Lately, Singapore banks have been quietly slipping. Shares of DBS, OCBC and UOB were down 1-2%. Not a huge crash.
But could this dip be a sign of more worrying things ahead? What’s driving Singapore banks lower? And is it a good time to buy now, or sell?
Let’s dive in.
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Singapore banks dominate the STI Index
Just to put this out there – history is filled with investors believing in all the crazy things. In other words, the stock market behaves like a herd. If we aren’t careful, we can behave like one too.
Right here and now, Singapore banks have been on a bull run until lately. These bad boys now account for over 50% of the STI Index.
This was much higher than 34% of the index in 2024. And this is much higher than other stock market indices. For instance, US banks account for 13% of the S&P 500 Index.
The question I’ll ask is not whether DBS, OCBC and UOB can actually go higher. The question I’ll ask is…
What happens when earnings fail to catch up to valuations?
Now, there’s no doubt Singapore banks are one of the best businesses to own – high-quality assets, a reputable deposit franchise and an unbeatable monopoly in Singapore.
But in my 15 years of investing, the financial graveyard is filled with investors who bought high-quality assets at the wrong price. Just because you identified a high-quality business doesn’t mean the stock is always a buy.
And what price you pay for high-quality assets is determined by the interest rate cycles. I’ll explain.
In my last article I spoke about interest rate cycles. With the Fed cutting interest rates last month, and hinted at another two more by the end of this year, it’s good news for stocks.
But bad news for banks. Because sometimes, you can’t expect the stock market to follow academic rules.
You see, when interest rates start to fall, banks should lower their loan rates. Normally, cheaper loans boost demand for companies and consumers to take up more loans. But this doesn’t happen instantly.
Why?
Loan growth takes time to respond. Like I’ve said, you can’t expect the stock market to follow textbook rules. Loans don’t adjust immediately to interest rate changes.
Instead, as we gradually move into a new interest rate cycle, lower interest rates will immediately impact lower profit margins. With little rise in loan volume.
As a result, banks’ profit margins will suffer from what I call margin compression. In other words, net interest margin, which is the spread between what banks earn on loans and pay on deposits – shrink. As banks adjust to a new rate cycle, profit margins suffer.
A few months ago, we saw DBS’ latest quarterly profits falling…
UOB’s latest quarterly net interest income has been falling quarter on quarter…
Same with OCBC’s latest quarterly net interest income, which also has been dropping…
I wish I was wrong. But what I’m reading suggests banks are nearing a peak in the interest rates cycle.
Is Singapore banks a buy after recent dip?
Singapore bank shares fell recently. But look, just because DBS trades at $52 per share doesn’t tell me how cheap or expensive a stock is. The way to value banks is something hardly people talk about.
And it’s diametrically opposite to how most people would decide whether a stock is cheap or expensive.
One of the simplest ways to value a Singapore bank stock is to look at its P/B ratio.
This compares a company’s share price to its book value per share, or a company’s net worth. It indicates how much investors are willing to pay for each dollar of a company’s net assets.
The higher the PB ratio, the more expensive it gets.
Disagree with me but I’ve been around the block to know bear markets creep up on investors when they least expect it.
Remember 2007? Overnight, shares of some of the biggest financial institutions crumbled. Even the strongest ones saw their shares plunged overnight.
One reason was simply their prices were just “too rich”.
In 2007, DBS shares treaded at 2.9x P/B ratio, the highest it has ever traded over the last 18 years. Today, DBS shares trade at 2.4x – we’re not that far off from the last cycle.
But wait. Do you also notice how this is the first time after 18 years a bank shares trades like this? Yet today, we don’t see toxic assets or subprime mortgages around.
What I see is very rich valuations that absolutely make me scratch my head.
For instance, even DBS trading at 2.4x PB ratio means it must be growing much faster than over the last couple of years. But that’s not what I’m observing as interest rate cycles change.
And when cycles do change… I don’t wish to know those who have bought DBS or any other Singapore bank shares at its peak.
Now, that’s scary.
My final thoughts
Bank stocks move in cycles, swinging hard during macro shocks – US debt crisis in 2011, Trump elections in 2016, interest rates hike in 2018, COVID-19 pandemic.
My pro-tip is this – protect your downside first. Because collecting dividends while watching your capital shrink isn’t my idea of passive income.
When prices and valuations are close to peak levels, the risk isn’t missing out on the next 10-20% gain. It’s being stuck in a 30-40% drawdown later.
The time to buy comes when such surprises jerk bank shares. Or when bank shares become unloved.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan
Good analysis. I long time investor also.
Hi A Tan,
Congrats! You must have been collecting your bags of dividends 🙂
Cheers,
Willie
Hi Willie,
Thanks for your great insights on Singapore banks which totally make sense. Buying the bank shares at the ‘right’ optimum P/B (vs their historical P/B) will ensure one does not start ‘kicking themselves’ whenever big pullback or ‘mean reversion’ happens esp. during market euphoria…
Hi Ian!
I agree with you. I’d still take note of knowing when to buy high-quality assets.
Cheers,
Willie
Great article. Banks indeed cyclical although DBS had somewhat went against the trend. It may not hold for long and that is starting to show of late.
Hi SC,
Thank you SC, appreciate it!
Yup, I’m just curious of thought process from buyers of Singapore banks at today’s peak.
Cheers,
Willie