With 2004 coming to a close, StarBiz organised a roundtable discussion on the outlook for the stock market next year.
The panelists were Chong Sui San, chief investment officer of Allianz General Insurance, Geoffrey Ng, chief investment officer of Pacific Mutual Fund, Johan Tazrin Ngo, Kenanga's investment director and K.C. Kok, CIMB's head of equity marketing and derivatives.
They were joined by StarBiz's associate editor C.S. Tan and senior writer Kathy Fong. Thursday we present their views on the stock market. We will publish their stock picks Friday.
STARBIZ: What is your outlook for next year?
Johan: The market recently got a boost from hot money. A lot of money came in on the ringgit re-peg speculation. It's obvious where that money went, especially the short-term. It went into fixed deposits, equities and blue chips ... whatever's liquid. It also went into five-year MGS (Malaysian Government Securities).
For the regulators, it's very difficult with all this hot money now to do anything with the peg. Probably with hindsight, they should have done it earlier, but with so much hot money here, I find it difficult to see anything happening to the peg for at least another six to nine months, until things calm down. Now, the point is that a lot of the hot money did actually inflate the KLCI (Kuala Lumpur Composite Index) and may get quite disappointed. Malaysia has outperformed. I mean, you may actually see that money going out over the next one or two months.
Foreign liquidity in the very short term, I don't think will be positive. GLC (Government-linked company) restructuring ... the expectations are quite high; it'll be challenging for these companies to meet such expectations.
So, based on that, our view for the first quarter is not one that's positive. But as far as 2005 is concerned, generally we are still pretty positive, although we expect the performance of the market to be back-loaded rather than front-loaded. Our KLCI target is about 1,000, which is quite conservative, and in line with consensus.
StarBiz: What's your view on corporate earnings growth?
Johan: Consensus is looking at about 9% to 12%. We're somewhere in the middle there. We reckon 10% to 11% is achievable.
The earnings reporting season for the third quarter was frankly nothing to shout about. Most of the companies came in inline with expectations but many disappointed.
I have a feeling that analysts are going to be spot-on in terms of their earnings forecast, so I think the chances of earnings exceeding expectations, as a catalyst for stock prices, will be tough going forward into next year.
StarBiz: Your 10% to 11% earnings growth forecast ... that's why your KLCI target is quite moderate?
Johan: That's right. It's pretty much in line with the GDP forecast of about 5%, 5.5%, using a multiple of 1.5 to 2 times for earnings growth. And again, relative to the region, it's OK.
We're positive on Malaysia because generally we're positive on global equities next year, but in a moderate sense. Asia continues to be an overweight for most global strategists because I think they have good cause to do that. But Malaysia in the context of Asia is very difficult even though you can justify a case to have exposure in Malaysia. It's a bit more challenging to justify an overweight position in Malaysia.
StarBiz: Where would the overweight recommendation be, for which country?
Johan: Most of the US fund managers are starting to take a contrarian view on cyclicals again, like technology for example. Taiwan and South Korea have been under-performing this year, so I think you may actually see some shift of funds back into North Asia again, if they were to take a contrarian view of that sort.
StarBiz: Geoffrey, what's your view of the market?
Geoffrey: It's been a very focused kind of market rise in the fourth quarter of the year. The tiered phenomenon that we spoke about in October (at the last roundtable) has widened even more. What has happened as a result is that we continue to see a lot of stocks, which still trade at very good multiples, which we would want to hold.
It's pretty much evident that everyone expects further moderation in economic growth. The other factor that is starting to concern me more is inflation, in the sense that inflation has risen. It's currently at 2.1% from about 1.6% and continuing to rise. This will be a catalyst to hold bond markets at its mercy. It will probably not affect the stock market to such a great extent because interest rates are coming from such a low base.
The balance sheets of a lot of companies are coming in much better position today than they did during the go-go days when people were just leveraging their balance sheets for capacity expansion.
One positive (point) that we like about the stock market going into 2005 is that companies are now starting to invest again, and increasing capacity.
A lot of them are doing it either from re-financing, which would lower their overall cost of debt, as well as internally generated funds. A lot of companies these days may not show very good earnings in terms of meeting very much elevated earnings expectations, but we've found that in every quarter of earnings announcements, cashflow positions are getting better and better.
Earnings aside, if you look at the cashflow generation of Malaysian corporates, they are probably at their highest ever. Two things will come out of this. One is that capacity will be expanded, hence earnings in future years will probably be driven by such capacity.
StarBiz: You mentioned “they're investing again”; are you're referring to the manufacturing sector? This is purely for domestic consumption?
