Little scope for upside at current valuations

Little scope for upside at current valuations

We remain cautious about the macroeconomic outlook through the end of this year and into next year, given potential fallout from the Sino-US trade conflict on the global economy. Despite investor hopes for successful trade talks, the current market valuation doesn't seem to offer much scope for upside, even under the scenario of negotiations making progress (actual resolution seems unlikely at this stage).

The low-yield bond environment (the recent bounce notwithstanding) should support equities, assuming that GDP growth slows but does not collapse. But with the market already at a high price/earnings (PE) ratio and with substantial macroeconomic risks in view, there could be more SET slippage in the run-up to the year-end.

2019 year-end target: Our base-case SET target for the end of 2019 of 1,594 is pegged to a 2019 PE of 16.1, which is about 1 standard deviation above the 10-year mean of 13.5 (and 0.65 SD above the five-year mean of 15.4). Our 2019 earnings-per-share (EPS) forecast of 99 baht is slightly below the consensus number of 99.8.

If the China-US trade talks scheduled for October fail to make progress, there will be a risk of deeper downside to the market. Thus we remain cautious in the run-up to the end of the year.

On the other hand, market optimism over the trade talks yielding progress could provide upside in the short term. Stocks that have been subject to PE deratings (such as in the Bank and Residential Property sectors and commodity-related plays) should see price recoveries, while stocks with high prevailing valuations are expected to underperform.

2020 year-end target: Our year-end 2020 target implies a 2019 PE of 16.1 on EPS of 108 baht. The assigned upper-band PE ratio assumes no recession, extended monetary policy easing among major central banks, and a relatively stable domestic political scene. Progress (or lack thereof) in resolving the Sino-US trade conflict is a key variable that could make for upside (or downside) from our base-case target.

Under our bull-case scenario for year-end 2019, a further market rerating could push the SET to around 1,697 (PE of 16.8, EPS of 101), supported in part by a functional government in Thailand and eased concerns over international trade conflict.

Sustained low bond yields in response to more dovish Bank of Thailand rate guidance (and/or quiescent inflation) will keep the equities-bond yield gap wide, increasing the relative attractiveness of equities.

Under our bear-case scenario, the year-end 2019 market PE ratio could fall to between 15.4 and 15.8 (implying an index of 1,520 to 1,463 and EPS of 95), squeezed by weaker global and domestic macroeconomic conditions. Intensifying emerging-market risks and heightened trade conflict could keep investors skittish. A US recession (not yet factored into our bear-case scenario) would push our PE and EPS estimates even lower.

Q4 RECOMMENDATIONS

Elevated external macroeconomic risks and expectations of Thai government economic stimulus keep us biased in favour of domestic plays. The key sectors warranting attention include Commerce (more stimulus aimed at boosting consumer spending); Finance (swift loan growth, contained non-performing loans and benefits from lower bond yields); Industrial Estates (ongoing EEC projects, manufacturing relocation from China); Tourism (visitor arrival growth recovery into the high season); and Food (elevated livestock prices tied to reduced pork supply).

The sectors likely to post strong earnings growth (above 15% year-on-year) for the third quarter are Food, Consumer Finance, Media, Industrial Estates, Tourism and Transport.

Defensive investments: The sectors that have reliably outperformed the SET in previous market downturns are Healthcare, Insurance, Property Funds, Commerce, Tourism and Food. Our defensive list also includes the Utilities and Ground Transport sub-sectors, especially stocks with low sensitivity to macroeconomic factors. Most of these sectors should be viable picks to outperform again if a downtrend manifests in the fourth quarter or early next year.

Stocks with high PE ratios (even in defensive sectors) could initially be subject to profit-taking, but their robust earnings profiles (low sensitivity to macroeconomic conditions) should make for faster price rebounds than for the market as a whole.

Risks: Our main worries include weak economic trends in the US and China (escalating trade conflict) and the EU; a subpar economic performance by the Thai government; falling world oil prices; and geopolitical/trade tensions.

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