index y -o-y (RHS) *Percentage change in trailing 12-month and 12-month forward EPS 4

5 July 212 The earnings revision ratio shows the number of upgrades in stock ratings. It is worth noting that the correlation between this measure and MSCI monthly y-o-y returns is high (.69). Thus, analysts recommendations and the market move in line with each other (but, as always, the causal relationship is unclear). Analysts recommendations on stocks typically follow the trade cycle. Below, we can see that analysts were busy upgrading in , 22-3, 26-8 and 21. More recently, analysts have started to revisit their outlooks and some downgrades have come through. analysts have moved into bearish territory. Upgrades as % of total earnings revisions* vs MSCI returns Recommendation consensus score (%) Analysts feeling more bearish Analysts feeling more bullish % upgrades MSCI SG Index y -o-y (RHS) Recommendation consensus score (RCS) Av erage ±2SD *Number of EPS estimates up as a % of total number of revisions in estimates Note: The recommendation consensus score (RCS) assigns a score of 1 to each buy recommendation, 3 to hold and 5 to sell. has always traded at a premium to the region (average c2%). The market has traded at an average of 14.5x 12-month forward earnings but currently is trading at a forward PE of 12.1x. Analysts expectations of EPS growth for 212 are also low (7.5%) compared with the region, which gives room for upside surprise. on average has traded at a 2% premium to Asia ex Japan PE valuations. This is a reflection of low volatility and lower risk to earnings. Currently, this premium is around 19%. s earnings yield has been stable over the cycles, mostly in the range of 6-8%, indicating low risk to corporate earnings. Forward ROE for is currently estimated at 1.6%, while the post-21 average is 11.2%. But the current forward PB multiple is 1.3x, lower than the average of 1.6x. This suggests that analysts are optimistic about the future prospects of companies but investors have yet to price that in. 5

6 July 212 A similar picture emerges on PE levels as depicted in the PE band chart earnings are forecast to rise but the market has not yet priced this in. : PE band chart Relative valuation May-2 May-3 May-4 May-5 May-6 May-7 May-8 May-9 May-1 2x 15x 1x 5x May-11 May PE:SG/Ax J : Earnings and bond yields : PB vs ROE/COE (12-month forward) BY EY PBR ROE/COE Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC 12-month forward PE vs 1-year average and standard deviations from average Current PE Rolling 1-yr avg Rolling 1-yr SD # SD from avg Industrials Cons Discretionary Consumer Staples Financials Telecom MSCI Fund flows To gauge fund flows we depend on mutual fund data by EPFR for in the absence of FII data from the stock exchange. The mutual funds went net negative late in 21 for the first time since June 23 and have stayed that way. Currently, AEJ funds are neutral on. As measured against history, there is not much room for them to cut positions further. 6

7 July 212 Cumulative foreign institutional funds since June USDbn funds active weight and Z-score relative to benchmark Funds Current -1M -3M -6M -12M Active weight Z-score Source: EPFR, HSBC Jun-3 Jan-4 Aug-4 Mar-5 Oct-5 May-6 Dec-6 Jul-7 Feb-8 Sep-8 Apr-9 Nov-9 Jun-1 Jan-11 Aug-11 Mar-12 Source: EPFR, HSBC Economic basics has a strong free-market economy and per capita GDP is higher than in most developed countries. The economy depends heavily on exports, particularly consumer electronics, petroleum products, pharmaceuticals, and a growing financial services sector. The city-state is seen as a bellwether for the region as its trade is three times the size of its economy. Given the global nature of its economy, is vulnerable to problems overseas, especially Europe and the US. The global financial crisis hit hard. The economy contracted 1% in 29 but then rebounded 14.8% in 21 and 5% in 211 on the strength of renewed exports. Leif Eskesen Chief Economist for India & ASEAN The Hongkong and Shanghai Banking Corporation Limited, Branch Over the longer term, the government hopes to establish a new growth path that focuses on raising productivity. It is counting on two new integrated resorts to help fuel tourism and economic growth. The government hopes to double visitor arrivals to 17m by 215. Economic policy primer The primary objective of the Monetary Authority of (MAS) is to promote price stability as a sound basis for sustainable economic growth. The MAS monitors core CPI inflation to capture price pressures that are persistent and generalised in nature. The central bank has a reputation for being prudent and effective in policy making. Monetary policy is centred on the management of the exchange rate rather than targeting interest rate levels. The MAS manages the dollar against a basket of currencies of the country s main trading partners and competitors. The trade-weighted nominal effective exchange rate (NEER) is allowed to fluctuate within a policy band, and where necessary, MAS conducts direct interventions in the foreign exchange market to maintain the exchange rate within this band. Changes in policy can involve a shift in the position of the band, a change in the slope of the band, and a change in the width of the band. Monetary policy meetings are typically held twice a year. The government conducts fiscal policy through annual budgets prepared for each financial year beginning 1 April. By law the government is required to keep a balanced budget over the policy cycle. Many years of prudent fiscal policies have allowed to build up significant fiscal reserves, and the government does not borrow to fund expenditure. 7

8 July 212 Key economic data % Year f Consumer spending Government consumption Fixed investment Stockbuilding (% GDP) Domestic demand Exports Imports GDP Industrial production Unemployment (%)* Consumer prices Current account (% GDP) Budget balance (% GDP) SGD/USD* month money (%)* year bond yield (%)* *Period-end Source: CEIC, HSBC estimates Political structure is a parliamentary republic. The head of state is the President, but the post is largely ceremonial. The head of government is the Prime Minister who represents the ruling party in the national legislature, which has 87 seats. Key regulatory bodies The Monetary Authority of (MAS) is s central bank. It also supervises the securities industry, banking, insurance, and the financial sector in general. Exchange (SGX) owns and operates s Securities and derivatives exchange and their related clearing houses. The Straits Times Index (STI) is the main benchmark index. 8

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