Our five panelists - Surf88.Com.Sdn Bhd chairman Lee Siang Chin, Mayban Investment Management Sdn Bhd CEO and director Amin Rafie Othman, CIMB head of equity markets and derivatives Kok Kong Chin , AmResearch Sdn Bhd executive director Gan Kim Khoon and KAF Research Sdn Bhd director Lucy Ng - discussed the prospects for the Kuala Lumpur Stock Exchange for the rest of 2003 in the first part publichsed on Thursday June 26, 2003. In the final part Friday they talk about the impact of the US economy, their investment strategies and choice of stocks. The discussion was chaired by StarBiz' senior editor (corporate) David Chow early this week.
STAR: Are there major uncertainties on the external front? The US economy seems to be picking up, with consumer confidence rising to its highest level in six months in May, thanks to the end of the war in Iraq and rising stock prices. What is your view?
Rafie: Basically, the major risk for us is not on the domestic front. Domestically, politics is stable and so is the economy, and corporate governance is no longer an issue. We have taken positive steps in that field. But the factors that will impact on us the most will be global. What will happen to the global economy? Will the US recovery proceed as planned? Will there be negative incidents that will impact on global recovery? I think if we don't see any negative impact, our economy will grow better next year and so will the market.
Star: Actually, there seems to be conflicting views on this in the US. Paul Krugman of The New York Times said there is no real news to justify the US markets' rise. People seem to be buying stocks just because they are rising. The economic recovery is patchy and unemployment has risen to an 8-year high of 6.1%. In fact, recently, there was a report by Bloomberg that said selling by corporate insiders reached a record 2-year high in May. This was similar to the wave of insider sales which preceded the 27% drop in the S&P in May 2002. What does this all mean to you?
Rafie: I think it just means that there is no consensus among the analysts as to where the market is going. There are always two views to it. My personal view is: if you look at the liquidity flowing into the market, it is still very high in the last couple of months. Once again, you can't ignore the fact that the Federal Reserve will in all probability reduce the interest rate further at their coming meeting (the Fed has just announced a 25 basis points cut in the rate to 1%). This means interest rates would be relatively low. To me, alternative investments or other places to put their money into instead of cash, would be seriously looked at by investors in the US.
The psychology of momentum trading in the US is also very strong. Once you build the momentum, from the institutional or on the growing intra-day side, I think it would have a life of its own. It would create its own virtual cycle for the stock market. It may not reflect the current economic trend but I think, for the stock market, it's positive.
The other thing is obviously the threat of terrorism. But I think it is just temporary, unless the terrorist attacks are of such a serious nature. Bombings in different places, I think, are just temporary. The markets have recovered quickly post-Bali.
Star: Gan, is there a bubble emerging in the US and are we likely to be affected?
Gan: Well, if you look at the factors that caused the Dow to rally by more than 20% from the low in the middle of March, it was largely because of a pent-up demand by investors. Prior to the Iraq war, most were out or staying out of the market. Then there was the expectation that the Fed would cut interest rates further.
Thirdly are factors such as the tax cut and tax exemption on dividend mooted by President Bush. Lastly, I would say the relatively upbeat earnings guidance made by the big companies such as General Motors, have also contributed in a large way, to the continued optimism on the Dow. I personally don't know if there is going to be a bubble at this level. I don't know what sort of price earnings ratios (PERs) the markets in the US are trading at. But I think they are still way below the heights reached in 2000. If you look at it from that point of view, the answer would be no, I don't think there is a bubble in the making yet, not especially when interest rates are going to be cut further.
And also, not if the earnings outlook for US companies is better, particularly so with the weak US dollar, as some of these US companies export overseas and would benefit from the weak US dollar.
Ng: It does have a bubble in terms of valuation. But I must say it is nowhere near its high of early 2000. But, it's still very high against historical norms of 50 years and 200 years. Now, the surveys done on the US stock markets have shown a very consistent median of 15X PER for the stock market. At the bear market bottom, the stocks can go as low as 8X to 12X. In 2000, at the height of the mania, PERs were well above 30X.
So, if you look at the PER now of Dow Jones and SPX, their PERs are more than 20X. So if we look at it from a historical cycle basis, Dow Jones or the American stock market is overvalued. I would say, yes, any uptick that we see is temporary, as I believe we have just seen the biggest stock market mania of all times ending in 2000. There is no way it can be erased in 3 years. Good examples are Japan and Malaysia.
