Daily Voice: Joanne Goh of DBS Bank prefers small, midcaps given high growth potential

Rate cuts are expected this year, but it's likely we might see only one instead of the three initially anticipated in March. This shift towards a "higher-for-longer" interest rate scenario continues to gain traction as rate hiking has been less effective as a policy tool than previously thought.

It is important to understand the context behind this shift. Inflation has been high due to a combination of factors affecting supply and demand. Although some issues with global supply chains have improved, high interest rates haven't significantly lowered overall demand, leading to persistently high inflation.

Additionally, trends like reshoring and an increase in Treasury issuances are expected to keep inflation and bond yields at elevated levels. Despite these challenges, the global economy remains robust, supported by strong corporate earnings growth projections of 7.7 percent this year.

What does the current stance of Federal Reserve mean for equity asset class?

The Federal Reserve's current cautious monetary policy stance has significant implications for the equity markets. Despite a robust rally in the first half of 2024, the outlook for equities remains positive for the remainder of the year. This resilience is supported by a combination of factors: the corporate earnings outlook is positive, stock valuations are reasonable, and an expanding US monetary base provides additional liquidity.

The widening negative yield gap between US equity dividend and 10-year treasury yields underpins the relative attractiveness of bonds over equities, with year-to-date flow of funds data further evidencing broad-based preference for bonds on a cross asset basis. Thus, we retain a preference for bonds over income-generating equities given their attractive risk-reward.

Do you expect the equity rally to broaden in US markets given the possibility of slow rate cut? Which are the sectors to bet on?

Yes, despite expectations for a slower pace of rate cuts, the US equity rally is likely to broaden. Key sectors poised to benefit from sustained household demand, even amidst elevated interest rates, include Big Tech, upstream energy companies, and largecap financials.

Big Tech companies, with their significant cash reserves and continuous innovation, are projected to see strong earnings growth in the coming years. Upstream energy companies are also expected to perform well due to stable demand influenced by inelasticity and geopolitical uncertainties. For large-cap financials, particularly those with minimal exposure to commercial real estate, elevated interest rates could improve net interest margins as interest income on loans tends to be repriced quicker than interest expenses. However, caution is warranted for banks with significant investments in commercial real estate. Looking beyond the US, India presents significant growth opportunities, especially in technology and consumer sectors, driven by a young and expanding population.

In India, favourable demographics supports broad consumption growth, with sectors like appliances and consumer electronics expected to nearly double in value by 2025. Additionally, India’s strong tech talent pool has produced global tech leaders which boast healthy balance sheets similar to those of global Big Tech companies. This blend of factors across both US and Indian markets offers diverse opportunities for investors looking to benefit from current economic trends.

As a foreign investor, what is your take on India after the formation of Modi government for third time?

India under Prime Minister Modi's third term provides a promising landscape for foreign investment, characterised by policy consistency and proactive economic reforms. The government's ongoing focus on inclusive growth and infrastructure development, coupled with fiscal discipline, enhances both stability and investor confidence. Specific initiatives such as PM-Kisan and the Pradhan Mantri Awas Yojana (PMAY) underscore a commitment to vital sectors, while concerted efforts to tackle issues like food inflation and agricultural stress further showcase the government's responsiveness to economic challenges.

Domestic sentiment should continue to drive market returns. Although elevated oil prices pose a risk to domestic sentiment, improving current account and fiscal positions should mitigate this sensitivity. On a risk-adjusted basis, we prefer India’s small- to mid-cap segment, where high growth potential offers opportunities for significant returns, especially as the market cap-to-GDP ratio remains low. With the near doubling of public capex in Modi’s agenda, capex recovery is likely to continue driving economic and corporate earnings growth for equity markets in the near future.

Are you betting big on AI space? Is there any kind of bubble in the space?

We are closely monitoring the AI space and its value chain, which includes hardware, software, and applications. Investing in AI varies between regions. The US and Europe lead in design and innovation, with companies like NVIDIA and Google at the forefront of AI chips, software, and cloud services. Asia excels in manufacturing, with firms such as TSMC and Samsung dominating semiconductor and memory production. While AI is a key investment theme, there is growing speculation about a potential bubble due to the rapid advancements and high valuations in this space. However, the fundamental growth drivers and transformative potential of AI suggest long-term value despite short-term volatility.

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