WE are now in September, with the Dow Jones up some 16.53% on a year-to-date basis despite the trade war woes and fears of an impending recession due to the signals being emitted by the inverted yield curve.
Ask nearly every economist and most see a US recession coming by the end of 2021. However, look for data supporting this forecast and we get no real answers.
This is because the typical ingredients of a recession – such as an asset inflation bubble brewing, a huge amount of debt in trouble or financial institutions imploding – are nowhere to be seen.
Nonetheless, the biggest piece of “proof” – the inverted yield curve viewed as a reliable precursor to an economic downturn – has appeared in recent months. The spread between the 10-year and three-month notes has sustained its inversion almost for a quarter. Not to mention that the spread between the two-year and 10-year yield curves has also inverted on several occasions in the last one month.
The behaviour of the yield curve suggests that more money is going into long-dated bonds, as investors are uncertain of the short-term prospects of the economy. This has got many investors worried and they are starting to fret of a recession coming within the next 12 to 18 months.
Having said that, a yield curve inversion does not spell out when the economy will go into a recession. It could be a year or two before the downturn happens.
Thus, the recent inversion is reason to be cautious but not bearish, say fund managers.
“If you look at the local stock market, it has been on recession mode for five out of the last six years. Since 2014, Bursa Malaysia’s benchmark index has come in lower every year with the only exception being 2017, ” says Phillip Capital Management chief investment officer Ang Kok Heng.
What is perplexing is that the US stock markets continue to blaze a trail despite a more subdued economic outlook and fears of a recession. The Dow Jones and S&P 500 are currently close to their all-time highs. The Dow is at 27,197.32 points, while the S&P 500 is at 3,009.08.
Global markets, led by the United States, have been on a bullish run for the eleventh year now.
Rakuten Trade’s head of research, Kenny Yee, is of the opinion that a recession is unlikely.
“I think the word recession has been overused – and that is too strong a word. A more appropriate word to use may be ‘slowdown’, ” he says.
Yee believes the food and beverage (F&B) players as well as the numbers forecast operators (NFOs) will be relatively unaffected in the event of a slowdown. “I think people will continue to try their luck with lottery tickets whether times are good or bad, ” he says. Other sectors likely to weather the storm, he says, are the rubber glove and healthcare players.
“On the other hand, I believe banks will be among the first to be hit in the event of a slowdown, as people cut down on spending and use fewer credit cards, ” he says.
Meanwhile, Kenanga Investors Bhd chief investment officer Lee Sook Yee is of the opinion that data remains mixed when it comes to suggesting a looming recession at this juncture.
“There are signs of deterioration such as the falling purchasing managers’ index (PMI) and yield curve inversion which warrant increased attention.
“With regard to manufacturing PMIs, the reading for key economies (the United States, EU and China) has mostly fallen below 50, which is contractionary. Looking into the details, it is mainly driven by weakness in Europe and China and looks to be bottoming out. On the other hand, service PMIs are still resilient and are generally holding above the 50 mark, ” she adds.
With that, Lee points out that data has weakened, but still not as yet pointing to an imminent recession.
“At present, monetary policy has turned supportive with the US Federal Reserve (Fed) cutting rates and stopping quantitative tightening. Meanwhile, the People’s Bank of China has also cut its reserve requirement ratio and injected liquidity into the economy. The European Central Bank looks ready to restart quantitative easing. Should these measures be insufficient, there could be more fiscal stimulus launched by policy makers, ” she says.Lee favours defensive sectors which include consumer staples (such as basic F&B and household necessities), utility (such as power and water consumption), telecommunications and real estate investment trusts.
This is because demand for these goods and services is more essential in nature and is less elastic compared to other discretionary products.
In the meantime, recent data coming out of the United States has been positive. In August, the unemployment rate remained at one of its lowest levels at 3.7%, unchanged for the third month in a row, with the number of unemployed people at six million.
Total non-farm payroll employment rose by 130,000 in August. Wage growth remained robust at 3.2% year-on-year in August. In fact, hiring for temporary positions and weekly working hours strengthened – two positive indicators for the job market.
