Investors in the Singapore stock market should be a happy bunch this year.
The Straits Times Index (SGX: ^STI) has breached a 17-year high and has logged an impressive year-to-date gain of 12%.
Blue-chip names such as DBS Group (SGX: D05) and Singapore Exchange Limited (SGX: S68), or SGX, have done well.
Singapore’s largest bank’s share price has surged by 27.3% year-to-date while SGX has jumped 16% year-to-date.
Investors may be wondering if there could be more in store for the bellwether blue-chip index? Could it revisit its all-time high of 3,906 attained back in 2007?
Index components and weights
First, let’s take a look at the composition of the Straits Times Index to get a sense of which stocks affect it the most.
As of 30 August, the three banks, namely DBS, United Overseas Bank (SGX: U11), or UOB, and OCBC Ltd (SGX: O39) have the highest weights.
DBS has a weight of 22.61%, UOB 15.8%, and OCBC 11.75%.
Together, the trio of banks make up slightly more than half (50.16%) of the index’s weight.
Hence, an increase in the share prices of these three local banks should have an outsized positive effect on the Straits Times Index.
Next in line will be Singtel (SGX: Z74) at 7.26% and then CapitaLand Integrated Commercial Trust (SGX: C38U), or CICT, at 3.3%.
Together, these five stocks take up more than 60% of the index’s weights.
Other blue-chip names such as Keppel Ltd (SGX: BN4), SGX, and Singapore Airlines (SGX: C6L) take up just 2.64%, 2.74%, and 2.68%, respectively.
First interest rate cut since 2020
Although the Straits Times Index has done well year-to-date, there could be a good catalyst for it to perform even better.
Just yesterday, the US Federal Reserve slashed interest rates for the first time since 2020.
In an aggressive move, the central bank reduced its benchmark interest rate by 0.50 percentage points to a range of between 4.75% to 5%.
According to the median forecast of policymakers, there could be an additional percentage point of cuts in 2025.
This reduction will spell relief for businesses with substantial debt and also provide respite the beleaguered REIT sector.
Lower rates should also provide a much-needed boost to the economy by increasing consumer spending as people now have more disposable income as they need less to service their loans.
The overall improvement in consumer sentiment should trickle down to higher demand for goods and services, in a virtuous cycle that will prompt businesses to expand their capacity to sell more.
Banks are less sensitive to interest rates
Investors may, however, argue that interest rate cuts are bad for the banking sector as lower rates will translate to lower net interest margins.
In turn, this will trickle down and negatively impact net interest income.
However, banks do not only rely on net interest income but also fee income as part of their total income.
DBS saw its fee income climb 25% year on year for the first half of 2024 (1H 2024) to S$2.1 billion due to higher credit card spending and wealth management fees.
OCBC saw its non-interest income rise 15% year on year to S$2.4 billion.
With stronger consumer spending, banks may see their fee income growing.
Lower interest rates also encouraging more people to put their money to work in investments to achieve a higher return.
Such activity should see wealth management inflows for the banks and contribute to wealth management fees.
Net interest income consists of two key components – the net interest margin and loan growth.
Even if net interest margin suffers, stronger loan growth may help to offset the impact as more businesses and individuals take up debts with lower rates.
Finally, banks are now also less sensitive to interest rate changes.
DBS, in its 1H 2024 CEO message, said that net interest income sensitivity was reduced to just S$4 million for each 0.01 percentage reduction in the Federal Funds rate, down from a range of between S$18 million to S$20 million back in 2021.
Lower borrowing costs for all
Lower interest rates also result in lower borrowing costs for a variety of businesses, and will benefit businesses with heavy debt loads.
Singtel had S$11.9 billion of debt on its balance sheet as of 31 March 2024 while Singapore Airlines total debt stood at S$13.3 billion as of 30 June 2024.
Keppel also carried a substantial debt load of S$11.8 billion on its books for 1H 2024.
REITs will also benefit from reduced interest rates that will help to relieve pressure on finance costs.
There are currently seven REITs within the Straits Times Index that take up approximately 11.3% of the index’s weight.
These REITs could see their fortunes improve as borrowing costs ease and they can start to pay out higher distributions once again.
Get Smart: Sufficient fuel for the index
The Straits Times Index chalked up an impressive performance year-to-date.
However, this may just be the tip of the iceberg.
A new interest rate cut cycle may see the economy boom with more people willing to splurge.
Banks stand to benefit from this spending and loan growth while other businesses, including REITs, should enjoy relief from the high rates of the past three years.
There could be further fuel for this rally to carry on and the index may come within striking distance of its all-time high.
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Disclosure: Royston Yang owns shares of DBS Group and Singapore Exchange Limited.