Geoffrey: That's right, which again ties in with our view that next year will be driven primarily by domestic consumption, and supported by exports. Exports are not falling off the cliff in terms of growth. They are moderating but they are not the main driver for 2005.
Our asset allocation strategy for 2005 is still towards equities in the sense that if you have RM1 to invest today, where do you put it in terms of financial assets? Do you put it into cash or do you put it into bonds? We still don't have a choice at this point in time, but be in equities, mainly because with our expectations that inflation is going to rise quite significantly next year, they will cap bond performance. Our target is the KLCI hitting 1,013 in the first half of the year.
StarBiz: KC, what are your views?
KC: Let me be the bullish one. My sense is that the first-quarter equity market is going to be very strong, basically fuelled by the momentum we saw in the last month or so in emerging Asian markets.
If you look at Malaysia specifically (our research tracked the foreign fund flows in the last five quarters - third quarter 2003 to third quarter 2004), we had a total inflow of about RM29bil that went into equities, which is about 4% of market cap (capitalisation). That is equivalent to the 1989-1993 inflow of about RM33bil, which is about 5.5% inflow for that kind of bull-run period.
Definitely, a lot of foreign liquidity has come in. Just to give you an indication of the type of liquidity we are seeing, it's primarily from the non-benchmark money. Now, what we've been talking about this whole morning is actually the benchmark money.
There is a very different class of investors whom we call the absolute return or hedge fund investors who don't look at benchmarks. They go very macro and then they will take very big country bets. We've been seeing a lot of this sort of money in the last one, two months.
In fact, you can see it clearer when you do primary deals. Just to give you two examples. We did the SapuraCrest's US dollar convertible. It's an US$18mil issue, which will convert into 30% of the new equity of the company, which is a big issue for the company. It sold out within two hours. It was launched after 5 o'clock. The book was more than one-and-a-half times covered.
Last week, we did the Khazanah exchangeable bonds into PLUS (Expressways Bhd) US$400mil-over issue - it sold out within an hour. We launched the book at around 6 o'clock in the evening. By the time we closed the book at about 8.30, we had over US$900mil in bids. We had to close the book and refuse to take bids.
This is from the non-benchmark funds that have come in. Of course, you also have the Malaysian funds - there is a lot of liquidity out there - and they need to put the money to work. A case in point is the Ornasteel IPO (initial public offering): the institutional tranche was 27 times covered. We have not seen this kind of numbers for a really, really long time.
StarBiz: What is the case for Malaysia? Is there an economic case for Malaysia in view of corporate earnings growth?
KC: I think people like the new administration. People like what they see with regard to the GLC reform. The new management at Khazanah, for example, they understand markets. They are very dynamic.
The authorities have initiated the small cap research programme. They've initiated the Bursa-SGX (Singapore Exchange) cross-trading. Potentially, you're talking about tapping Singapore's domestic savings pool which is over S$100bil.
At the same time, you have Government agencies like Khazanah having a systematic divestment plan. One of the most frustrating things for foreign fund managers investing in Malaysia is not enough liquidity. The free float is very small. So, the authorities are tackling all these key issues, and it will increase liquidity. And you know, liquidity will beget liquidity.
Through all these various deals that we did ... the dollar deals ... once people have a position in the country then they will pay a lot more attention to Malaysia. But if you don't have a position in Malaysia, you won't even bother to look at the deals or follow them.
So, I believe the first quarter will see a very strong market. Of course, I think the retail punters are talking about it being a rooster year, the same as 1993. Even though I don't subscribe to that idea, the fact is that when the retailer has good sentiment, it will be able to boost the market.
Our research forecast is a 14 times PE (price/earnings ratio) target, which is very close to what the rest of the panel has mentioned. We're talking about 1,020 (for the KLCI) for next year.
StarBiz: Your KLCI target doesn't sound as bullish as your comments.
KC: Okay, that is a pure, fundamental target based on EPS (earnings per share) growth and on PE valuation. As we know, the market can over-shoot the valuations. The momentum can drive it higher.
But, you see, this is a year where although the market will be driven by all this momentum and liquidity, you have very serious external issues. It's not something where you just put all your money and load up your beta and fire all engines. I'd like to stress that stock picking would become very important. It's not going to be a broad-based rally where all stocks will rise. I don't think we'll see that next year, unless you suddenly go back to 1993 and everything will rise.
StarBiz: Are you looking at another round of focus on blue chips?
KC: I think it'll mainly be on the big-caps still, unfortunately. I'd like to see the small-caps and mid-caps perform but so far, in the last two months, we've seen the big-caps perform. Because that's where the big fund managers can put big money. You tell them to buy US$1mil of a small-cap stock, to them, even if this thing triples, it means nothing to their billion-dollar funds. They need to put US$50mil and what kind of stock can you invest in? Actually, not a lot.
