Market pundits say the second half is likely to see the CI scale new heights. But can it reach 1,500?
THE debate on whether or not Malaysia is witnessing a bull run is over. Indeed the market is smack in the middle of one; it may not be the fast and furious over-the-top exuberance but it's been a good run nevertheless. Year-to-date, the key barometer has gained 254.82 points or 23% in the stock market. From a year ago, the key barometer has added 400 points or 50%.
And while the bullish outlook was occasionally tampered with, be it from a statement by an ex-regulator in US or concerns of a possible meltdown in China, it has generally managed to hold up.
»The KLCI bull-run is just six months old« SHERILYN FOONG |
But it took awhile getting to this point where optimism outweighs doom. At one point, earlier in the year, when the Shanghai market tumbled, it set off a domino effect in world markets. The market lost 162 points in five days. The earlier optimism began to fade and was replaced by extreme caution. Market pundits had then said that it will take awhile for the market to regain its footing.
Fortunately, they were wrong. In less than a week, the market stemmed the free fall and was, once again, rearing to go but it appeared that the steam was not quite there.
Other concerns were offsetting the renewed optimism in the market. These factors included the US subprime default fears in March. Malaysia, like Asia in general, reacted to this seemingly negative news and the wild gyrations of the benchmark CI kept investors at bay.
Macro picture
From the macro perspective, Malaysia’s inflation unexpectedly eased in May to 1.4% – the lowest in three years – as the effects of a fuel-price increase last year faded and a strengthening currency reduced import costs. Inflation averaged 2.2% in the first five months of this year.
The ringgit has gained 1.9% against the dollar and 6.1% against the yen this year.
Growth of the Malaysian economy moderated to 5.3% in the first quarter of 2007, down 0.4% from the revised 5.7% increase in the previous quarter. Strong expansion in the construction and services sector were the main drivers of growth.
»For the market to reach 1,500 points in 2008, all plans must be perfectly executed« VINCENT KHOO |
In the US, the Federal Open Market Committee (FOMC), held steady on interest rates at the conclusion of its June 27-28 meeting, but maintained a hawkish tone on inflation.
The FOMC kept the Fed funds target level at 5.25% for the ninth time in the past 12 months. While it acknowledged that the growth and inflation mix had improved since the last meeting, the Fed made it abundantly clear that it remains resolute in containing inflation risks.
Since its last policy meeting on May 9, global markets have become more wary of rising inflation, and bond yields have moved up sharply. Firmer energy and commodity prices in June, with crude oil futures topping US$70 per barrel once again, and strength in other commodity prices, suggest that inflation might be on the rise in the next few months.
The US economy expanded at a 0.6% annual rate in the first quarter, the slowest pace in more than four years.
“While inflation is a fear, it is also a sign of growth. How bad can that be?” says one observer.
Undeniably though, it is a rocky road ahead for most markets. Despite fears of inflation, economists point out that the macro outlook across the globe has never been more resilient.
In Malaysia, there has been a flurry of feel good news supporting the market's upward climb, largely owing to the rolling out of the projects under the Ninth Malaysia Plan, strengthening pace of mergers and acquisitions, implementation of various incentives to draw investors and the improving economic outlook.
Can the market rise further?
As far as consensus goes, yes, the market still has legs to run. There are many reasons for that – and many more investment strategies to accommodate that.
»The market will eventually scale to 2,000 mark over the next 24 months« TAN TENG BOO |
Alliance Investment Bank director and head of equity capital markets Sherilyn Foong adds that the KLCI bull-run is just over 6 months old.
“Compare this to the fact that our market has been a laggard regionally for the last 2 to 3 years. Regionally markets such as Singapore and Indonesia surpassed their pre-crisis highs much earlier compared to the KLCI which has only done so in the last couple of months. On these grounds, one can argue that ours is still a very young bull run,” she says.
“Investors should not miss this market opportunity as this is the bull market that the investment community has waited a decade for,” says CIMB Investment bank research head Terence Wong, chiding investors who are far too sceptical. He suggests that investors scour around for high beta-stocks with strong news flow and adds there is still much value to be discovered in mid- to small-cap stocks: “The spate of recent privatisation exercises is indication that many stocks remain undervalued even after the market upturn. In fact, the pace of privatisations appears to be accelerating.”
He also expects a property boom to take place in the next 3-5 years. With that in mind, he says that many listed property companies that are trading at wide discounts to their revised net asset values (RNAVs) may be prime candidates for privatisation exercise.