US consumer confidence retreated a bit in August, as optimism on the present situation improved to its highest level since late 2000, offsetting a weakening in the outlook on economic conditions, the Conference Board said on Tuesday.
More importantly, the US gross domestic product (GDP) hasn’t contracted. The US economy is likely to grow at a 2.3% annualised rate in the third quarter, based on the data on the domestic durable goods orders in July, the Atlanta Fed’s GDP forecast model shows.
This was a tad faster than the 2.2% pace estimated by the Atlanta Fed’s GDP programme on Aug 16. What is certain is that times are uncertain and caution is in the market. Investing now wouldn’t be that simple, especially with indexes at record levels.
Ang of Phillip Capital says that only a recession in big economies such as the United States or China would have an impact on smaller countries like Malaysia that could experience a slowdown.
“It is more difficult to invest in the market when there is an air of caution, but opting to keep cash as an investment is not wise. The cash should be preserved to grab opportunities, ” says Ang.
Sectors recommended by fund managersInvesting when the economy is on slowdown mode is difficult.
When the market is rising, fund managers tend to choose stocks with high beta. Beta stocks are stocks that rise with the general tide of the market. For instance, a stock with high beta will move more than the key market index.
When the market is sluggish, Phillip Capital Management chief investment officer Ang Kok Heng says that the tendency is to pick alpha stocks.
“Stock selection is more difficult, ” he says.
One thing is certain – keeping cash as a mode of investment is not an option, as capital will deteriorate as inflation picks up.
In times like these, what are some of the sectors to look at? Where can investors put their money where the downside is quite protected and returns are still possible?
StarBizWeek talks to some fund managers for their views.
Medical equipment and device companies
In uncertain market times such as these, holding on to medical device companies could be better than dividend-yielding stocks. After all, the healthcare industry is resilient and has propelled the growth of medical devices.
Medical device companies in Malaysia are dominated by companies engaged in the production of medical gloves and other disposable medical products. Few are aware that Malaysia is the world’s leading producer and exporter of medical devices such as catheters and supplies 80% of global demand.
Listed Malaysian medical device companies include Supercomnet Technologies Bhd (Scomnet), Dufu Technology Corp Bhd, UWC Bhd and Karex Bhd. Safe for Karex, these companies have so far delivered growing earnings despite poor market conditions. In the case of Scomnet, it is one of the suppliers for a global medical technology company in California. Scomnet supplies catheters, cannulas and urine bags.
Scomnet’s share price has been rising since the start of 2018 after the acquisition of the remainder 80% of its medical subsidiary, Supercomal Medical Products Sdn Bhd. That exercise was completed in April 2018. Since then, Scomnet has showcased seven consecutive quarters of growth.
For 2018, it was among Bursa’s top-10 gainers, with its share price surging 104.4% from 34 sen to 70 sen. Earnings-wise, Scomnet has registered growth in the first six months of the year. At its current price of 77 sen, it is trading at a price earnings (PE) multiple of some 32 times its earnings.
Dufu, another manufacturer of medical devices, is a gainer in the bearish market. Its share price has risen some 247% from 71 sen to RM2.45 in just less than seven months.
Dufu’s products are listed as chairs and tables for optometrist usage. For 2019, it continues to be up some 34% on a year-to-date basis at its last price of RM2.47. Despite the growth, its PE is at a reasonable 13 times.
Integrated engineering supporting services provider UWC made a strong debut on the Main Market of Bursa Malaysia, opening back in July. The stock closed up 58 sen at RM1.40 with 200 million shares being done, making it the best-performing stock on its trading debut so far this year. Its products are listed as the manufacture of parts and components for stretcher trolleys, laboratory equipment parts, ultrasonic machines and immobilisers.
Its strong performance has been backed by strong earnings. For its fourth quarter ended July 31,2019, it recorded a net profit of RM10.1mil and a revenue of RM46.9mil. For the full financial year, the group’s net profit and revenue grew 16% and 5.8% to RM36.2mil and RM144.4mil, respectively. At RM1.57, the stock is trading at a PE of approximately 15 times.
