The first part yesterday of the roundtable discussions dwelt on the KLSE’s lacklustre performance for 2002, and the factors contributing to its weakness. The concluding part talks about the market’s probable outlook for this year, given the looming prospect of war in Iraq. The panellists were Mayban Investment Management Sdn Bhd chief executive officer and director Amin Rafie Othman, AmResearch Sdn Bhd executive director Gan Kim Khoon, Surf88.Com Sdn Bhd chief operating officer Tan Beng Ling and K&N Kenanga Bhd vice-president and head of research Seow Choong Liang, with the discussions chaired by StarBiz senior editor David Chow.
STAR: Coming back to the US economy, consumer demand seems to have slowed, indicated by sluggish sales even during the holiday period, which is the peak spending season of the year. Unemployment figures are rising and US markets are also struggling, as third quarter earnings have not met expectations and this is likely to continue into the first quarter of 2003. What is your take on all this?
Tan: If you look at the consumer numbers, I would think they are actually quite impressive. Because considering Sept 11 and considering the unemployment rate which has been going up over the years, that it is at this level is actually quite commendable.
Star: So what are your forecasts, since it is going to impact on the performance of the Malaysian economy?
Rafie: It is not out of the woods, but the picture is clearing. I’m not pessimistic about the US economy. The 12 rate cuts the Fed has implemented over the past year and a half have to have some impact. I think the Republican Congress will help in terms of public policy, especially with tax cuts, which are positive. The consumer numbers, as Beng Ling said, are overall, quite positive. Going ahead, the corporate scandals will diminish. So there are some grounds to be positive. But there are also some concerns. Like what is the impact of war against Iraq? They have said they are going to spend US$100bil to US$200bil. Recently they asked for approval for an increase in their deficit spending.
The other thing of concern to me is the pension fund problem in the US, which has not been given as much attention as it warrants, because it has not blown up yet. During the days when the stock market was going up, the defined benefits were needed to attract people and cash was abundant. The markets were good, so it was OK. Now with the markets sliding for the past three years, there is a hole in a lot of the defined benefits. And this, under the law, they have to give. So if there is a hole, the companies have to contribute, to put in money to plug that hole. So where does that money come from? Next year for example, it is estimated that they going to need over US$20bil. Where does the over US$20bil come from? It has to come from earnings and once you do that, it’s going to take money away from re-investing in new business, capex, whatever and that’s a significant impact. That’s a real problem. So maybe a 5% – 6 % return from US markets next year, but no major bull run as in the 1990s.
Gan: I think consumer spending in the US is likely to slow in 2003 for three main reasons. Firstly, the US unemployment rate today, at 6%, is actually the highest since 1995. Apart from the ratio being at 6%, what is more worrying is that it means companies are not hiring. In fact they are laying off. This means that if you are a consumer in the US, you will be more cautious about your spending habits in the future.
Secondly, in 2003, consumers would have less avenues for increased spending. In 2002, with the lower interest rate scenario, mortgage refinancing had become very attractive and affordable to many. Even car purchases have become very attractive. Next year, going forward, with the US government going through a federal deficit, interest rates in the US are likely to have bottomed at this level, with no further cuts. If that were to be the scenario, then you would not find mortgage refinancing as attractive anymore. Next year, there will not be any lower interest rates to encourage you to refinance your mortgages. So consumers will not have more money in their pockets because if you refinance, you actually refinance at market value as opposed to your original cost and this could put more money in your pocket to spend. This was what happened in 2002. It would not happen next year.
Thirdly, even if Bush could push through his fiscal policy on tax cuts, it would most likely be directed at businesses rather than individuals, as the individuals have already benefited this year through the tax rebates and tax rate reductions that Bush announced late last year. With this, consumer spending is expected to slow. Consumer spending contributes about two-thirds to the US GDP and was the main driver of their economic recovery last year. That is the concern. Apart from consumer spending, the other worries that most people have about the US is the prospect of deflation and its impact on business decisions. Another one would be the housing “bubble” in the US. That hasn’t actually happened yet, because it has been held up by the low interest rates scenario but it would appear that a bubble is being built up in the housing market. We do not know if it would actually burst but if it does, it would be quite negative as well. I think this is something one needs to recognise as a potential risk factor.
