Flipping through the markets
The Bank of Japan remains as one of the only outliers in responding to inflation. The latest YOY National CPI print brings the inflation measure to 4.3%. More than double the 2% inflation target and a 41-year high. A change in Governor from the incumbent Kuroda to Ueda could spell the turning point in the BOJ ultra-low interest rates strategy. For now, at least, Ueda seems to signal policy continuity…
After completing an inverse Head-and-Shoulder pattern, the FTSE Taiwan Index Futures broke out higher. As it now consolidates in a symmetrical triangle, we watch closely for a potential setup here. TSMC, at 20% of the index weight, will be our canary in the coal mine, with the stock’s outperformance generally leading the index, e.g. in July 2022 & January 2023. Where TSMC heads next, will build the overall direction for the Index ahead.
And on the note of Index component weights, the MSCI Singapore Index Futures presents an interesting divergence. The 3 largest components (DBS, OCBC & UOB), which make up a total of 47.5% of the index are now up almost 30% since 2021. Benefiting from the higher interest rate environment. While the next largest component Sea, at 10.3% is down close to 56%. Suffering from the tech rout?
The decade-long support we called out in last month’s article still remains valid after a month of sideways trading. With prices now trading even closer to the trend support, the improved risk-reward from here could make this trade.
The revival of the hawkish narrative has once again driven further expectations for interest rate hikes. And higher rates spell headwinds for highly geared industries such as REITs. Since 2021, rising rates have been trailing the path for lower REITs. A break and retest of the support for the SGX iEdge SREIT Leaders Index Futures point towards more downside from here as the index and interest rates diverge.
What’s inside our playbook?
With the labour market still strong, inflation still persistent, and hawkish fed speak, it’s only right if we start to consider what happens if more rate hikes are on the cards. And as we approach this potential change, we find value in looking into what’s inside the index or how its components behave.
To start, let us take a look inside the MSCI Singapore Index (SIMSCI). The SIMSCI components reveal a heavy weightage to the three local banks (DBS, OCBC & UOB) which have been the winners of this high rate environment as net interest income surges. Should rates continue to surge higher, we suspect this outperformance of the banking sector will continue. More importantly, considering the 50% weightage of the index to financials, continued outperformance will likely translate to further upside for the index, ceteris paribus.
But as they say, one man’s meat is another man’s poison and in a world where banks are enjoying the sweet nectar of higher interest income, REITs unfortunately taste the poison.
REITs being one of the more interest rate sensitive industries, due to the higher gearing ability of the business, might see trouble ahead. Higher interest rates mean potentially higher interest expenses and refinance costs, and if borrowings are not hedged to fixed rates and debts are due for refinancing, then this could just prove to be the worst possible time. All these could translate into a negative impact on income and potentially lowered dividends.
In an environment where the ‘risk-free’ rate investors can get from Treasuries or equivalent is pushing upwards of three and a quarter percent. Dividend yields have a high hurdle to start becoming attractive again.
On a separate note, we also expect some volatility on the SIMSCI due to rebalancing flows over the next few days with the inclusion of Sembcorp Marine (S51/SCMN.SI) happening on March 2nd.
Executing the plays
A hypothetical investor can consider the following two trades1:
Case Study 1: Long MSCI Singapore Index Futures (SGP)
We would consider taking a long position on the SGX MSCI Singapore Index Futures (SGP) at the present level of 294 and set the stop below 275, roughly two times the weekly Average True Range (ATR) away, which could bring us a hypothetical maximum loss of 19 points. Looking at Figure 3, if we pick the next level of resistance as our exit, SGP has the potential to reach the 360 level, 66 points away. Each point move in the SGP contract is SGD 100.
Case Study 2: Short SGX iEdge S-REIT Leaders Index Futures (SRT)
We would consider taking a short position on the SGX iEdge S-REIT Leaders Index Futures (SRT) at the current level of 1,195.5. If higher rate situation plays out, the index has the potential to reach, 1143, a previous level of support. Taking a 3:1 risk reward ratio, a reasonable stop can be set 17 points above at 1212. Each point move in the SRT contract is 25 SGD.
Original Link: https://www.sgx.com/research-education/market-updates/20230228-sgx-traders-playbook-whats-inside-matters
Examples cited above are for illustration only and shall not be construed as investment recommendations or advice. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios.