Is the bull energised for 2008?

The Year of the Boar was a record-breaking year for the local bourse with the KLComposite Index surging to an all-time high of 1,440.39 in early December. However,2007 also saw many investors burnt in two major pullbacks in February and August asBursa Malaysia was hit by external factors such as China's Black Tuesday and the USsubprime fiasco. What is in store for the stock market next year with the threat of aworsening US credit crunch? 

StarBiz: Does the bull still have the energy to charge ahead next year given external uncertainties particularly rising defaults in the US subprime loans, rising global commodity and fuel prices resulting in inflationary pressure?  

Lim Chee Seng (CS): I think the subprime problem is definitely getting worse. It has actually spread to other types of loans – auto loans and credit cards.  

The situation will get worse before it can get better. Meanwhile, you will see a lot of write downs by major financial institutions.  

There will be more news on write downs, provisions and downgrades by rating agencies. Moody, for example has just downgraded about US$119bil worth of US credit. 

No doubt the Bush administration has come up with rescue plans.  

This will only prolong the pain, it will not resolve the structural issues underlying the US subprime mortgage market.  

The positive part is that the US has the ability to ease policy coverage, to ease the pain and hold off the cycle.  

No doubt the situation is going to get worse, but I think they can actually hold out the growth cycle for 2008. In this case, it will be a soft landing rather than a hard one.  

I think after major events such as the US presidential election or the Chinese Olympics in 2008, the risk will actually rise rather than drop.  

However, the concern of a potential threat coming from a sharper than expected downturn in the US economy remains varied at this stage. 

Pankaj C. Kumar (PK): The wildcard that the world economy has now is liquidity and central banks around the world are making efforts to ensure the subprime issue is isolated and does not damage the real economy.  

I share Chee Seng's opinion that the US economy will slowdown next year. Chances of a recession may not be more than the 50% level.  

With the ample liquidity that we have in the global financial system in Asia, we don't really have a big problem.  

The Malaysian economy has become domestic oriented and this would help us to sustain the growth momentum that we see in 2008. 

Lim Suet Ling (SL): Our house view is that the worst is yet to be.  

The fact that the banks are already writing off so much shows that they are trying to predict ahead. It is partly also because they have so much profits this year. If you look at the US, this year is actually a record year.  

So, is the worst over? I think it is a bit tough, to say.  

Our expectation is next year will be a very volatile year. It could be a year for consolidation, in terms of the various industries, the real economy and the financial market. 

The Asian market or companies in general is in a better position because of our experience in the crisis.  

The good thing is, based on what we have seen for the last 20 to 30 years, every time the US cuts interest rate it is positive for the market over the next 12 to 18 months.  

Although in between, you may have a technical slowdown – so the fear has always been in the first and second quarters. 


How would rising commodity prices, inflationary pressure and rising food prices around the world impact Malaysia and the rest of Asia? 

SL: A lot of the rise in commodity prices is more demand-led. If you see the global economy slowing down, naturally demand will come down. In terms of oil prices, there is a 10% to 15% speculative element there. So it is not a question of shortage, but rather a question of demand.  

Once the real economy slows down, then logically prices should ease but it would definitely not go back to the lows of before.  


What do you see are some of the concerns for the economy next year? 

PK: Well, inflation is definitely a concern. It really depends on the Government's stance moving into 2008, whether they want to remove subsidies or to what extent subsidies will be reduced as well as the measures taken to address some of the price-controlled items that we have in the market.  

In an open economy in a more developed country, the subsidy element can exist but it has to be addressed in a proper channel, not across the board. Give it to somebody who needs it, not somebody who does not need it. 

At the end of the day, I think inflation will be a big concern for Malaysia next year. Secondly, will be the external factor – a slowdown in the US or even China for that matter, will have an impact on our economy.  

Last but not least consumers must have the confidence either to spend or invest.  

SL: We cannot run away from inflation and subsidy issues in Malaysia. There is no perfect solution.  

The earlier they push it to a more open market, be it petrol or any other subsidy, the better it is for the economy.  

You must know how to actually reduce the tax level and relate to the poorer people. I think the problem is the Government does not have a good way to rebate back to the people who really need it. 

I think the other way is through the currency.  

Hopefully we can strengthen a little bit; that will take some pressure off any of the subsidies being given. 


