Many of the most closely watched bellwether indices, save for that in Japan and China, made advances in 2010 for the second straight year following the sharp drop precipitated by the global financial crisis in 2008. The US Dow Jones Industrial Average and the broader-based Standard & Poor’s 500 indices were up 11% and 12.8%, respectively — both closing above their pre-crisis levels.
Our FBM KLCI was among the better-performing indices last year, gaining 19.3%. And in the first three trading days of 2011, the bellwether index surged another 47 points, closing at 1,566.2 on Wednesday, a fresh all-time high.
Most market observers currently expect the rally to continue, at least for the next few months.
Rising tide lifts all boats
This current rally will be driven, primarily, by the massive infusion of liquidity into the global financial markets, including that from the US Federal Reserve’s US$600 billion (RM1.84 billion) quantitative easing programme, which is slated to run through 1H11. Liquidity will buoy asset prices, including equities, commodities and properties.
Equities for emerging markets, in particular, are expected to attract more than their fair share of inflows on expectations of stronger than global average growth. Both hard and soft commodities too are likely to continue rallying driven by the anticipated weakness in the US dollar — as the result of the Fed’s quantitative easing — and speculative funds seeking higher returns.
Thus, it would not be surprising to see prices hit fresh record highs in the coming months.
Is the rally sustainable?
The bigger question is whether the rally is sustainable. Beyond the wall of liquidity that is pushing prices higher, will the global economy grow at a pace that is supportive of current earnings expectations?
On the positive note, outlook for the US economy has brightened considerably and this was one of the key reasons driving prices higher in recent weeks. The improved confidence was underpinned by a flurry of better-than-expected economic data.
The manufacturing sector continues to fare well, bolstered by demand growth from emerging economies and the weak greenback, which makes US goods more competitive in the global market.
More importantly, consumer spending, which accounts for 70% of economic activities, has been gaining traction. Retail sales for the year-end holiday period tallied better than expectations, supported by an improving job market.
Extension of the Bush-era tax cuts worth some US$858 billion will put more money into consumer pockets. Coupled with the wealth effect from stock market gains, consumer spending is expected to strengthen further this year.
Indeed, fears of a double-dip recession for the world’s largest economy have been rapidly receding over the past six months. A stronger US economy is definitely good news for the rest of the world.
Dose of caution warranted
Having said that, it is quite likely that future data could turn patchy, especially going into 2H11, which would not be surprising given the depth of the financial crisis. As such, we suspect there will be increasingly more volatility down the road.
For starters, although the US economy is starting to add jobs again, the pace is too weak to make significant inroads in terms of cutting the unemployment rate. Case in point, the unemployment rate rose slightly to 9.8% in November 2010 as more people were encouraged to return to the job market. The so-called “under employment rate”, including part timers wanting to work full-time and those who have given up looking for a job, is even higher at an estimated 17%.
Unless the job market picks up steam, it could hurt the rebound in consumer spending beyond the last festive season and, in turn, result in renewed build-up in inventory. Most businesses are yet to feel confident enough to renew hiring of full-time staff.
The housing market, one of the primary sources of household wealth, also continues to struggle with unsold stock, including those expected to come onto the market from pending foreclosures. Demand remains weak following the expiration of government tax incentives. In fact, market observers are debating whether housing is experiencing the beginnings of a double-dip right now.
Paradoxically, anecdotal evidence of the US recovery gaining traction has precipitated a sell-off in the bond market, which pushed up long-term borrowing costs — despite the Fed’s aim of achieving the opposite with its massive quantitative easing programme. Higher mortgage rates would damp refinancing activities, which typically frees up cash for homeowners, as well as end-demand.
The creation of more liquidity has not done as much in terms of stimulating bank lending or demand for loans as hoped. Both the banking industry and big businesses are sitting on vast amounts of cash reserves rather than putting the money to work while credit is still tight for small and medium-sized companies.