The US economy will probably still grow 2.5% - 2.6 %, as it did for 2002 on the whole. It is not going to recover very strongly. I don’t think it will go down to another recession. Whether a bull run will be sparked will also be dependent on whether there is going to be a major war in the Middle East.
Seow: I think a lot depends on the momentum, whether it is positive or negative. For the US at the moment, the momentum is slightly positive and that can be maintained. Bear in mind that everything that has been done to manage the US economy so far has been on the monetary side, like interest rate cuts. They have not used much of their fiscal policies. They have been running up surpluses as far as the budget is concerned, right up to 2000. They are just beginning to go into deficit this year, so they still have a lot of firepower as far as budget deficits are concerned. I don’t think they will have any problems raising funds to finance the deficit. What I like about the US economy is that it is very diversified, innovative and dynamic. Their companies are quick to react to changes. They are well placed to do very well in the coming upturn, especially in the electronics sector and other sectors as well.
However, all the forecasts are based on the absence of any shocks. The US economy has weathered the downturn in their stock markets really well. In the first quarter of this year, their GDP grew faster than Malaysia’s and the momentum is still positive because their corporations are reacting very quickly to changes. That’s why I am quite bullish about the prospects of the US economy. If their corporations start doing well, their stock markets will go up and that will feed onto itself and create even more positive momentum.
Tan: I am as still mildly optimistic as the rest. Consumer spending won’t moderate because of the surprising strength in the last two years. At the same time, business investments have really bottomed. They have reached a point where replacement investment will have to come in. Since the beginning of 2002, US analysts have been cutting their earnings forecasts almost every quarter. Earnings expectations have been adjusted down to more realistic levels, so the gap between earnings and expectations has narrowed, even taking reduced consumer spending into account.
Star: Alan Greenspan said recently that business investments have slowed in the US because of increased geopolitical tensions. Is it mainly because of the prospect of war in Iraq?
Rafie: A lot of investments in the US have been held back because of the uncertain impact of such a war on the US economy. From what I have read, a lot of companies do not want to commit capital until the situation is clearer, to be prudent. This has had a snowballing effect on the economy. People are just waiting on the sidelines. Purely on probability, I think the war will take place.
Gan: If you have been reading the world news and the statements made by the US, they seemed intent on waging war against Iraq, notwithstanding the fact that Iraq seems to be complying with their demands. If the war in Iraq turns out to be a mess, it will destabilise the whole of the Middle East and that will be a very negative impact on the financial, oil and other markets. If it is a short one and the US emerges as the victor, or at least from the Western perspective it was a satisfactory solution to the Iraq problem, you might see the markets recovering very sharply after that, just as in 1991.
Rafie: The main uncertainty would have been taken away.
Star: To me, the prospect of war is still uncertain, with all these UN inspectors doing their job and so far finding nothing.
Seow: For global markets, the countdown had begun since end-November and in the short run, it has affected the KLSE. The reason is that since early December, oil prices have been going up, gold prices have been shooting up and they continue to do so. The US dollar has been very weak. Since Malaysia is seen as a US dollar based market because we are pegged to the US dollar, they are avoiding us as they are avoiding the US dollar.
Rafie: We need to look at it from the personal viewpoint of Bush rather than America as a whole. Bush has a lot more to gain from a victory. If you look at it objectively, then he should impose the same sanctions and demands on North Korea but there is nothing there that the US wants, whereas Iraq has the second largest oil reserves in the world, which the US wants. Given their relationship with the Saudis, which is not at its best, they need to find a secure source of oil in going ahead for the next 50, 60 years, and a friendly Iraqi government would be more than happy to oblige. The other question is why are they in Qatar in such a big way? They have this huge, fantastic base in Qatar, which I have seen. There is no need for them to be there, but they are there and Qatar has the third largest reserves of natural gas in the world, after Saudi Arabia and Sudan. So at the end of the day, it’s about resources and politics.
