Sunday, November 29, 2015

Where is the market heading?

Indications are that the emerging-market selldown is coming to an end. But will it mean a revival for Bursa and other Asian exchanges?

WHEN asked about the future direction of the FTSE Bursa Malaysia KL Composite Index (FBM KLCI), most investors and fund managers don’t really have an answer.

The opinion is divided on whether the local bourse is cheap or expensive. Without doubt, Malaysia has faced a barrage of negative developments throughout the year - on both the political and economical fronts - with things looking a bit settled now.

The FBM KLCI peaked in April at 1,863 points and has since then dropped over 250 points to its low of 1,532.14 on Aug 24. Since then, it has been moving sideways.

The big drop in the index this year was mainly because of the steep drop in the ringgit and its plunge beyond the Asian financial crisis peg of 3.80 to the US dollar. This has triggered selling pressure in the stock market so far this year. The ringgit is currently trading at 4.21 to the dollar.

At 1,683 on Thursday, the FBM KLCI has stabilised and is now trading at a price earnings (PE) of 17.79 times this year’s earnings and 15.04 times 2016 earnings. So, where does the market go from here?

One very positive catalyst has been the sale of 1Malaysia Development Bhd’s (1MDB) power assets via Edra Global Energy Bhd to a Chinese-led consortium for RM9.83bil, to be completed in February next year.

Credit Suisse sees this news as positive for the ringgit and has revised its US dollar/ringgit forecast to 4.20 in three months and 4.40 in 12 months, from 4.50 and 4.60 previously.

“The sale of the 1MDB power unit for RM9.8bil in cash is the first step towards resolving 1MDB’s RM42bil debt. The sale of 60% of Bandar Malaysia will likely be concluded by year-end. We believe 1MDB would then be wound down,” said Credit Suisse.

This has seen Tenaga Nasional Bhd (TNB) rallying, as investors cheer that TNB will no longer need to “bail out” Edra.

Another plus point for the market is that ValueCap Sdn Bhd, the Government-owned fund set up to buy undervalued stocks, is expected to come into the market in the next few weeks armed with RM20bil. But it must be noted that RM20bil is miniscule compared to Bursa Malaysia’s market capitalisation of over RM1.3 trillion.

In the meantime, with Malaysia having suffered from almost a year of low oil prices, the economic fundamentals of the country remain intact. This is seen in the trade surplus, the narrowing budget deficit and the banking sector that continues to lend. The Malaysian economy recently grew by 4.7% in the third quarter, having grown by 4.9% in the second one.

A bigger catalyst, however, which many have failed to notice, is the improving earnings of stocks on Bursa Malaysia.

While earnings have disappointed consensus expectations over the past six consecutive result seasons, the current reporting season appears to be pointing toward the end of a prolonged downcycle in earnings growth.

Consensus is now expecting the FBM KLCI’s core earnings to grow by 8.7% in 2016 compared to only 1.9% this year.

Not surprisingly, the FBM KLCI has been rallying over the last 14 weeks, on a mixture of the Edra sale and perhaps the improving earnings.

Zulkifli: ‘The Government has also improved its finances and made a non-disruptive transition towards a less petroleum-dependent fiscal situation.’ MIDF Research head Zulkifli Hamzah expects 2016 to be the end of three years of “earnings recession”, with the average earnings growth of FBM KLCI stocks projected to surpass 8%.

“This is a necessary precondition for the market to perform better next year. In addition, Malaysia is expected to be the biggest beneficiary in Asia should there be a rebound in commodity prices. Most importantly, there has been significant progress in the qualitative space. For example, issues relating to 1MDB are being resolved. The Government has also improved its finances and made a non-disruptive transition towards a less petroleum-dependent fiscal situation,” says Zulkifli.

Perhaps, the worst really is over. On a year-to-date basis, there has been a cumulative net foreign outflow of RM18.5bil, compared with the RM6.9bil outflow for the entire 2014.

MIDF estimates the overhang of foreign liquidity for money that has come in since early 2010 to be less than RM10bil, at only RM9.4bil.

In other words, foreign presence in the local equity market is currently very low.

It seems increasingly likely that the United States Federal Reserve (Fed) will raise interest rates in December. However, should the Fed be raising interest rates, it doesn’t necessarily mean that stocks would fall.

“Now is not the time to write the market off. We definitely see opportunities in the market. Bonds are not a good place to be in, they give very low yields at the moment. And in an environment of low interest rates, the stock market is the best place to be in,” says Phillip Capital Management Sdn Bhd chief investment officer Ang Kok Heng.

