14 March 2005
The Singapore stock market, as measured by the Straits Times Index, is up so far this year, continuing the bull run that began in 2003. However, fundamentals do not suggest that this bull run has much further to go, while one particular technical indicator actually seems to be flashing a warning sign for Singapore stock investors.
First let us look at the economic backdrop.
Singapore's manufacturing output fell in January by 7.6 percent from the previous month on a seasonally-adjusted basis. However, the fall was mostly attributed to a fall in output from the volatile biomedical manufacturing cluster, which contracted by 8.6 percent over January last year. The spillover effect on other sectors relevant to the stock market is likely to be minimal.
The purchasing managers' index compiled by the Singapore Institute of Purchasing & Materials Management showed a reading of 51.5 in February, down from 52.4 in January. This indicated that manufacturing growth is likely to continue but at a possibly slower pace.
The dip in the overall PMI was attributed to lower new orders and new export orders, as well as lower levels of production output. The electronics index, however, rose to 53.9 from 52.6 the previous month, with strong growth being registered for new orders and production.
In the US, the PMI monitored by the Institute for Supply Management was 55.3 in February, a fall from January's 56.4. The sub-indices for new orders, production and employment all fell.
The global manufacturing PMI compiled by JPMorgan and NTC Research also registered a fall -- albeit slightly -- to 52.8 in February from 53.0 in January.
Paul Kasriel, director of economic research at The Northern Trust Company, thinks that manufacturing activity may decelerate further. In a commentary on 4 March, he said that the growth rate in global central bank holdings of US securities is relatively highly correlated with the ISM manufacturing index four quarters in the future. With the growth rate in these holdings turning down lately in the face of interest rate hikes by the Federal Reserve, he warned that manufacturing activity, and hence economic growth, is likely to slow down in the US.
Of course, as the US economy goes, so does the Singapore economy. And that bodes ill for the Singapore stock market.
In a weakening economic environment, valuations are not likely to be supportive of the market. In a report on 26 February in The Business Times, Teh Hooi Ling said that dividend yields and price-to-book ratios around current levels have historically been associated with weak market performance over the subsequent year. While the equity risk premium is still high compared to historical levels, she points out that rising interest rates and moderating corporate earnings may actually point to a lower equity risk premium.
Not surprisingly then, perhaps, that in an interview by The Edge Singapore of the managers of the top-performing Singapore funds for 2004 and which it published at the end of last month, none of the managers seemed particularly bullish on the Singapore stock market. And just last week, Merrill Lynch said in a strategy report that "we see the Singapore market trading at about fair value with a six-month target raised to 2,190", which is only 1 percent higher than Friday's close of 2,169.41.
If fundamentals do not look particularly bullish, what do technical indicators tell us?
I mentioned in a previous commentary the divergence between the trends for the large-cap Dow Jones Industrial Average and Standard & Poor's 500 from that for the Nasdaq (see "US stock market bullish but divergence and valuation are concerns"). I said that this divergence could be an indication of an impending market reversal.
The divergence between the large-cap index and small-cap index is even more pronounced in Singapore. In the first half of 2004, the STI gained 4 percent but Sesdaq lost 9 percent. This divergence widened in the second half, with the STI gaining 12 percent while Sesdaq lost 13 percent. In 2005 so far, the STI has gained 5 percent while Sesdaq has lost 3 percent.
Sesdaq had been formed in 1987 as a platform for small companies to raise funds. Over most of its history, Sesdaq tracks the mainboard Straits Times Index quite closely. It participated in the broad bull markets of 1993, 1998-99 and 2003, as well as the broad bear markets of 1997-98 and 2000-03. It did appear to go its own way in 1994-95, when it fell sharply by 58 percent while the STI fell by only 15 percent, but this could be attributed to the naturally greater volatility of small-cap stocks.
And yet, in the two main bear markets that it accompanied the larger market, there had been significant divergences at the start of those declines.
In the 1997-98 bear, the Straits Times Index had begun to fall in January 1997. From the beginning of January to the end of July, the STI fell 11 percent. However, over the same seven months, the UOB Sesdaq index rose a remarkable 37 percent.
In the 2000-03 bear, the STI peaked on the first trading day of January 2000, but Sesdaq had peaked in early July 1999. From the beginning of July 1999 to the end of December 1999, the STI rose 14 percent, but Sesdaq fell 20 percent.
The directions differed in the two examples -- Sesdaq outperforming in one, STI in the other -- but the divergences are clear. Possibly, the 1997-98 case reflected frothy excess, with the small-cap Sesdaq outperforming the STI at the end of the cycle -- remember, this took place just prior to the Asian Financial Crisis. On the other hand, 1999 may have been a case of a chastened and sceptical market giving Sesdaq a miss towards the end of its run-up.
Even the 1994-95 Sesdaq bear might have been a signal of relative weakness in the broader market. Although the STI did not tank until 1997, it mainly traded sideways from 1994 to 1996.
Divergence between the STI and Sesdaq has had a good, albeit short, track record. The current divergence has been unusually long and sustained. Investors should watch it carefully.
Disclaimer: The commentaries posted here represent the opinions of the author at the time of posting and should not be taken as investment advice. Readers who wish to take any investment action based on information obtained from this site should seek appropriate advice from a qualified financial adviser.