Growth amid global uncertainties

  • Business
  • Friday, 01 Oct 2004

Three fund managers and a share placement director came to Menara Star on Monday for a roundtable discussion of the stock market outlook for the fourth quarter. Excerpts of the discussion.  

The participants were Chong Sui San, chief investment officer of Allianz General Insurance, Geoffrey Ng, chief investment officer Pacific Mutual Fund, Johan Tazrin Ngo, Kenaga's investment director and K.S. Kok, CIMB's head of equity markets and derivatives. 

They were joined by StarBiz associate editor C.S. Tan and senior writer Kathy Fong. 

STARBIZ: What is your target for the KLCI? 

Johan: For this quarter, I reckon it'll be a market with a wide trading range. But perhaps the lower end of the trading range is not going to be 780, but maybe about 800 to 900 (points). 

The main reason for that is there is still a lot of uncertainty. I think you'll get a volatile global market. 

The participants were Chong Sui San, chief investment officer of Allianz General Standing from left are: C.S. Tan, Geoffrey Ng, Johan Tazrin Ngo and K.C. Kok. Sitting are: Kathy Fong (left) and Chong Sui San.

You are starting to see warnings by corporates in terms of guidance for third quarter numbers in the US. Economic data generally has been fine, but they have been moderating and we still have concerns in terms of where interest rates are going to go and the oil crisis. 

There will be pockets of strength in the run up to the US presidential election in early November. After that, I am not so sure any rally on the global side is going to be sustainable. That will affect Asian markets. 

Ng: My view is relatively similar with Johan's. The market will be driven by risk premiums, the aversion to risk, that is set not by domestic funds but by the offshore funds. If you look at the last six months, what happened in March was a re-allocation of equities, not into the bond market but back to cash.  

And it was very quiet during the summer. Now, we're starting to see a lot more volume coming back to regional markets.  

If you take a look at some statistics, Hong Kong's volume on a month-on-month basis was up about 300%, Singapore was up 250% in terms of daily average volume.  

My target for 2004 is still pretty much from 880 to 890. That's our base case. If there is a significant amount of foreign flows into the market, it's probably at 920-level. 


StarBiz: How about next year? 

Ng: Malaysia's GDP is expected to be 6% officially. We are slightly bullish; we are looking at 5.8%. Corporate earnings growth will be about 10% to 12%. So, there will still be every reason to have the bulk of a portfolio in equities, given that there aren't many opportunities out there for other asset classes. Cash, in particular interest rates, are low and bonds would probably inch up but not sufficient enough for you to want to overweight. 

Kok: It is interesting you mentioned the hedge funds are among the key players in the market. Our trading side saw a lot of momentum money coming in the last couple of months. At the same time, since it is momentum money, the reversal of it can also be quite significant.  

But the interesting thing is that we saw RM13bil to RM14bil in net foreign portfolio inflow this year. This is something that we have not seen since 1993, so there is definitely a new pool of money that came into Malaysia. That is why our market has been re-rated up from the days of 600 to 700.  

I personally don’t have a target for the index because I don't do research anymore. Our research target is 910, which is based on 14 times PE (price/earnings ratio).  

Foreign investments will continue to flow into the oil and gas industry.

But, it's quite a unique situation we are facing in the sense that the long term macro indicators for Malaysia, like international reserves are at all time high, exports are rising, corporate free cashflows have improved from negative RM10bil to RM8bil in 2003, net gearing in the corporate sector and non-performing loans are coming down. The long-term health of the economy is improving.  

But unfortunately in the short-term, we are affected by a couple of factors, one of which is the slower earnings momentum. So, this causes a lack of catalyst for the market to go up.  

The China factor, the US slowdown as well as oil prices - these are some of the factors that is putting a cap on the market in the fourth quarter. 

Chong: On the broad market, it will still be range trading. It will be sandwiched on the upside between 890 and 900 and on the downside it will be supported at 830.  

What is important for us to establish is that the 781, recorded on May 17, is the corrective low for the year. And we have five months of consolidation after the market peaked on March 26 at 908.  

With the five months of correction, a lot of bad news has been discounted. The market is also discounting the slower economic growth next year.  

Moving into 2005, I think it is more interesting than this year. We find (from a brokerage's roadshow) that no fund managers had any hopes for 2005.  

