The U.S Federal Reserve (Fed) raised interest rates by 25 basis points (bps) to between 0.50% and 0.75% on 14 December 2016, marking only the second increase since 2008. It also indicates that it expects to be making more hikes in 2017.
Lower interest rates are usually meant to stimulate economic growth by encouraging businesses and people to borrow money cheaply and to invest additional money that they have. By increasing current interest rate levels, the Fed is effectively indicating that it sees the economy improving with healthy growth proposition. As economies improve, such as move is necessary to stem the proliferation of inflation.
Over in Singapore, it can hardly be said that we are experiencing any of the positivity that the Feds feel. Only last month, Singapore posted its 24th consecutive month of deflation. The country is also mired in a structural transition with tightening labour laws, fighting the downturn in the oil & gas and offshore & marine industries, which are core components of our nation’s GDP.
With interest rates in Singapore closely tracking that in the U.S, many investors will be asking which companies will turn out to be the winners and losers as interest rates go up. Typically, a rise in interest rate is seen as a positive signal that global growth is strengthening. However, there will always be some businesses gaining more and others losing out in any policy announcement, and it is extremely difficult to pick and choose which companies will outperform or underperform its peers.
Below, we take a look at how interest rates may affect some of the stocks listed on the SGX.
Generally, banks are tipped to gain from interest rates going up as they can earn bigger spreads on interest they have to pay people saving money at their banks and the interest they earn from lending money out. This is commonly termed as its NIM (Net Interest Margin).
As interest rates increase, savers are also more and more incentivised to save money in banks as its yields increase. This gives banks the liquidity to lend out even more money. With DBS being Singapore’s largest banks with 53% of the local savers’ money, they are best positioned to gain from this potential upswing.
Insurers also stand to make better profits from this rising interest rate trend. Typically, insurers have two main sources of income – premiums and investments.
Some of the premiums they charge are paid out in commissions to their agents. The returns on their investments, however, are able to earn them much bigger profit as interest rates rise, since fixed-income products such as bonds and money market funds they they invest in will generate higher returns.
Companies With Exposure To US (Such As Venture Corporation)
Venture Corporation, with over 55% of its revenue derived from the US, stands to gain as the world’s largest economy strengthens. Counting some of the biggest technology names in the country as its clients, Venture will benefit as the world’s largest economy continues to strengthen and flex its financial might through increased business and consumer spending. As US interest rates continue to rise, the US dollar is also expected to appreciate. This will make Venture Corporation’s products for exports relatively cheaper.
Singapore REITs, and REITs in general, are usually saddled with large loans of up to 45% in some cases. These REITs are at risk when interest rates rise. As a rule of thumb, for every 50 basis points increase in interest rates, you can expect distributions from REITs to decrease by 1-3%. As of earlier this month, interest rates have already increased by half this amount, and it is expected to surpass this amount in 2017.
What this spells for REITs is that their borrowing costs will go up. However, with expectations of interest rate increases already in the market for a long time, stronger REITs would have already taken such scenarios into consideration. Also, as interest rates go up, weaker REITs will be most affected as there will be a “flight to quality” to the stronger REITs. This should keep refinancing relatively stable for REITs with quality track records and good management.
In a recent report by Bloomberg, it stated that Singapore builders and trusts have a staggering amount of debt maturing in the last quarter of 2016. It also carried quotes from JP Morgan and Credit Suisse remarking the segments fragility. Having been written in August, this does not take into consideration the recent increase in interest rates as well as the very likely increases to follow in 2017.
Motley Fool ran a story on small cap oil & gas stocks with declining financial strength over the past 12 months. These stocks also saw their debt-ratio soar between 16% and 72%.
Small-cap stocks with high levels of debt or those that require more debt to continue growing will be most at risk. While this segment of stocks also represents the best value, there are risks that investors need to understand before going into them.
In Singapore, stocks in the utilities and telecommunications sector are highly leveraged. Even though this may be a norm in their particular industries, such stocks will come under pressure as they will need to pay higher interest rates when they refinance their loans.
According to SGX’s Stock Facts, out of the largest 50% of listed stocks in Singapore, these 10 ranked highest in terms of its Debt-to-Equity (D/E) ratio. A high D/E ratio indicates the proportion of a company’s assets financed by debt. A high D/E ratio means the company is utilizing debt to finance its operation, which may not be a bad thing as debt tends to be cheaper than equity.
However, this also means that the company is highly leveraged and may be put at risk if it cannot generate sufficient cash to satisfy its debt obligations. Investors need to be familiar with the risk that they take on when interest rate increases.
What You Should Be Doing
As an investor, you should not be panicking if you have certain “losers” in your portfolio or rejoicing that you have certain “winners”. The aim is to look at the long-term potential of your holdings. When you do your yearly review of your portfolio, you can use that time to assess if any stocks in your portfolio no longer meet your financial goals. You could utilize benchmarks for its returns or growth using the Straits Times Index (STI) or other indexes or nominal values you are adhering to, such as the 2.5% CPF returns.
Bonds and Fixed Income