In a downtrend, the market can go up and down. But in the long term, it is down until valuations go back to the secular market lows. Right now, we are looking at market PERs in the low teens, which, if we transpose to the US experience of 8X to 12X market PER lows, means we are there.
I think we are on a long term secular uptrend. Yes, maybe, we will have a lousy second half but when we look back in 2005, we will see that we are on the uptrend.
I would say the US is in a secular bear market. What you see is a bear market rally. Over here, we have bottomed in 1998 and over the long term, we are on the way up. The other thing I am bullish about Malaysia is that I have always argued that the US has to fall out of favour before the international investors start looking elsewhere. If the US is a fantastic stock market to invest in, why should they come to emerging markets where the risks are ostensibly higher. So the US has to lose favour before we can have our bullish run.
Star: Do you fear the impact of Wall Street's performance, KC?
Kok: Maybe, I will just talk about the US economy. As far as we are concerned, we all know about the tax cut which is good for consumer spending in the US. We know that US consumer spending typically drives the US economy. We are actually quite positive that in the second half, there would be continued acceleration in the GDP. Of course, the risk for the US is that the payroll and unemployment rate continued to weaken. In fact, the unemployment rate of 6.1% is why the Federal Reserve is going to cut the interest rate this week. Typically, in the US, they adjust to overcapacity and the unemployment figures very fast. The earnings of the companies take the hit, the next quarter, they are up. Globally, the deflation is partly powered by China. China is basically exporting deflation to the rest of the world, especially to the traditional manufacturing countries like Malaysia.
The other thing that worries me is the Japanese banking crisis which had been there for the last 10 years. This thing - if not handled well - can send shock waves to the entire South East Asia and globally as well.
Star: Siang Chin, what is your view? Do we need to fear a Wall Street crash?
Lee: With the removal of risks from the Iraq war, I think the recovery is very much liquidity driven. So, President Bush will no doubt make sure that all the members of the public feel good. The best way to feel good is to have a good stock market so that the pension funds look better. They will spend money on the economy. Recently, there was a run-up. The initial run-up was because of the end of the war when the risk premium was removed. The run-up, I think, was greater than expected. So, there were a lot of fund managers who felt left out and they all jumped into the market. The real economy, as shown by the unemployment figure at 6.1%, was not good and jobless claims are at a 20-year high.
But the leading indicators announced last week showed an improvement - 8 of the 10 leading indicators in the US economy were positive. So there is a general belief that things are improving and I think most economists are looking at 3% GDP growth for the US this year. There were fears of deflation but that is being removed now. So I don' t think it will crash but the summer is here and it is normally a very lethargic time. The usual practice is sell in May and go away. I think this will happen and I believe in the next two to three months, it (the market) is not going to go far.
Star: What is your forecast for the KLCI by year-end? What investment strategy would you advise for the rest of the year? Let's start with Rafie.
Rafie: I think if one is looking at GDP growth in 2004 at 5% to 5.5%, then we are looking at the market to trade between 700 and 750 points. The caveat is obviously foreign liquidity and the retail market, who would, hopefully, be coming in a manner that they used to trade in May and push it higher. That would be a reasonable and happy target for us in the next 6 to 8 months. Given that expectation, our strategy has been consistent for 2003 going ahead. We are looking at an increased beta of our portfolio, not conservative because we are bullish. There is upside and there is no reason yet for us to switch that bias. We are ignoring the defensive stocks and looking at growth and value stocks that have lagged behind.
Gan: We are maintaining our original end-2003 KLCI target of 780 points. I have said earlier that the market would look beyond the Q2 earnings (and also beyond War and SARS). We will probably look at Q3 or even next year's earnings, given that we are already half way through 2003.
This year's earnings growth may not be very exciting - just around the 10% range - if we talk about the CI component stocks. Next year, for the CI components, we are looking at 13% EPS growth. We also expect the interest rate would not rise, not in Malaysia, for the next year. So that is actually very conducive for equity investments, particularly if you look at the earnings yield gap. The 3-month Klibor rate is hovering between 2.8% and 3%. With the earnings yield of 6.8% for the market based on our market PER of 14.7X today, that's a differential yield gap of 4%. Now, part of the 4% is to account for equity risk premium or the risk premium for investing in Malaysia. But, is 4% a reasonable gap? I think it is too wide.
