DBS bullish on tech stocks; favours S-REITs for yield

Tech and healthcare stocks have outperformed the market in recent years but from the perspective of DBS Group Holdings, these are still the sectors to stay bullish on. “It is worth noticing that in tech and healthcare, they have recouped all the losses after the pandemic meltdown, and have hit all-time-highs, unlike other sectors still struggling,” says DBS’ chief investment officer Hou Wey Fook at the bank’s 3Q outlook briefing.

To him, this is an affirmation of the strategy DBS has advocated for the past two years, to take sizable bets on “irreversible” growth trends as the world economy becomes a more digital one. Sectors set to benefit include ecommerce, 5G plays and semiconductor companies.

When the Covid-19 outbreak spread, entire swathes of the markets tanked. However, with the US Federal Reserves and other central banks making clear their intention to support the economies with quantitative easing, stocks have rebounded from the low of March 23. Some US$3 trillion ($4.1 trillion) worth has been put on standby, creating what Hou calls the “shock and awe” effect. “Don’t fight the Fed. Central banks are the only ones who can create money out of thin air,” he says.

Beyond just Fed’s war chest, DBS is analysing using various other data sets and observations. For example, it looks at Google’s Mobility Trend numbers to confirm that there’s higher human traffic to retail and recreational locations, which indicates resumption of actual economic activities and not merely liquidity sloshing in the financial markets. “We were convinced on these counts that the policies were indeed working,” says Hou.

However, in recent weeks, there have been growing worries that a second wave of infection will take root and thereby drive economies into another round of lockdowns. Now, even without the recurrent wave, DBS believes that a new behavioural pattern forced by the outbreak has taken root.

“As the country gradually re-opens its economy, we believe some forms of precautionary measures, such as social distancing, will remain in place, particularly in the absence of a vaccine,” says DBS senior investment strategist Dylan Cheang.

For example, companies have come to the realisation that employees working from home can be equally productive and that potential savings in commercial real estate space can be significant. “We believe that this work from home trend will persist in some forms even after the viral crisis is over,” he continues.

Next, the growth of ecommerce is set to continue. When economies were under lockdown, the business of physical retailers and food and beverage companies were hit abruptly. Many had to quickly redirect their businesses online. “This trend is expected to persist even as the economy reopens as consumers take precautionary measures and practise social distancing. Online retailing as well as online food delivery will see rising demand,” Cheang adds.

DBS also sees e-sports to become increasingly popular. During lockdowns, traditional sporting with the masses of spectators in attendance were cancelled. Online gaming, broadly categorised as e-sports, became the alternatives people turn to. Gaming platforms such as Twitch enjoyed sharp jumps in viewership.

When there are masses, money will follow, and vice versa. According to data gathered by GoldenCasinoNews. com, ten largest e-sports tournaments of all-time have hit US$176.1 million in total prize money. With US$134.4 million in total prize money or 77% of that amount, the tournament known as The International — an annual e– sports world championship hosted and produced by game developer Valve — ranked as the world’s leading arena.

In another indication, Activision Blizzard — a leading US gaming company formed in 2008 via the merger of Activision and Blizzard Entertainment — had a market capitalisation of US$45.33 billion at the start of the year. Throughout the Covid-19 induced market turmoil, Activision Blizzard became more popular than ever. Year to date, the value has grown to US$58.7 billion.

Cheang does not believe this surge in esports’ popularity will be a “flash in a pan”. The way Cheang sees it, esports allows sporting bodies to stay engaged with their fans and sponsors as well as diversify revenue streams. “Moreover, e-sports is also less prone to disruptions given that Internet connectivity is all it needs and therefore, consumers’ interest in this space is expected to stay resilient,” he reasons.

Bifurcation in play

Even before the pandemic, tech stocks have outperformed, and for a good reason. They are simply generating more earnings than other sectors. US tech stocks are commanding operating margins double that of the broader S&P 500 average. “Equity investing is about buying earnings,” says Hou. “As the world becomes more digital, earnings for digital companies will be sustainable, resulting in continuous outperformance,” he adds.

As at June 12, Nasdaq has outperformed the broader market by 12.7 percentage points, while the so-called “FANG+” basket of the top tech blue chips of Facebook, Apple, Amazon, Google (listed via its parent Alphabet) has outperformed by a whopping 33.4 percentage points in the same period.

“This is bifurcation in play and we expect this trend to accelerate in the post pandemic world given structural tailwinds underpinning the sector, such as strong pricing power and improving operating costs control,” says Cheang.

On the other hand, DBS is not optimistic on the prospects of US airline and financial services stocks. They face continued headwinds as global economic momentum moderates. Airline stocks, says DBS, will be particularly vulnerable as companies and consumers cut back on air travel. Financial services firms, meanwhile, will feel some heat from net interest margin contraction, rising loan loss provisions and weakening loan growth.

Stay the course on S-REITs

Within Singapore, DBS recommends investors to stay the course on Singapore REITs, even though there are concerns over their ability and propensity to continue to give the same kind of distribution their unitholders have long enjoyed. Indiscriminate selling and margin calls at the onset of the market slump didn’t help either. Indeed, the past three months have been “challenging” on S-REITs. DBS estimates that in a bid to conserve cash and also because of operational pressure, REITs — especially for those in hospitality and retail that are seeing a direct hit — are cutting their distribution per unit by between 10 and 30%.

By taking an average cut of 20%, DBS estimates that the future yield spread of the S-REITs based on current prices will be 3.9% yield instead of 5.2% currently. At 3.9%, the yield is still higher than the historical average spread of 3.5%, and no way less attractive when pegged against Singapore’s bond yield of just 0.7%.

Despite the business challenges posed by the lockdowns, DBS believes that 2020 is a “year for a REITs reset”. The current price to book value is at the near-historical low levels of 0.85 times last seen during the Global Financial Crisis (GFC) more than a decade ago. “Historically, such deep value discounts have led to strong price recovery owing to strong balance sheet strength among industry leaders. The REITs have demonstrated their abilities to grow dividends over the years by asset injection or yield accretive acquisitions other than organic growth,” says DBS.

However, DBS is not so sure about the residential property sector. The bank believes that unlike the GFC period when property prices enjoyed a V-shaped recovery, there will be challenges for the sector now as Singapore faces not just the deepest recession ever but also one that might be protracted. Naturally, the unemployment rate will be high and therefore the ability to service mortgages will be curbed. DBS expects prices to fall by 5–10% this year with primary sales volumes to contract 20–25%.

Nevertheless, there are already a few “backstops” in place to rein this market from actually suffering from the “worst” case. First, the government’s multiple-round of cooling measures put in place over the last few years. Loans are limited and a range of stamp duties have stymied speculative behaviour. “Singapore’s home prices are entering the economic recession in a less “bubbly” stage. This also implies that there is policy flexibility for the government to reverse some of the curbs should the home market turn more bearish,” says DBS.

The unprecedented $93 billion package of economic stimulus measures, which amounts to some 20% of the total GDP, will also help alleviate economic hardship, and that includes job support, loan extension and support for small and medium-sized enterprises.

DBS also expects a “significant drop” in the supply of private residential properties because of the delay in construction. To curb the outbreak, foreign workers, the backbone of the construction industry, are not allowed to leave their dormitories. In return, the government has allowed developers to extend the completion period by six months.

Furthermore, developers will also be less pressured to dispose of unsold units at deep discounts as they can also request an extension on the requirement to dispose of units within five years of completion. Annualnew completions are likely to fall to the lowest in two decades. E