Seow: US foreign policy, since the early 70s, has, to a large extent, been driven by oil. This time round, I’ve heard some oil analysts predicting that if the US wins the war or disarms Iraq and has a new pro-US government installed in Iraq, the price of oil could drop to US$6 a barrel. Exports, which are practically nil from Iraq, could grow, it is predicted, up to 5 million barrels a day within two years.
Rafie: The excuse is that Iraq needs the money to develop or reconstruct.
Star: But once the war starts, you have no idea of how it is going to turn out. It may destabilise the whole region.
Rafie: We need to look at it from two scenarios, the best case and worst case. The best case is a short war, which will be over in a month or two, and Saddam goes into exile. The worst is that they have weapons of mass destruction and actually use them to good effect. And that would create a mess.
Seow: According to the theory of war, you don’t go in without knowing the outcome. I think they know what they are doing.
Rafie: Which is why they are taking their time, rather than going in today, or tomorrow. That is why some analysts are suggesting March, because by then everything will be in place.
Seow: Some military analysts expect the war to be in February or March. The US would need time to build up their weapons stockpile.
Rafie: The question is, what would be the impact of a war on Malaysia? The immediate impact would be that oil price will go up and all export and import shipments in the region would be affected. Another effect would be our exports of palm oil to India and Pakistan. Shipment costs and insurance costs would be higher. The key is – how long? If it is long, the impact would be greater.
Seow: The good thing about this is that it’s not a shock to the global economy. It’s been a slow build-up. We know it’s going to possibly come in a few months. Therefore, decisions would be held back. Because of this, there would be an impact on the last and first quarter earnings. The discounting process has been ongoing. The further downside, when war starts, is that consumer demand may weaken as people are glued to their CNN live telecasts everyday.
Star: So what’s going to happen to the stock market in the short term? Will the KLSE remain in a state of paralysis?
Gan: In the immediate future i.e. short to medium term, geopolitics will be the main driver behind stock markets globally. In other words, developments in the Middle East, the US and North Korea will remain the main focus of attention for all markets. Until and unless that is satisfactorily resolved, the markets will still be listless in the first half of next year. Even if we assume that the war will take place in February or March, we still do not know how long it will take before the war is over. Even if you say that the market has been discounted as expectations have been building up, I still think that the war, when it happens, will have very negative impact. Whole markets will be shaken and there will not be any investor interest in the markets until the war is over.
Star: Is it useful then, to hazard a guess where the KLSE or the CI is heading next year?
Gan: Given the organised way the US is going about it, I think the war will be short, relatively speaking, and I think the markets have discounted a lot and I think we are going to see a rally after a month or so, when we see the war going on as planned.
Rafie: You have to have a view and I go with the view that it will go according to plan, without major worries. The market next year is going to be volatile. But I think the market is now trading at an oversold position at current PEs and there is irrational pessimism among Malaysian investors and they shouldn’t be as pessimistic as they are now, especially in retail. I’m not saying they should be gung-ho about it. But not participating in the market at all is a mistake for next year. I think one should take position early, even now, and as they say, in times of uncertainty, there is great opportunity. We have companies trading at very attractive levels historically speaking. If you are looking at 3 months or 6 months, you shouldn’t even be looking at these markets, you should be looking at gold. But if you got an investor-type horizon, which is one year or more, then you should be looking at the market for a return that is higher than what you are getting now. The opportunity cost is a downside that is relatively limited i.e. 600 for a very short period of time.
Star: Do you see a Chinese New Year rally?
Rafie: It’s a question of leadership. If there is leadership somewhere, then maybe. If not, then we have to wait until hostilities break out.