While Wong says it is far too early to say if the local market will witness a prolonged multi-year bull market, he is sure about its prospects over the next 9-12 months. He has come up with a new 12-month KLCI target of 1,700 points based on an unchanged 18x PE while keeping its end-2007 KLCI target of 1,440 points.
“The 1,700-point target comes on the back of accelerating market EPS growth from 19% in 2006 to 22% in 2007.
Besides the event-driven news flow reasons, fundamentals and valuations remain sound. CIMB is encouraged by the significant earnings upgrades over the past 3 to 6 months.
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Despite the KLCI’s upsurge over the past 12 months, stronger-than-expected earnings growth has kept PE valuations at near historical lows.
The research house says that the KLCI is trading at a calendar year (CY) 2008 core PE of only 14.6 times (x), and this is still at the bottom of its 20-year range.
What's up for the near term?
No doubt the overall outlook of the market appears rosy but as far as near term is concerned, analysts say there might be a breather in the offing. For a market that is expected to rise further, that is a sweet note for investors who have missed the boat in the earlier sessions and looking to fish for value stocks.
JP Morgan executive director and head of broking Clement Chew says the market has gone up substantially in the first half of 2007. “I think it will get a little more difficult looking for stocks with compelling valuations. Furthermore, markets that have done less well, for instance Taiwan, South Korea and Thailand may take the interest away from Malaysia.”
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“I foresee the market continuing to appreciate, but we won't see a surge like what we saw in the first half of the year. In Malaysia, stock picking is extremely important. However, I don't think it will be difficult for the market to hit 1,450 to 1,500 sometime in 2008,” says Chew.
Holding a less sanguine outlook on the market is Asseambankers research head Vincent Khoo. As the market has been up nearly 50%, in less than a year, Khoo feels that most of the positives have been factored into the market.
“For the market to reach levels close to 1,500 points in 2008, all plans must be perfectly executed. The market needs to see execution from the Government to proof that earnings will really come in.
“I see the rally moderating. Domestically, we have had a spate of negative news, for instance the accounting irregularities, and a narrower positive breadth in the recent reporting season (which indicates less likelihood of earnings upgrade). On the global scene, there are concerns of interest rates going up due to inflation concerns,” says Khoo.
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With the market's present buoyancy, it would be riskier to take no risk at all. After weighing the positive and negative factors affecting the stock market, there are still far more positive catalysts driving the market higher.
Wong says that the full impact of the 9MP pump-priming including disbursement of contracts and mobilisation of equipment is likely to be felt in 2008. Besides construction works, news flow on property sector incentives and development corridors should be strong.
Wong adds that the momentum of market earnings per share upgrades remains robust and there is still significant upside potential for 2008 estimates. He is forecasting 2007 EPS growth at 22%, an acceleration from 2006’s 19%. Return on equities are set to improve from 15.2% in 2007 to 15.6% in 2008.
On the external front, regional and Wall Street prospective valuations are reasonable at mid to high teens levels, coupled with strong earnings performances.
He says market psychology is still favourable as many local institutional and retail investors remain cautious. Wong does not see any “irrational exuberance” yet.
Reaching 2,000 points?
On the flipside, Tan Teng Boo of Icapital is extremely bullish; he sees the market eventually scaling the 2,000 mark over the next 24 months.
“The whole world is now booming. We can't get a better environment worldwide than present times. For now, I think the market needs to undergo a more prolonged correction before it is able to resume its upward trend. This trend will be supported by fundamentals, rising earnings and strong economic growth.
“I think the year end should see the CI above the 1,400 mark,” he says.
With surging global liquidity, pundits expect sharp reversals in risk appetite among investors. Central bankers have moved to mitigate this risk; in US, interest rates have been rising in the last couple of years and in China, measures are being taken to cool off the speculative pressures. Yet, many expect US and China to be less of a worry over the medium term. Analysts are also expecting the US to start cutting rates over the next 6 months.
With that the markets have been witnessing some form of consolidation with the Malaysian bourse being no exception. Chew feels that the recent consolidation may continue till the third quarter and as such, he advises investors to scoop up stocks during the weak points.
“Stocks with multi-year growth at reasonable valuations are preferred. Investors should remember that when markets go up, so does the risk. Investors should realise they are accepting higher market risks now,” he says.
