Sell Banks – Late Cycle Performers, but End-STI Bear Mkt. Losers

 Downgrade DBS to Sell, UOB still top Sell:
Banks have delivered an expected late cycle outperformance vs. the STI, notably OCBC, UOB, on solid loan growth/NIMs, although 2Q08 disappointed on poor markets-related income, regional concerns.
Past bear cycles show that as the STI approaches a trough, banks sell-off as an economic downturn broadens and deepens. Downgrade DBS to a Sell from Buy; UOB top Sell. Banks look cheap on consensus PER, but may falter as downside risks emerge and earnings visibility deteriorates. Banks could then test the lower supports implied by Price-Book, which may mark the bottom of the STI bear.

 Singapore bear markets & recessions:
Citi Strategist Hak Bin Chua notes that in the past 4 bear markets accompanied by economic downturns, the STI fell an average 44% from the peak over 71 weeks. The current STI fall of 29% from the peak has taken 46 weeks, suggesting a further 10-15%fall and several months to go. From the Oct '07 STI peak, the 3 banks have outperformed the STI 8%-16%. In the previous 4 bear cycles, banks sold off at the end, giving up their late cycle outperformance, but marking the bottom for the STI's fall.

 Assessing downside earnings risks:
The catalyst for a sell-off is earnings risk as the economy endures a tough next 12-18 months. GDP contraction is now a reality in several countries. Citi Economist Kit Wei Zheng has cut 2009E Singapore GDP growth to +3.6% (2008E +4.1%). For banks, net interest margins should weaken, while analysts may underestimate the extent of provision charge increases. Fees should slow on weak markets-related income, slowdown in retail spending and tourism. We have cut FY09/10 forecasts 7%-9%; we are now 12%-19% below consensus.

 Finding the banks' valuation trough:
The difficulty for investors to sell banks is that they are close to trough on PERs. But as in past cycles, if a downturn hurts earnings visibility, prices may break down through normal PER supports, and test the lower P/Book troughs. This bank sell-off will likely mark the bottom for the STI.