In view of all these concerns, what would the prospects be for Bursa Malaysia next year? 

PK: It all boils down to the fundamentals of the market as well as valuations.  

When we started this year, market expectation of earnings growth was just in the mid-teens, but we are ending 2007 in the high 20s. All of these were mainly driven by the oil and gas and plantations sectors, which have been clear performers in the market this year because of rising commodity prices. 

Today, at the 1,400 level, the market still looks pretty attractive. As we move into 2008 and once earnings come on stream, depending on the numbers and ratios, revisions would be made by the market.  

If the revisions are on the upward trend, you will see a re-rating in the market. If there is a slowdown and earnings are cut, then you may see investors limiting their exposure in the market. 

We see the market hit 1,650 in 12 months based on current market estimates of the stocks' fair value.  


You think the bull still has more energy? 

SL: I think if the US does not go into a prolonged recession but just a slowdown, hopefully yes. China has been trying to slowdown its economy for more than a year.  

This is actually good as it should level off oil prices and commodity prices. We can also see consolidation for the market.  

However, I would not want to put a year-end figure to it.  

CS: If you look at it based on 2007 earnings, the market is actually fairly valued, but we should be focusing on 2008 earnings because we are all investing for the future.  

Based on a soft landing for the US, there should still be quite good earnings growth. There is potential for the market to trend up after a phase of consolidation.  

If you build that number in terms of new values created for earnings growth, we are talking about a target of 1,600 for 2008 in 12 months time. Due to volatility caused by uncertainty, there may be an even sharper correction in the first half before the market comes back.  

If you look at the current market situation, I think probably there will be a 10% to 15% correction in the market and it could actually come back up quite well in the second half. 

PK: This year saw two major pullback in February (200 points) and August (250 points).  

You will see such things happening again in 2008, whether it is subprime-related or just an excuse to sell. When one market falls 10% in a day, you will see liquidation coming from the Malaysian market.  

One of the reasons is that the Malaysian market has more foreign investors now than before. Obviously when there is volatility in the external or Asian markets, or even in the US, there is a tendency for our market to follow suit.  

In view of that, how does it affect your decisions and investment strategies? 

Gerald Ambrose (GA): Our portfolio is a result of visiting as many companies as we can.  

We try and find the companies with good business plans that can increase profits for 10 years, a balance sheet that can fund that expansion and a management that is transparent and realises what the minority shareholders' rights are.  

Naturally the few companies that fall through our filters and offer good value tend to be oriented towards domestic consumption.  

PK: In our case I will be very wrong to say that I am not bullish. At this level there is an even chance for anybody to make a 10% to 15% return for 2008 but you have to be very picky in terms of what you are buying.  

As you can see even now the retail participation in the market is not that great. As it is we have a two-tier market where the blue chips continue to outperform and the second and third tier stocks are completely forgotten.  

The Mesdaq market is more or less forgotten now.  

Investors are very focused on a few names and sectors. You have to be very vigilant going into 2008 in terms of how you position yourself in the market and when you take profits.  

Be mindful of events because that is going to dictate your total returns for 2008. 


Is Bursa Malaysia competing for funds among other regional bourses? What is your view on the attractiveness of Bursa among its regional peers in terms of valuations and inflow of foreign funds? 

PK: A foreign fund manager will look across Asia ex-Japan to see which market has the best attraction or upside potential whether in sectors or the market as a whole.  

If we want to compare on a market basis, we are somewhere in the middle of the pack trading at about 15.5 multiples, some markets are trading at 11 times to 12 times.  

There are markets trading at 17 times to 18 times so we are in the middle. 

So we are not extremely cheap nor are we expensive.  

At the end of it just like fund managers here in Malaysia, foreign fund managers also look at sectors and individual stocks to see where they can put money in.  

SL: In terms of valuation we are in the middle but in terms of potential – if the Government pushes through the Ninth Malaysia Plan and all the various corridors – we could be quite a good defensive market to be in.  

If we have our domestic consumption growth to boost the economy as well as our sectors, we could be a safe haven to the foreign managers and domestic managers here.  

At the end of the day our dividend yield is attractive relative to the region.  

Unfortunately we tend to be a laggard market. But if you look at our YTD performance I think we are quite credible. We had quite a good year this year. 