Global economy yet to fire on all cylinders
There is a risk that the fillip of excitement from receding fears of a double-dip recession could give way to a period of ambivalence if growth starts to lose momentum. In addition, we suspect the eurozone sovereign debt crisis will continue to buffet investor confidence through the year.
The latest rescue package for Ireland failed to stem the contagion from spreading. Investors have turned to Portugal, Spain and even Italy and Belgium as potential bailout candidates. Even with bailouts, eventual debt restructuring cannot be ruled out if the level of indebtedness ultimately proves to be untenable.
At the minimum, deep austerity measures being undertaken by European governments to rein in their budget deficits will sap economic growth for the region for the foreseeable future.
Even as Japan, the world’s third largest economy, is struggling to keep its flagging recovery afloat under the threat of deflation, perhaps more worrying is the prospect of massive liquidity-fuelled inflation in the rest of the world.
Most market observers expect higher interest rates and tighter monetary policy in emerging economies this year as governments try to nip asset bubbles in the bud. Rising commodity prices are already causing havoc and would eventually eat into consumer purchasing power and hamper economic as well as corporate earnings growth.
Economic and corporate earnings growth losing momentum
Following an estimated GDP growth of 7% in 2010, Malaysia’s economy is forecast to expand at a slower 5%-6% pace this year, which will most likely be front-loaded.
On top of slowing global demand and waning impact from inventory rebuilding, the strengthening of the ringgit is further eroding our export competitiveness. Malaysia’s export growth slowed to 5.3% year-on-year (y-o-y) in November 2010, and was 4.1% lower from the immediate preceding month.
Separately, rising global commodity prices are coinciding with the government’s plans for gradual subsidy withdrawal resulting in a double whammy of price inflation. The most recent five sen to 30 sen per litre hike in petrol prices (for RON95/97) as well as the third price hike for sugar in the last year alone are expected to filter through the economy, accelerating inflation.
And prices look likely to rise further. Crude oil futures on the New York Mercantile Exchange traded as high as US$92.06 per barrel, the highest level since October 2008, last month. Prices have since retreated slightly but are expected to trend higher.
Meanwhile, government service tax is raised from 5% to 6% effective Jan 1, including that newly imposed for pay-TV. Prices for other goods and services too are on the rise. It was recently announced that it is only a matter of time before electricity tariffs are raised while the government may also implement the delayed goods and services tax (GST).
With wages unlikely to keep pace, rising prices will eat into consumer disposable incomes and negatively affect domestic consumption growth. The impact will be compounded by expectations of more interest rate hikes in 2H11, which will raise debt servicing costs. Household debt in the country, at 76% of GDP, is the highest in Asia ex-Japan while debt as a percentage of disposable income is 140%, higher than that in the US.
Corporate earnings growth is already witnessing a gradual loss of momentum in 2H10 and is expected to slow further in 2011. The latest reporting season for 3Q10 offered little for investors to cheer about while outlook remains somewhat hazy beyond the near term.
Ride the rally with key blue chips in 1H11
Given prevailing expectations, including the possibility of an early general election, we expect a rally of some sort over the next few months. In this respect, we would stay with big cap blue chip stocks with familiar names like Maybank and CIMB. The banking sector is a good proxy for the domestic economy while the banks’ overseas footprints will further benefit from expected high growth in regional countries such as Indonesia.
Whilst taking advantage of the liquidity driven rally, investors should, however, be prepared to be nimble — given that there is still considerable uncertainties and potential headwinds, some of which were highlighted above.
Biased towards lower risks, high yielding stocks in 2H11
As such, we are inclined to lean towards lower risks, high yielding stocks going into 2H11 — pending greater clarity on the global economic outlook.
In this respect, we believe domestic-centric companies in relatively resilient industries such as Pantech, HELP International Corp and DiGi.com will offer good returns on a combination of capital gains and yields.