I am very upbeat on 2005 because there is practically no expectation. When we were approaching 2004, there was so much expectation. It was such a fantastic economic scenario that simultaneously, in the global economy, there was growth. And everyone was so bullish and how it turned out to be otherwise. 

For 2005 where there are zero expectations, that is where there can be surprises. As we move into 2005, people will look at the second-half and even 2006. They will see signs of growth so they will start factoring the growth coming in. 

In 2004, from March onwards, people were talking of slower growth and factoring that into the prices. If we don't look at the index, if we look at the other universe of stocks, the correction has been quite steep. Some stocks have corrected 30%, some, 50%. The market has been held up by some of the blue chips.  

For the index to go up to the upper band, it has to rely on the performance of the two Ts (Tenaga and Telekom) and the M (Maybank). So it all depends whether foreign flow will continue coming into those stocks.  


Ng: The market has tiered itself into one which is totally outperforming and the mid-caps and small-caps have just bombed out.  

Foreign portfolios, whether it's long-term or short-term, are no longer interested in the smaller plays because they find it impossible to get out of the mid to small-cap stocks once liquidity dries up. We ourselves have found it very difficult to exit smaller positions. 

Until such time that more liquidity comes in, you will continue to see this kind of situation. 

Johan: Just to reiterate from what Geoffrey was saying, over a 12-month-period, the KLCI is up 15%, the KL Emas is up 10%, the KL Second Board (Index) is actually down 13%.  

Even though the KLCI does appear to be quite healthy but the broader market is a lot weaker - it certainly does not reflect the 860-level at the moment. It probably reflects less than 800. 

I think the key source of news flow for next year is going to concentrate on the US monetary policy. That could be the trigger point for the market. I am taking a more positive view. 

People are trying to second-guess the Fed and wondering whether you are going to get a peak in interest rates as early as next year. The futures market implies that by June next year, the Fed rate will be 2.5%, which is not far off from the target of the end of this year of 2%, and maybe 2.75% by the end of next year.  

My view is that global growth is going to be reasonably robust; it is just moderating from this year. 

And I think in the global economy, including Asia, growth is moderating but it is non-inflationary, despite high oil prices. 

I have a positive view that you are going to get stability in GDP growth globally next year. You are still going to get economies growing in a synchronised manner. As a result, that will give a stable backdrop for the markets next year. 


StarBiz: How high do you think interest rates will go up? 

Ng: Alan Greenspan can't do much now because even though the economy is improving, there is still structural unemployment and jobs growth is still very anaemic. He knows that only certain sectors of the economy are growing rapidly and that is due to productivity improvements. He knows that for many Americans, there is still a high chance they may fall back into unemployment.  

So, he cannot raise interest rates as aggressively as he wants to. And he has every reason not to; inflation is still weak, just below 2% in spite of oil prices rising in the way they have. And the higher oil prices are actually doing the job that higher interest rates will do. It taxes people.  

When I was in the US in June last year - price at that time was US$1.20 per gallon. The last time I was there, it was US$2.20 per gallon. So, imagine if you're a consumer, you've to fork out almost double. 


StarBiz: What level in the US interest rate will trigger a hike in Malaysia's rates? 

Johan: The US Fed is trying to move from a very accommodative to a neutral strategy. What neutral means the markets are still trying to determine. Basically, economists look at 2.75% to 2.5% as a neutral policy.  

This won't affect local interest rates, which are in a decent premium.  

Chong: Asia could be divorced from US interest rates as (South) Korea shows that it can. If the liquidity is still strong, what is there for us to raise interest rates? 

The 10-year bond, there is a rally now and it is also sending a signal that there is a limit as to how high the (US) interest rate can go up. I think once Alan Greenspan (chairman of Fed) gives a signal that he has done with it (raising interest rates), that is when I think the market will shoot up. 


StarBiz: Which is the most attractive regional market to foreign funds now? 

Chong: They are only picking Singapore and Hong Kong. Asset reflation seems to be there but not yet in Malaysia. 

Kok: These are the current favourites. But, talking to the regional boys and the US guys, the bigger funds are looking beyond the current favourites because they can't make money out of the current favourites.  

Typically, these people are taking a longer term and slightly contrarian view and the money is actually going to (South) Korea, despite the fact that the tech sector most probably has another two quarters of slowdown, and there is absolutely no visibility. And that (South) Korean economy is not in that great shape.  

But you can actually buy Samsung Electronics for six times PE on 2004 earnings, and Samsung is the world's largest semiconductor company after Intel. And you can buy Hyundai Motor that is gaining market share globally at 6.5 times PE 2004.  