Foong's belief that Malaysia's bull run is still relatively young could also be taken to mean that the downside risk is limited. “Any surge in liquidity can potentially be a double-edged sword. However, in previous market cycles we have seen local funds enter the market when value emerges from a foreign-led sell down.”
Of sectors and ratios
Not many analysts expect Malaysia to be accorded a higher price earnings valuation compared to leading markets such as Hong Kong and Singapore (which are presently trading within the same PE band). Unless of course, as Khoo points out, the execution of all that has been promised and is being anticipated has been carried out.
Wong says that on a PE basis, Malaysia is trading at a wider premium of 18% to the region versus 12-13% six months back.
“Malaysia has finally caught up after lagging behind in past years and is one of the best performers year to date. The premiums are justified by the improving earnings outlook and relatively high dividend yields,” he says.
Logically speaking, one's investment strategy and its subsequent outcome really depend on the individual stocks as well.
“If the stock is really undervalued, well managed, relatively cheap and has good management, I think it doesn't matter whether the index goes up or down,” says ICapital’s Tan Teng Boo. He's got a point.
Khoo expects some activity in mid cap stocks as the market consolidates in the next few months. He favours mid caps in sectors such as oil and gas, construction, property and building materials. As for large cap stocks, Khoo suggests high-yielding companies.
“Stocks with multi-year growth with reasonable valuations are preferred. Investors should remember that they are accepting higher market risks now,” adds Chew.
Chew likes the property sector, particularly those involved in commercial developments. He also favours the oil and gas and commodities sector like palm oil and timber, as their outlook is solid.
Dominant themes
Themes such as 9MP, continued reforms by Government-linked companies, Visit Malaysia Year 2007 and even the speculation of a general election that may fuel interest in the stock market is likely to be dominant in the second half of the year. The development of the Southern Corridor or Iskandar Development Region fuelled massive interest in the first half of this year and is expected to do so for the rest of the year on the back of more incentives.
But a new theme will soon emerge in the market which is likely to generate interest in companies that are viewed as major beneficiaries and that involves the development of the Northern Corridor, the launch of which is slated sometime end July.
“Meanwhile, the monetary policy has remained accommodative with Bank Negara holding interest rates steady as inflation has come off an earlier peak as a result of cost-push increases,”
“Add to this the increase in liquidity released from the surge in privatizations and takeovers as well as asset reflation due to the stronger Ringgit,” says Foong.
Wong says that the banking sector is a natural beneficiary of private financing initiatives financing and the upcoming property boom. Oil & gas should remain a favourite, shored up by sustained high oil prices and global opportunities.
More recently Foong says that some major research houses have based their bullish market outlook on an expected boom in the property sector. She points that this is valid for Malaysian properties in terms of affordability on a regional basis.
“This has translated to actual property transactions by foreign buyers recently. Like our equity market, this too is only just happening at an initial stage. The knock-on effect of the upturn in the property market will be a broadening of investor interest in property-related stocks beyond just the top property developers to the other smaller players as well as the REITs,” says Foong.
Execution - Key To Success
On the many projects that the government has rolled out, Chew feels that success to execution is key to the Malaysian story.
“The execution of the Iskandar Development Region (IDR) project is important, as it will prove Malaysia's ability to compete. It is for this reason, that the IDR will be more significant for the stock market,” he says.
Khoo says that these things take time to happen, as a plan of such magnitude cannot materialize overnight. Despite the long gestation period, he does concede that market momentum is very much alive.
“The property market is a catalyst on its own, nevertheless most of the private initiatives are still in the planning stage. We still need the foreign direct investments coming in, and we also need the coordination between all the related parties for a one stop centre to attract investors,” says Khoo.
Tan says that on the domestic front, policies by the government seem to be promising when compared to the previous administration.
Nonetheless, the speed of project implementations are slow.
“On one hand, the signs of things improving are showing, but then there are also signs that we shouldn't get too excited or bullish. At the end of the day, people want to see whether Malaysia has really changed,” he says.
While there has been plenty of hype over a new growth corridor in the North, Khoo feels that the IDR would be a more significant story for Malaysia.
“People have seen the success in Shenzhen, and the overflow of benefits coming from Hong Kong. People want to see that same overflow coming from Singapore,”
“And the Singapore story is an extremely compelling one, where it will be a tourism hub for Asia. With the scarcity of land in Singapore, and if IDR is executed properly, there will be lots of benefits to reap,” says Khoo.
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