Pantech to benefit from growth in oil & gas
Oil and gas is one of the government’s key focus sectors for growth going forward. Recently announced tax incentives and high global crude oil prices bode well for more marginal oil fields and enhanced oil recovery projects, in addition to deepwater exploration and production.
Pantech (62.5 sen) is among the largest one-stop suppliers of pipes, fittings and flow control products in the country and should benefit from the expected increase in contracts flow in the oil & gas sector. Its products are also used in the petrochemicals and palm oil milling sectors.
At the same time, export sales would be boosted by its manufacturing capacity expansion and joint-venture deal with Saudi-based Al-Otaishan Trading Group, which paves the way for it to supply state-owned oil and petrochemical companies in the oil-rich country. The stock’s low valuations — less than five times forward P/E — suggest room for handsome capital appreciation.
Decent capital gains plus yields for DiGi
Spending within the telecommunications sector is expected to grow steadily. And despite the intense competition, DiGi (RM24.90) has more than held its own — revenue is expected to expand at higher than industry average in 2010-2011. The company is focusing on higher value customers such as the smartphone market, which is growing at a rapid pace. We forecast the telco’s net profit to grow in the high single-digit this year.
It is in the midst of finalising a collaborative agreement with Celcom that could cover operations and maintenance, transmission and site sharing as well as radio access network. If all goes to plan, the tie up could result in up to RM150 million in annual cost savings.
With strong cashflow, the telco is likely to maintain a high dividend payout. As such, we see room for decent capital gains in addition to attractive yields on the back of fairly low risks. The stock is now trading at roughly 15.9 times our estimated earnings with net yield estimated at 6.9%.
HELP’s recession-proof business with long-term growth prospects
HELP (RM2.23) has a strong business model and brand name, which has helped expand its student population base, extend its presence overseas and increase the appeal of its own homegrown degrees awarded under “HELP University College” banner.
The rising — and increasingly prohibitive — cost of overseas degrees, and HELP’s strong branding and academic standing will continue to increase its student base and ability to increase fees in the future, especially for twinning degrees. This underscores the resilience of the company’s earnings, which have grown over 20% annually in the past five years.
HELP has a clearly mapped out growth strategy over the next few years, which culminates in the setup of its new flagship 23.3 acre Subang 2 campus. The campus will elevate HELP into a full-fledged university, from its present status as a university college granted since 2004, and serve as HELP’s regional centre for its increasing overseas student population.
In the medium term, growth will be anchored by growing student numbers — both locally and abroad — the staggered impact of fee increases and the addition of its Fraser Business Park campus. In addition to HELP’s current student population of about 12,000 in Malaysia, it has over 1,000 students studying for HELP accredited courses overseas, in Vietnam, China and Indonesia.
HELP is expanding its overseas base further, and is in the process of setting up new affiliations with a number of colleges in Indonesia, China and Cambodia, apart from establishing an education unit in Australia. With these new tie-ups, the company should see significant overseas income from FY11 onwards.
Quill Capita is a low-risk high yielding investment
For more risk-averse investors seeking higher-than-market-average yields, we favour real estate investment trusts (REITs).
Quill Capita Trust (RM1.11) is among the more attractively valued REITs, currently trading below its net asset value of RM1.22 per share, which should limit the downside risks. We estimate distribution totaling some 8.1 sen per unit this year. That will earn unit holders a fairly attractive yield of 7.3% at the prevailing price.
At present, the trust has 10 properties in its portfolio — with net lettable area totaling more than 1.288 million sq ft — worth RM788 million. Its assets, primarily commercial-industrial properties are located in Cyberjaya, Kuala Lumpur, Selangor and Penang. It is believed to be looking at two properties within the Klang Valley worth some RM400 million. Quill Capita is a unit under Singapore-based CapitaLand’s stable of companies. — InsiderAsia
Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.
This article appeared in The Edge Financial Daily, January 7, 2011.
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