Of PE ratios and the bull market

As the FBM KLCI represents the 30 main component stocks of the index and the index is now trading at 17 times PE, some may take this to mean that the big caps are relatively pricey.

The big caps have been rallying mainly because local funds have been supporting the blue chips from foreign selling for the better part of the year.

Ang feels that a PE of 17 times is not expensive.

“Whether or not the PE is expensive or cheap is relative. At 17 times PE, the FBM KLCI is now offering an earnings yield of about 5%, which is a good thing. So, we can’t say that the PE is expensive,” he says.

Typically, valuations tend to expand as bull markets mature.

For example, if the earnings of the FBM KLCI are expected to improve next year, the market would have priced this in and hence, stocks would start to run.

As the earnings of these stocks have yet to be delivered, naturally the P (price) component of the PE ratio would rise first. Subsequently, when the earnings are really delivered, the P comes down while the E (earnings) component goes up, reducing the valuation.

However, if there is another round of earnings growth, the P goes up again, raising valuations.

Another example would be the FBM KLCI in 2009.

Having just recovered from the 2008 financial crisis, PE ratios increased on anticipation of an earnings recovery. From the beginning of 2009, the PE of the FBM KLCI rose from 12 times and was trading close to 23 times by the last quarter of that year. The FBM KLCI’s PE quickly dropped to 19 times by early 2010, ending the year at about 17 times.

Now, a person without background knowledge of the FBM KLCI’s stock returns, might easily assume that with that sort of PE drop between 2009 and 2010, stocks naturally must have experienced a sharp fall in 2010.

Not at all. In fact, it was quite the opposite, The FBM KLCI ended 2010 42.31% higher to 1,272.78 points.

The PE ratio fell because projected earnings increased more than the stocks did. This is not surprising too, considering that the market was regaining its footing after the subprime and debt crisis in the US.

PEs are about long-term averages and made up of extreme highs and lows.

So, at 17 times PE, it doesn’t nescessarily show that today’s valuation is intrinsically expensive or cheap because it can keep expanding if earnings catch up and sentiment improves.

Sell-off in emerging markets over?

Malaysia has been part of the sell-off of the emerging markets as a whole. In Asia, save for the bourses of China, Japan and Korea, all other markets are down on a year-to-date basis.

Emerging markets have deteriorated sharply this year, following a slowdown in the Chinese economy and widespread outflows of capital. As of last week, global funds were still selling out of Asian markets although the selling has now abated (see chart).

Malaysia aside, the currencies of other developing markets have also tumbled close to their lowest levels this year.

Coupled with the impending US rate hike, this has propelled investors to flee emerging-market assets.

A research head who declined to be quoted says that the sell-off in emerging markets as a whole has ended since August.

“I feel that markets would rebound in the fourth quarter of the year. Even with volatility and the rate hike, markets will move higher. As you can see, emerging markets are now well above their lows,” he says.

He adds that the signs of the market bottoming are already there.

For example, the ringgit and the Malaysian Government Securities have strengthened, showing signs that investors are more confident. China has started taking steps to strengthen its banking system and most emerging-market currencies have stabilised. Also, the Baltic Dry Index, an indicator of bulk cargo trade, has sunk to its lowest levels, indicating that there may not be much more downside to the China economic slowdown.

The research head sees the FBM KLCI ending the year higher than the 1,761 points it started with at the beginning of the year.

Ang too feels that the sell-off in emerging markets is coming to an end.

Traders want to make money. The ringgit has fallen and the price of stocks has dropped. This alone is a reason to buy. By the sheer reason of investors putting money into emerging markets again, this will bring the currency up, and everyone will jump in. Then, people will come up with reasons that a new trend of investing in emerging markets has begun,” says Ang.

“Markets, after all, move in cycles. You just need a sufficient amount of fund managers to have the same idea on emerging markets for the positive trend to start,” says Ang.

“Currencies and equity prices of emerging-market economies have been in the doldrums for an extended period of time. The markets have been so conditioned by weak sentiment to a point that they appear immune to negative newsflow. Due to the prolonged period of depression, global investors are beginning to see value surfacing in these markets,” says Zulkifli.

He adds that a catalyst to an emerging-market ‘breakout’ from its abysmal state could be an improvement in the economic outlook.

“The soft global commodity prices, combined with cheaper currencies, have improved the competitiveness of some emerging markets and allowed them space to work on their economic vulnerabilities, such as current account deficits. These countries have also been busy in undertaking market and economic reforms,” says Zulkifli.

Related Posts Plugin for WordPress, Blogger...