People are buying brand equities, solid management and company track records. And you can find a lot of these companies in South Korea. 

Hong Kong had deflation every year since 1997. This is the first year when deflation is over. And when you talk to people in Hong Kong, those who own property are suddenly getting excited, especially when so many people were in 'negative equity' and they're saying: “At least, I'm alive now.” And there are signs of property prices going up. And you know Hong Kong stock market and economy are very sensitive to property. In Hong Kong, there are only two sectors - property and banks.  

Ng: As far as country allocation is concerned, the probable overweights now are Indonesia, Thailand and India. 

The Thai market was up 114% last year. This year, at its weakest, it was down close to 20% but it has recovered quite nicely. Its price earnings multiples are still very cheap. Growth is still very strong.  

Malaysia has shown over the last two to three years that its consumer market has finally been able to stand on its own. Indonesia is a 'turnaround' play in the sense that risk premium on the country is reduced. 


StarBiz: Our market is still driven by foreign fund flows. What has happened to local retail money, which is being kept in the banks? 

Ng: Remisiers now don’t get the kind of margin that they used to earn. A lot of them have either left the industry or they are not as motivated as they used to be. So when your remisiers have less motivation to do work for you or do proper research, there is less likelihood that retail money will be put into the market.  

There is still a lot of retail money that can be put into the market. But the infrastructure has to change in order to motivate them. 


StarBiz: Will the reduced FDIs (foreign direct investments) slow down the economy? 

Ng: Global FDIs in total have been moving from manufacturing into services. In 1990, manufacturing was 42%, services was 49% of total FDIs. In 2002, services was 60% of global FDIs, manufacturing was 34%.  

The implication for Malaysia is that we have been losing significantly in terms of FDIs to manufacturing. But so long as we are able to grow FDIs into services, we stand a good chance of growth, firstly, of course, through Cyberjaya, shared services and outsourcing. 

FDIs into Malaysia, where there is growth, are probably into oil and gas and tourism, which will then filter into consumption and property.  


StarBiz: What has happened to the oil and gas theme? 

Chong: The problem is our oil and gas was played one year too early. If it had not been played last year, it would have been a strong play this year. Now, there is an overhang of shares, with some of the funds stuck at higher levels.  

It’s the same for Telekom; expectations are too high. Long term, they will succeed but when you implement things, nothing is so smooth that every quarter you can see improvements; there will be blips between quarters. What I fear for is there are too many expectations.  

If, for example, the staffs don't take up the VSS (voluntary separation scheme) as per analysts' expectations, will it be a disappointment to them?  


StarBiz: Do you expect a VSS at Tenaga as well? 

Chong: Tenaga, there will not be because there is natural attrition due to aging of the staff.  

To me, Tenaga is in a more pleasant situation. They don't have competitors. Telekom has competitors. There are IPPs but Tenaga can control the IPPs.  


StarBiz: It is said Tenaga will cut its capital expenditure (capex). 

Chong: This is the fast route. Like Telekom, it cannot stop capex for too long, because technology changes all the time. So, if you stop capex at a certain time, it may look good on numbers but how about pushing through your business with a technological edge? 

So, when we ask analysts, they're banking only on costs, but how about the business model, how about revenue growth? That will be tough because that will be operational efficiency. It's always good in terms of financial re-engineering but when it's to filter through to the business, that's where you can get stuck.  

Ng: Tenaga's debt is so heavy. For it to generate the amount of cashflow to settle its debts is a huge issue.  

Chong: People are so fascinated with the Telekom, Tenaga increase. The stocks were stagnant for four years. So now, it's gone up by RM2. You divide over four years, it's only 50 sen per year. If you positioned your fund in Telekom, Tenaga over the last four years, you didn't make a sen out of it until this year. 


StarBiz: Do you expect the GLCs to lead the market? 

Ng: The proposition here is the GLCs will restructure, earnings will be enhanced, that will provide a higher level for the market. We hope this will be a catalyst to pull the second and third liners up.  

Chong: I think eventually it will, because like Singapore, after the index reached a certain level, the second liners were in play.  

Ng: The disparities are just too big. When Telekom and Tenaga are trading at more than 20 time PE, the rest are trading at low teens, many of them are below 10.  



Related Stories:KLCI seen on track to hit 900 points by year’s end 

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