Gan: I don’t think there will be a broad-based rally for Chinese New Year. But you may find some speculative rally in selected counters where there is considerable retail interest. But I don’t think there will be a strong rally as in the past.
Tan: Chinese New Year runs smack into the period of waiting for war to break out. So I don’t think there will be that broad participation. Right now there are attempts to rally in the last few minutes, but they don’t last.
Seow: I agree that Chinese New Year will fall during the waiting period for this potential war. Anyway, Chinese New Year rallies have always been speculative in nature and this year, there are no themes as to what counters may be moving up and for what reason. I think the banks and stock-broking companies have also been quite strict in not giving syndicates too much gearing to speculate. So I don’t think it will happen this year.
Star: In view of the pessimistic outlook, what are the 5 stocks you would recommend?
Rafie: I’m not pessimistic. I’m optimistic in the sense that 2003 will be better than 2002 in terms of market performance. The individual performances of the companies will be better. In that sense, I am optimistic and that will be reflected in how we manage funds.
Tan: I am also optimistic in the sense that with the current market at 640, it has discounted a lot. You have got a lot of value surfacing and there is a divergence between fundamentals and the stock market. So now we are waiting for the trigger so that the two can converge. At the moment you don’t see the catalyst for that to happen.
Gan: I’m cautious on the first half of the year. I don’t see the market moving up significantly in the first half. But in the second half, potentially, it could be better, depending on whether there is a war or not and on whether the US economy, which has bottomed, starts to show strong recovery in the first or second quarter of next year. If that happens, then the anticipation of a stronger rate of growth for us here could be the catalyst the market is looking for. On paper that could be the catalyst or trigger. But sometimes in practice that doesn’t really happen, because people are sceptical about the prospects of the economy, the numbers, or whether there is a real recovery in the whole economy. But eventually, the good news will sink in and that is when you will see the market moving up.
Rafie: Then there is the prospect of a general election, which is positive for the market ? In 2002 the budget has been lacking in terms of market incentives.
Seow: From where we are, the cycle is certainly going to be positive for investments in the stock market from now on, because the cycle of expectations is now low, the foreign investors are out of the market by and large. There are certain things going on among Asean countries because China has proven increasingly to be an economic threat to Asean. It’s creating more cohesion and giving Asean countries more reason to work together, for e.g. the recent announcement that they are going to kick off the pipeline through Thailand to Malaysia and that is extremely positive for both economies. Asean prime ministers are facing more and more pressure from China as far as the performances of their economies are concerned. China exports have gone up more than 40% in the last two years, while Asean exports have been stagnating.
So cycle-wise, it is probably optimum to start investing in the stock market, the best time in fact, as far as cycles are concerned. The warning is that you have to have a strong stomach, because there might be a short-term dip when the war starts.
Rafie: There might be a knee-jerk reaction, even though the war is largely discounted.
Star: We might as well wait then, because we do not know what will happen in the short term ?
Rafie: It depends on who you are – if you are an institutional investor, you might not get what you want.
Tan: For everybody it is very difficult to catch the bottom. You have to see value at some point in time.
Star: Give us some value stocks then, five of your favourites.
Tan: EON is one of my picks right now. In banking stocks I like AMFB. Also Genting and a small cap stock like Uchi Technology. I also like Oriental as it gives 5 odd per cent net dividend yield right now and is a very solid company.
Star: Why did you choose Uchi?
Tan: Uchi has more than doubled its pre-tax profit in the last two years, it gives you about 4% dividend yield, it is a very research oriented company that will grow in the next five years and I am talking about less than 10 times PE for the current year. It also has a proven track record of the management.
Star : What about Oriental?
Tan: Oriental is trading at 20% below NTA, it gives me 5% over net dividend yield and you can see the success of Hyundai on the road. I think that is also a case of undervaluation.
