Risk of technical recession rises

GDP growth cut by 0.5% to 5.6%(2011) and 5%(2012). Our Singapore economist sees external demand gradually improving going forward, even as it faces the uncertainties in Europe and US. Negative sentiment poses downside risks to the economy as consumers could pullback expenditure and companies could put expansion plans on hold. He cuts 2011 GDP to 5.6% (previous 6.2%) and that for 2012 to 5% (previous 5.5%). The risk of a technical recession is also rising but it’ll be a close call with the local economy able to marginally avert one. Inflation remains significantly higher than the historic average despite increasing downside risk to economic growth.

Currency band could shift to NEUTRAL from upward appreciation stance. In the upcoming policy review in October, MAS will have a tough decision to make as it seeks to balance the risks between growth and inflation. There is a fair chance for a shift in currency band towards a neutral stance from the current appreciation trend. We have seen the low for USD/SGD at 1.20 and expect the USD/SGD exchange rate to average 1.24 in 4Q11 before the SGD strengthens again to 1.22 by 1Q12 and 1.17 by 3Q12

More downside to FY12 earnings, flattish growth in FY11. The recent wave of earnings cuts - between 3% to 4% in 3Q11 captured disappointing 2Q results and downgrades in GDP growth. Current earnings growth of 4% (For FY11) and 10% for FY12 remain at risk, in the event of a recession, affecting domestic proxies - banking and property sector, which account for 36% of STI’s earnings. The 3 key contributors to earnings growth are Banks, Property and Industrials.

Banks earnings growth for FY12 has been cut from 18% to only 8.3% over the past two quarters due to the deferred rise in SIBOR putting pressure on NIM, and conservative loan growth assumptions. Further downside risk to our assumptions is a significant turn in credit cycle and a rise in provisions if banks adopt a conservative view on credit risk and default rates.

Property sector earnings could come under pressure from a) lower office rentals which could decline by 5% to 10% due to oversupply and slowdown in economic growth and b) lower ASP and slower volume sales in residential segment complicated by changes in accounting policy to recognize earnings on completion method.

Industrials, which capture offshore and marine and transport companies will face earnings risk from the deferment of new orders, and weak freight rates affecting yields for liners.