Monthly wrap for July 2022: Bad news is good news – until it is bad news

Date: August 1, 2022

  • The STI rose 3.5% over the month to 3,211.56 underpinned by firm Wall St
  • US market’s rally came on rising hopes of slower rate hikes as economy contracted in 2Q
  • US futures market now pricing in two more 50-points hikes by end 2022, and then rate cuts in first half of 2023
  • Singapore’s June factory output cooled to 2.2%
  • Singtel to divest Amobee for US$239m
  • UOB reported 11% rise in Q2 profit to S$1.1b

“Bad news is good news’’ drove Wall St and local market higher in July

Wall Street – and by extension markets everywhere – occasionally enter a curious phase in which bad news for the US economy is seen as being good news for stocks.

This was very much the case last week, when Wall Street rallied before the July Federal Open Markets Committee (FOMC) meeting at which the Fed delivered a widely-expected 75 basis points rate hike, but then continued to rally on Thursday after news that the economy contracted for the second consecutive quarter.

Of course, how much longer this “bad news is good news for stocks’’ will continue is anybody’s guess but if the economy does actually enter a recession without a concurrent fall in inflation, then investors will have to deal with the prospect of stagflation, or stagnant growth amidst rising inflation.

Whether that scenario eventually does materialise remains to be seen but for now, local investors had good reason to cheer July’s trading, particularly during the final week when the Straits Times Index regained the 3,200 mark that had been lost on 10 June.

For the week, the STI rose 30 points or 0.9% and for the month, it posted a gain of 109 points or 3.5% at 3,211.56.

What’s driving Wall St – interest rates, the economy and earnings in that order

In the lead-up to Wednesday’s FOMC meeting, the federal funds futures market was pricing in only a 20% chance that the rate hike would be 100 basis points. As a result, stocks rallied when the Fed announced the rate hike would be 75 points.

More importantly however, was that the market took heart from statements by Fed chair Jerome Powell that if the data were to moderate, then the pace of rate hikes would be reduced.

“While another unusually large increase could be appropriate at our next meeting, that is a decision that will depend on the data we get between now and then,” he said.

“As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases.” Powell even said that interest rates, now at a range of 2.25% to 2.5%, are likely at “neutral,” meaning they are neither accommodative nor restrictive.

On Thursday, the rally duly continued because the data showed a slowing, contracting economy. The news was that the US economy shrank at a 0.9% annual rate in the second quarter, reflecting a weakening economy as consumer spending slowed amid rising prices, while business investment declined, and the housing market cooled.

Wall St enjoyed its best month in two years – in July, the Dow Jones Industrial Average gained 3%, the S&P 500 4.3% and the Nasdaq Composite rose 4.7%.

Is the US headed towards a possible recession?

The second-quarter data marks the second straight quarter of negative growth in the U.S. economy, after it contracted 1.6% in the first quarter. This is a trend traditionally associated with formal recessions.

“I do not think the U.S. is currently in a recession,” Powell said on Wed. “And the reason is there are too many areas of the economy that are performing too well.”

Similarly, most economists, who had forecast 0.3% growth for the quarter, don’t believe the U.S. is in an official downturn yet, but the second-quarter data will fuel concerns that recession is around the corner.

CNBC quoted Michael Pearce, senior US economist at Capital Economics as saying, “With rates now close to the Fed’s estimate of neutral, the economy clearly showing signs of a slowdown in the face of rising rates and inflation set to fall in July, we suspect the Fed will shift back to smaller hikes from here, with a 50bp hike in September the most likely option’’.

What the futures market expects

Six weeks ago, interest-rate futures were pricing in a peak federal-funds rate target range of 3.75% to 4% in early 2023. As of Friday, that peak is implied at 3.25 to 3.5% in December, just a point above the current target.

Furthermore, futures pricing now implies two quarter-point rate cuts from February to July 2023. In other words, the market is betting the Fed will slow down the pace of its rate increases by the end of this year, then rapidly switch to easing policy.

Singapore’s June factory output cools to 2.2%

Singapore’s factory production growth slowed to 2.2% in June, down from 10.4% in May as the sector was dragged down by softer electronics output and declines in pharmaceuticals and chemicals.

The 2.2% figure was well below the median forecast of 5.4% in a Bloomberg poll of private sector analysts. Output in the key semiconductors segment shrank by 2.6% reversing May’s 32.1% expansion.

Nomura’s Euben Paracuelles and Charnon Boonnuch were quoted in The Business Times saying the electronics sector will face greater headwinds going into 2023 but added that “drags from the change in pharmaceutical product mix and the maintenance shutdowns at chemical plants should dissipate soon, resulting in a rebound in output’’.

Said OCBC’s chief economist Selena Ling “I would expect Singapore’s manufacturing growth to hover in the low single-digit year-on-year growth range given the high base in the second half of 2022 and the global growth slowdown or recession concerns across major economies like the US, European Union and China’’.

Singtel to divest Amobee for US$239m

Singtel last week announced it is selling its wholly-owned subsidiary Amobee to the UK’s Tremor International for an enterprise valuation of US$239m, a transaction that will realise net proceeds of US$197m.

Singtel said the sale is in line with its strategic reset to sharpen business focus and recycle assets and capital into growth areas with higher returns.

Analysts viewed the deal as both earnings- and value-accretive for Singtel, which posted pre-tax losses of S$70.2m and S$81.9m in FY2022 and FY2021 respectively.

DBS said the net proceeds are in line with expectations and maintained its “buy’’ rating on Singtel with a target price of S$3.24. “Singtel’s earnings compound annual growth rate (CAGR) is higher than most blue-chip stocks in Singapore and similar to earnings CAGR offered by Singapore banks but less reliant on the economy,” said DBS.

Citi said it is raising its FY2023 and FY2024 recurring estimates for Singtel by 1-2% and raising its target by 2% to S$3.30 to reflect the removal of Amobee’s losses from the telco’s earnings.

Singtel closed at S$2.61 on Friday.

UOB reported 11% rise in Q2 earnings to S$1.1b

On Friday, UOB was the first of the three local banks to report Q2 earnings – an 11% increase to S$1.1b on improved margins driven by higher-than-expected net interest income as well as trading and investment income recovery. The figures were in line with consensus forecasts in a Bloomberg survey.

UOB’s shares ended S$0.71 or 2.5% weaker at S$27.55 on volume of 5.3m on Friday. Both DBS and OCBC also ended lower.