Seow: Our preference is for smaller companies. I think they are on the verge of actually posting very strong earnings growth once the cycle turns positive. These are companies like APM Automotive, MBM Resources, Globetronics. I also like MPI in the semiconductor industry because of their very good management. I agree with Beng Ling about Oriental mainly because the franchise is under-developed and because of the introduction of Afta. In fact Rafidah has said they are going to start cutting duties soon. The market share for non-national cars like Honda and also potentially Hyundai, will grow by leaps and bounds from next year onwards.
The reason for selecting APM and MBM is, if you benchmark them against Asean manufacturers of parts, for example, they are out there and they will stand to benefit from Afta. For Globetronics and MPI, it is a cyclical thing. I think they will benefit from any small upturn in the semiconductor industry. That momentum is building up. With new products and lower prices, I think that the technology cycle is probably on the way to an upturn. It’s a matter of when.
Gan: I like MAS. I think the restructuring that has been completed is an excellent thing for the company. They have already turned into the black in the recent third quarter and going forward, we are actually quite excited about their prospects now that the debts have been taken off. The heavy capital expenditure commitments have also been taken off their shoulders. The loss-making domestic operations have also been shelved/hived off. Going forward we think what they are trying to do, by focusing on the Orient routes, would translate into higher yields for the airline notwithstanding the fact that there are still going to be concerns on terrorism in Malaysia. So I am quite excited about MAS at this price particularly.
In the plantation sector, we like PPB Oil Palm. We have included OYL Industries because of the potential of their China operations. That could still be very little understood in the market, in terms of the potential that OYL has for its Chinese operations, especially now with China opening up.
Maybank is the other one. Although I am not particularly bullish about the banking sector as a whole for next year because I think the operating environment is actually becoming increasingly difficult for banking in Malaysia, I do think that Maybank offers very good value at this level. But we said earlier that there are many value stocks and Maybank certainly stands out as one of them. It does have higher outreach compared to the other banks and that does to a certain extent compensate for the higher price valuations, but its standing as Malaysia’s biggest bank, its conservative loan loss and provisioning policies and strong management track record, I think, justify the premium one is paying for Maybank. The last one that we have is Genting.
Rafie: I share one pick, which is Genting. It has the benefit of increased contributions from its plantation interests, Star Cruises is doing quite well, it has a strong balance sheet and is included in both the Composite Index and MSCI indices. All this will make it a natural focus if foreigners do come back into Malaysia. I share Gan’s view about not being particularly bullish on the banking sector.
Nevertheless for banks, my pick is Commerce-Asset. We have some concerns over its purchase of Bank Niaga but I think the outcome will still be some time to go in terms of whether it is a good decision or not. It is not going to be next year but further down the line, therefore it is not going to impact much. It is trading at valuations at a major discount to its price to book. It is trading at the lower end of its historical trading range. At RM3.00 plus, the company is having a share buyback programme and it is very consistent, at RM3.10 and below they are buying back their shares. The downside is very minimal and once again if you do believe that the GDP is going back to 5%-6%, then Commerce-Asset should not trade at RM3.00 knowing what we know today.
The other one would obviously be the plantation sector and most institutional managers would be looking at that. IOI and KLK are two picks. I like KLK as it is probably the best managed plantation company, it has a good land bank, it is very focused – 70% of its earnings come from plantations – rather than IOI, which is a bit mixed from properties and other things. They usually buy back between RM4.00 and RM4.50. They are very conservative and if they are buying back their own shares, they must be very confident. I personally think that the public has not really factored in how much of an impact an average of RM1,600-RM1,700 in terms of the palm oil price per tonne will have on the bottom line of this company. When it actually comes up, there should be some re-rating of the company.
The last one would be construction as once again public consumption is still going on in terms of public expenditure. Gamuda is one of the better construction companies. It is not very exotic but I think it is relatively safe and once again, if the economy goes up, then Gamuda’s earnings should improve along with it. It has cheap valuation, very strong EPS growth and is undervalued.