Ever since 1999, the gap has been only around 2.8%. If one thinks that the market should go back to the historical range of 2.8%, that means the market PER should be 17X level for this year, that would put it at 800 points for KLCI stocks. Lastly, for what it is worth, our chartist is quite bullish and expects that in the immediate term, the CI could hit 740 points. For the end of the year, our chartist is predicting the CI to hit 780 points or 16.8X PER.
If you look at the large capital blue-chip stocks, some of them have already done very well in the May rally. Our strategy would be to actually focus on the laggards among the CI stocks or large cap stocks.
The other strategy, especially if one wants to maintain continued outperformance, is probably to focus on second liners - the mid-cap or small cap stocks.
Star: Lucy, I note that you are more bullish this time. What is your strategy?
Ng: I noticed that a lot of stocks are trading at 8X PER. This reminds me of the long-term historical bear market bottom of 8X PER. So I can't help but be bullish by just looking at valuations alone. We are not talking about Telekom, TNB or Maybank. We are talking about second and third liners – companies with real businesses and real dividend yields and real order books and contracts. One example is Isyoda Corp Bhd. I could not believe my eyes when I came across the counter. It is trading at a prospective PER of less than 5X! I believe that the valuations are with us.
Coming to our target, I predicted three levels - base, pessimistic and optimistic. Our base case is 740 points, our pessimistic case is 680 points, which we have exceeded, and our optimistic scenario for 2003 is 810 points. I am now looking at a target closer to 800 points – barring unforeseen circumstances – as we enter the witching months of August to October.
As for investment strategy, we are looking at undervalued stocks. There are so many. If you go from a bottom-up approach, it is incredible how many you can get for between 6X and 8X PER. A lot of property stocks are trading below book and there are also penny stocks. Now, I don't subscribe to penny stocks. Now, there are so many healthy stocks below RM1. Even if you buy those, you can probably make 30% when they hit RM1 in better times. So I think there is fantastic value to be found here. I would be looking for these.
The second thing I would look at is the election theme. For that, the answer is quite obvious. If you look at the stocks which are performing on the KLCI, those which are leading the market now, I think election stocks are the champion stocks. Not forgetting our institutional shareholders, we are also looking at high growth stocks which we still have but these again are the medium-sized companies which give us 15% to 20% earnings growth, a decent 3% to 4% dividend yield and 20% in capital appreciation per year.
Kok: The CIMB Research target is 780 points or 15% upside from here, exactly the same as Gan's forecast. In terms of investment strategy, obviously with the improved market, if you are a trader, you should look at small to mid-cap, liquid and high beta stocks. The investment strategy I subscribe to is more of a long-term strategy focusing on a few factors. Gone are days when you buy stocks purely based on rumours and pure growth stories. Someone has just mentioned that there isn't much of a growth story in Malaysia as it has become a more matured stock market.
First, the company must have a very strong management. Secondly, they have to focus on shareholder value creation. What I meant by that is the ROE (Return on Equities) and dividend yield.
The third thing is that there must be a market leadership. Fourthly, the international investors are looking for strong corporate governance. These are the four key factors going forward in stock selection. We must have this change of mindset.
Lee: We are looking at an index range of 660 to 750 points for the year, so that gives 14X to 16X PER. From here, we have about 10% to 11% upside in the index but if you look at the index, it is very heavily weighted by the top 10 stocks. So, it may not be fair representation of the overall performance of the stock market. Normally, in an initial run-up, the heavy weights would perform better, after that it would trickle down to the medium sized companies and then the smaller ones.
I personally don't believe that we would get back to the high PERs that we had in the pre-Asian crisis for the simple fact that the Malaysian economy was growing regularly at 6% to 8% or even 9% over a sustained period. Now that we are considered a semi-matured economy, I think I would be very happy to see our economy growing at between 3% and 5% and therefore, I believe the PERs have to be downgraded as well.
As for investment strategy, I think it is important that we look at the bottom-up approach rather than picking the CI component stocks. We have always looked at the laggards, companies with low PERs, high dividend yield, management and balance sheets. So that means we have to look further down at medium sized companies and second board companies that are trading on good fundamentals.