12-month STI target of 2,991

Since 11 June, the market has risen a further 13% to an 11-month high of 323, driven in part by stronger than-expected 2Q results and, consequently, 6% upgrade in consensus estimates. This, in turn, was mainly due to better margins rather than top-line growth. While the market could take a breather in the near term, given the sharp bounce, this suggests that market earnings could see another leg-up as the top-line picks up – particularly during the sweet-spot before costs catch up with revenues.

With 2010E consensus earnings still down by 38% since March 2008 and at only 74% of the peak in 2007, there is probably further scope for consensus upgrades. In particular, we expect upgrades in the transport sector, where earnings are now 20% of 2007’s peak, to kick in.

Our 12-month STI target of 2,991 is based on a five-year average P/B (for 2010) and implies 16% potential upside. The corresponding MSCI Index target is 356, or +15%. Our P/B versus ROE analysis suggests that another 18% 2010E earnings upgrade over the next six to 12 months would bring the market back to the historical average P/B.

We maintain our overweight stance on transport, banks, media, financials and real estate. On the other hand, we remain underweight capital goods and telecom. Our top picks are SIA, UOB and SPH. Within the mid-caps, we like NOL, YZJ and Midas. Our least preferred stocks are COSCO, Sembcorp Marine and SMRT.

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