Investors are still wagering on the market bottom, as the coronavirus pandemic has yet to peak. It could take weeks before we see evidence of success of dramatic measures taken in Europe and the United States, but China, South Korea, Singapore and Japan appear to have brought the virus under control.
In the US, the Federal Reserve has opened the monetary spigot and a fiscal boost is in the works. Once investors become confident that containment efforts are working, the market will be ready to bounce -- even if economic numbers look likely to remain grim for months ahead.
SET target: Our base-case SET target of 1,370 points for the end of 2020 is pegged to a 2020 price/earnings (PE) ratio of 16.5 times, which is about 1 standard deviation (SD) above the five-year mean of 15.4 times.
Our 2020 market earnings per share (EPS) forecast of 84 baht is below the consensus number of 90.70 baht, reflecting the downside tied to Covid-19 and an average Brent crude oil price of $40 a barrel. The 2020 GDP forecast of 1.1% is vulnerable to further downside revisions, depending on the severity of the pandemic and how long it takes to contain it.
Normalising economic activity towards year-end and the prospect of higher growth in 2021 from a low 2020 base should enable the SET PE ratio to return to trade near its historical upper level of 16.5 to 17 times.
Under our bull-case scenario, a further re-rating could push the SET index to around 1,496 (PE of 17 times, EPS of 88 baht) at year-end, supported in part by effective government economic measures, a quick recovery from the virus outbreak, and no other economic shocks.
Sustained low bond yields amid a climate of dovishness among central banks (including the Bank of Thailand) and tame inflation (below the central bank's mid-range target of 2%) should keep the equities-bond yield gap wide, boosting the relative attractiveness of equities.
Under our bear-case scenario, the market PE ratio could fall to 13.6 times (the long-term mean, implying an index of 1,020 with EPS of 75 baht), squeezed by weaker global and domestic macroeconomic conditions, due to a slow recovery from Covid-19 in the first half.
Other risks include the possibility of a surge of cases in Thailand, lower oil prices, renewed trade conflict between the US and other countries, and escalating conflict in the Middle East.
Focus on earnings quality: Several sectors are trading at attractive PE ratios of 5-7 times (but still exposed to some profit downside risk tied to Covid-19, depending on its severity). Evidence of containment could prompt material rebounds in those sectors.
We favour plays with relatively secure earnings profiles, but where prices have fallen along with the SET, such as Contractors, Finance, Agriculture and Food (except restaurants) and Electronic Components.
Among sectors likely to be moderately affected, we expect decent rebounds along with the SET (in Commerce, Banking, Property, Chemicals and Ground Transport). In contrast, the prices of tourism-related stocks are likely to take longer to recover.
Weak baht helps: We currently assume almost flat (down 0.4% year-on-year) exports for 2020, but there is downside risk tied to global demand slippage resulting from Covid-19. Supply chain disruption related to China should ease soon, as Chinese factory production is resuming.
On the export revenue conversion front, the baht has weakened 7.6% against the US dollar since January, which should mitigate exporters' pain somewhat.
Yield gap valuations attractive: The SET's current equity yield gap against the Thai 10-year bond is 7.35%, or 2 SD above the mean -- much wider than the normal cheap space of 0.7 to 0.8 SD above the mean.
If the coronavirus pandemic is brought under control soon, the current yield gap will be a good entry point for the market. But with the number of new cases still accelerating globally, we don't have any confidence that infections will peak soon.
If we were to assume a further cut to the consensus SET 2020 EPS forecast to 84 baht (from 90.70 currently) and a 50-basis-point bounce in bond yields, the yield gaps against the Thai 10- and 3-year bonds would still be cheap at 1.32 and 1.1 SD above their respective means.
Under the same adjusted assumptions (EPS of 84 and bond yields up by 50 basis points), going back to long-term mean yield gaps against the three- and 10-year bonds would imply SET levels of 1,349 and 1,426, respectively.