Like I said, I believe the first quarter will be a very strong quarter. The momentum is still there, liquidity is there, sentiment is there.
After the first quarter, I'm not too sure because you have a scenario of rising US interest rates, rising Malaysian interest rates. We're looking at the US Fed fund rate going to 3.5% to 3.75%. It's a 1.25 to 1.5 percentage point increase. Talking to some of the US investment bankers, they're looking at the Fed fund rate going as high as 4% next year.
The second risk is the OECD (Organisation for Economic Cooperation and Development). If you look at the OECD lead indicators, they are pointing down. Until you see OECD indicators starting to point up, you may not see significant flows going into the equity markets.
One possible negative external factor is US dollar weakness, although one can argue that US dollar weakness may be good for Malaysia because then our exports will be cheaper. The fact is that if it is a gradual decline, it's fine. But once you have a US dollar shock, financial systems cannot withstand such a shock. So when you have a shock in such an important indicator as the US dollar, you'll see significant volatility in the financial markets.
Of the other issues, one is the terrorist threat, which is very real. And this could be one of the shocks next year.
And, of course, there's China. I think China has put in place a lot of programmes to slow down the economy. I think next year you'll probably see some shocks coming out of China. We are already seeing signs of shocks.
You look at the China Aviation trading scandal where they lost S$550mil. It's very interesting. They had a monopoly to supply jet fuel to China, and they had in place risk management policies - there are 10 traders and each is assigned a maximum loss limit. So, if the firm loses US$10mil, they will stop trading. But how did they lose S$550mil? Basically, it shows that there was a serious issue with regard to internal risk management.
If this can happen to China Aviation, it can happen to a lot of companies. When an economy is growing well, you can hide a lot of things. But when you have shocks like oil price fluctuations, when you have shocks like the US dollar, when you have shocks like interest rates, then risk management problems may be magnified. So, these are some of the risks I see going forward. In terms of our GDP forecast for Malaysia, for 2005 we're looking at 5% compared with 7% for 2004, but recovering to 6.3% in 2006.
StarBiz: Your views, Sui San?
Sui San: For me, I'm on the more bullish side, like KC. I think that in the first quarter, the market will still be quite bullish. Despite the recent quiet period, for some of the big cap stocks the accumulation was very heavy and very steady. The PEs are quite high but people are still paying for them.
Like AirAsia, the accumulation is still going on. Of course, there is selective buying of some of the smaller cap stocks, like the water sector which is in play. And you can see that now, each correction is getting very shallow and you can see that on every weakness, the money just comes in and buy. And what will kick-start the market? No one will know. The catalyst will only be known after the fact.
StarBiz: Will you need strong fourth-quarter earnings as a catalyst?
Sui San: It's not so much the fourth quarter now. People are looking at 2005. You are looking at a slowdown in 2005. That's why after March you could see April, May, June, two to three quarters, a lot of focus was on 2005 and everyone accepted the fact that 2005 would have slower economic growth than 2004.
And I think as you move on into the second quarter or third quarter, like KC mentioned, the OECD indicators will start bottoming out, and then people will start positioning again.
For the first half there are some recommendations ... you may go for the fixed currency markets like Hong Kong, Malaysia, because these are more defensive markets. So, that's why the liquidity stayed on in Malaysia. But in the second half, they may go for higher beta (more volatile) markets, because you're looking at 2006 economic growth. Malaysia is not a beta country. In that sense, it may lag behind South Korea, Hong Kong. You can play Hong Kong for China.
StarBiz: Isn't Malaysia a beta country?
KC: It's not a high beta country, except for 1993.
StarBiz: Relative to Singapore, Singapore used to be a boring market.
Geoffrey: It has a higher beta now.
Sui San: The current correction is building up a momentum for the first quarter. And there is a strong possibility the KLCI will move towards the 980, 1,000 level in the first quarter. The first quarter is a good market, but it will be volatile because those risks that KC mentioned will still inter-play in the market.
StarBiz: The punters will probably interpret Q1 as a Chinese New Year rally.
KC: One point I forgot to mention is that we actually tracked the first-quarter performance of our market in the last 11 years. Nine out of 11 years, we had a positive first quarter.
Sui San: It was only during the SARS (severe acute respiratory syndrome) time that the first quarter was not good; then it was delayed to the second quarter.
StarBiz: Is 2006 expected to be a better year for the economy?
Sui San: As the year moves along, and they are getting more numbers on 2006, if it is going to be stronger than 2005, that's when the market momentum will pick up again. Last year, no one anticipated the oil factor; so it's the same for next year, no one knows what will be the main factor in play.