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Singapore’s Economic Growth Is Slowing: Here’s Why Stock Market Investors Should Not Worry

According to a Business Times article published earlier today, economists surveyed by the Monetary Authority of Singapore expect Singapore’s gross domestic product (GDP) to expand “in the range of 2 per cent to 2.9 per cent this year.” The median estimate by the economists was 2.7%.

The economists’ forecasts are at the lower-end of the MAS’s official growth outlook of between 2% and 4%. For some context, Singapore’s GDP expanded by 2.8% in 2014 and 3.9% in 2013.

With these GDP figures in hand, it’s not unreasonable to conclude that Singapore’s economic growth seems to be slowing. If that’s really the case, should stock market investors in Singapore start worrying? Not quite. There are two good reasons why Singapore’s economy may not be a cause for concern.

1. What the economy does can have no correlation to how the stock market performs.

The chart immediately below plots Singapore’s GDP growth rates and the Straits Times Index’s (SGX: ^STI) returns for each calendar year from 1993 to 2013.

Singapore's annual GDP growth rate and the Straits Times Index's yearly return

Source: World Bank (for GDP figures); S&P Capital IQ (for the index’s returns)

In 1993, Singapore’s GDP shot up by 11.5% and the Straits Times Index generated a 59% return; in 1998, GDP expanded by 8.3% and yet the Straits Times Index endured a stomach churning 22% decline. Epic GDP growth of 8.9% in 2006 was accompanied by a juicy 27% climb in the Straits Times Index; but, a 6.1% uptick in GDP in 2011 had a negative 17% return in the index for company.

Given all these, I trust it’s easy to see that there’s no observable relationship between GDP growth and stock market returns.

2. Singapore’s stock market has an attractive valuation now.

Last month, I wrote in an article that the Straits Times Index had an attractive valuation at the end of 2014 based on its Graham and Dodd price-to-earnings (PE) ratio. The following’s a recap, with some slight changes made for clarity and brevity:

In a presentation given on 10 January 2015 at an investment forum, Teh Hooi Ling, the Head of Research at boutique investment management firm Aggregate Asset Management, showed that the Straits Times Index was valued at just 13.7 times its Graham and Dodd PE.

The Graham and Dodd PE is a measure of value that compares the price of a stock with its average earnings per share (EPS) figure over the past 10 years. It’s a technique that was introduced by the legendary investor Benjamin Graham as an improvement over the simple PE ratio since the usage of an average EPS figure for a decade-long period helps smooth out the volatility that may come with business or economic cycles.

History has shown that a Graham and Dodd PE of 13.7 can be considered cheap. Ms Teh pointed out in her presentation that the Straits Times Index’s average Graham and Dodd PE for the three-decade period between December 1985 and December 2014 was 20.8, some 50% higher than the index’s Graham and Dodd PE at end-2014.

There’s more that history can tell us. Ms Teh’s presentation also contained the chart below. What you can see is that the market tended to produce some healthy returns whenever it had a Graham and Dodd PE that’s around 13.7; the red and green lines show that the Straits Times Index had produced a median and average compound annual return of around 10% and 12%, respectively, over the next five years whenever it had a Graham and Dodd PE of between 12.5 and 14.5.

Singapore PE vs returns (from Aggregage Asset Management)

Source: Aggregate Asset Management, with data from Thomson Reuters Datastream

With the Straits Times Index now at a price level very close to where it was at the end of 2014, the conclusions that applied to the index back then could also be carried over to today’s context.

A Fool’s take

The pace of economic growth in Singapore might be stepping down, but as an investor, I’m not too worried. Like we’ve seen, economic growth can’t tell us much about what the market will do. Also, the low valuations that Singapore’s stock market is carrying today is something that should put a smile on investors’ faces.

But, there’re a few important caveats to note when it comes to the valuation issue.

While Singapore’s market has historically produced good average and median returns when it had a low valuation (as you can see from Ms Teh’s chart), there can still be a wide dispersion of outcomes. In addition, there’s no ironclad law which says the future must follow the path of history. As my colleague Morgan Housel writes, “People get history wrong when they look back at specific events and expect them to repeat in the future.” We must always be prepared for future outcomes that lie outside our history-derived expectations.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.