CS: I totally agree. The Malaysian market has been a laggard market since the financial meltdown.  

Moving ahead against a backdrop of rising external uncertainties, the Malaysian market would appeal to global portfolio investors in a sense that it is defensive, low beta, high dividend yield, high infrastructure spending, high commodity prices and a net exporter of crude oil. In such a situation valuations should actually be more expensive.  

There is still a case to pick stocks with certain themes and do pretty well in the Malaysian market.  

GA: I don't think we can compare ourselves realistically with India and China. We are very small in terms of weightage.  

In addition, we don't really have a theme do we? China is a huge domestic market and the cheapest manufacturer of goods in the world, Hong Kong is at the doorstep of China; India is another pure domestic economy play with very little exports and similarly Indonesia, Singapore is the region's financial centre. Malaysia doesn't really have a theme anymore, I suppose it could be in agricultural – it has the largest palm oil stock in terms of market cap, that could be one theme or oil and gas as we are a net exporter of oil.  

We like that kind of hook that exists in other markets in the region. However, we look pretty good value and we have a domestic economy that's doing a lot better than a couple of years ago.  


It seems a lot of your stock picks and strategy at this moment are defensive. Why? 

CS: I would say in the short term, until we get a clearer picture of how widespread the effects of the US subprime issues are.  

But increasingly I think one should actually be focusing on earnings visibility to create additional value for shareholders.  


What is your expectations for corporate earnings next year? 

PK: Judging from the consensus estimates we are looking at about 14%-15% earnings growth.  

That is based on current estimates. But as we move into 2008, when the first and second quarter results are released, or as events transpire the market will adjust for the changes. 

CS: Based on our projection, the normalised net EPS growth for the KLCI stocks under our coverage will slow down from +21.9% in 2007 to +13.6% in 2008.  

The strong EPS growth for 2007 was partly caused by the 12% average tariff hike for Tenaga.  

Stripping out Tenaga's profit, normalised EPS growth for the KLCI stocks under our coverage would moderate from +16.9% in 2007 to +16.1% in 2008, in tandem with our projections of a slower economy.  

However, there is downside risk to these projections given the US subprime mortgage debacle and its impact on global and Malaysian economic growth. 

GA: We don't have a prediction for overall market earnings growth. But I suspect that the trend could turn out to be above 13%. 

SL: I think in general the number would be lower than this year's. It has to be still stock specific. Market consensus now is still in the teens – from 13%-16%. 


In your opinion, can the domestic economy can be sustained? 

GA: Yes, I think it can for the time being. The way the world's imbalances can correct itself is that Asians in general will have to spend more and save less while the Americans will have to stop spending and save more.  

Malaysians' savings rate is very high.  

In the latest economic report, Bank Negara has said savings would fall from 37.9% to 35.8% over the next two years in terms of percentage of GDP.  

That will release about RM60bil in terms of discretionary spending and that is going to be one of the most attractive factors for Malaysia.  


Is the absence of a broadbased rally a concern? 

PK: No. The Malaysian market has always been a market where you have to be picky in terms of what stocks you have.  

Some of the asset managers and fund managers may not have a list of more than 50 stocks in their radar screen. Even stockbrokers cover about 80 or 90 companies at most.  

So the market is really dissected in that way. We may have 1,000 companies listed but how many are being followed?  

That is the other issue. Investors like us focus on visibility of earnings, management and our decision is based on what we see in terms of economic growth, sector-wise what are the pull and push factors. 

GA: Not really. I have often thought that Malaysia as an emerging market is a bit odd – it shouldn't have high dividend yield.  

Growth should be the factor and there would not be so much excess cash to pay out as dividends. But Malaysia does have that high yielding stocks of quality with consistent dividends maybe even more consistent than say Thailand.  

The system that we have of visiting as many companies as we can has thrown up a very domestic demand oriented economy type of companies. I think the growth will be in the insurance, financial services, retail, media, banking and finance. Not that broad based.  

SL: It is not a concern for the fund manager but it could be a concern for the retailer because they tend to look at the KLCI.  

For most of our portfolio, the stock list is about 30 to 50 stocks. As long as you can find stocks to deliver returns it is fine.  

  • Prepared by the StarBiz team: KATHY FONG, ELAINE ANG, CHAN CHING THUT and RACHAEL KAM
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