The strength and global market share of Malaysian glove makers have been well documented – they supply 60% of the world market for rubber gloves.
While Top Glove trades at 30 times, Hartalega trades at 40 times and Kossan at 27 times. MIDF Investment Research points out that Malaysian glove manufacturers stand to benefit from the recent US tariff imposition on China-made gloves, leading to higher demand for medical gloves.
It adds that exports to Europe are under threat, as China’s glove manufacturers are expected to reroute their glove exports to Europe in view of the trade sanctions.
Thus, local glove manufacturers would need to price their products competitively to defend their market share in Europe. Meanwhile, declining rubber latex prices as well as ongoing efforts to install more efficient production lines are expected to further reduce production costs.
From the recently concluded second-quarter earnings season, sequential earnings growth was weaker for Top Glove, Kossan and Supermax Corp Bhd. This was due to the abrupt upward movement in the rubber latex price by about 23% on a quarterly basis to RM5.00/kg. However, the rubber latex price has eased 12.0% on a quarterly basis to about RM4.40/kg. Hence, MIDF expects a lower cost of production going forward.
Meanwhile, effective Sept 1,2019, the US government has imposed a 15% tariff on medical gloves made in China. This is in addition to the 25% tariff imposed previously on industrial glove made in China. As a result, US importers are shifting the source of supply for medical and industrial gloves from China to glove manufacturers in the Asean region, specifically Malaysia, Thailand, Indonesia and Vietnam. “The imposition of tariffs on medical gloves from China is expected to have a positive impact on the top-four local glove manufacturers in the near term, given their focus on producing medical gloves (more than 90% of production volume) and established presence in the US market (more than 30% of total revenue).” Despite these positives, MIDF is maintaining its neutral stance on the sector, as it believes that the average selling price will remain subdued, given the heightening competition, especially from the European region.
Numbers forecast operators
While casinos may see a lower number of visitors during an economic slowdown or a recession, numbers forecast operators (NFOs) may be an area that bucks the trend. One reason for this is that consumers can buy lottery tickets for as low as RM1, for a chance of winning thousands of ringgit or more. So, it is very likely that regular buyers will continue trying their luck. In fact, it is possible that even more consumers would be drawn to buying lottery tickets, given the possibility of winning a large sum of money to pay off debts and sail through the tough times.
Another indicator of good times ahead for NFOs is the tightening grip of enforcement agencies on illegal players. The illegal NFO market is said to be twice or even thrice the size of the legal market, which means there is plenty of room for legal players like Berjaya Sports Toto Bhd (BToto) and Magnum Bhd to grow their revenue. According to reports, punters are already shifting from illegal NFOs to the legal operators as the crackdown by the authorities intensifies.
For these reasons, NFO players in Malaysia are seen as likely to weather the potential storm, and to emerge relatively unaffected. Kenanga Research, in a recent note, said it was positive on the outlook for NFO players. Maintaining its overweight stance on the entire gaming sector, it said the continuous clamping down on illegal operators would help boost ticket sales, which would benefit NFO players.
Another research house positive on the sub-sector is Alliance DBS Research, with BToto and Magnum as its top picks. “We are optimistic that the next catalyst for the NFOs would be the crackdown on illegal NFO activities.
“This is because tax revenue collection would increase from higher ticket sales, as punters switch back to legal NFOs and help improve the government’s finances, ” it said, adding that the authorities have accelerated efforts since the second-half of 2018 to curb illegal NFO activities. It is worth noting that both the listed NFOs, BToto and Magnum, offer attractive and steady yields of about 6% and above. In fact, Magnum’s dividend payout is expected to trend upwards with the full settlement of its tax liabilities in June 2019. Apart from this, the potential monetisation of its 6% stake in U Mobile could also boost its future dividend payouts.
As for BToto, while it incurred a loss before tax of RM26.8mil in the interim two-month period ended June 30,2019, the loss was due to a goodwill and asset impairment. Its core NFO numbers, however, have remained steady, with the company also expecting to maintain its market share through financial year 2020. In addition, after hitting multi-year lows at the end of last year, stocks within the gaming sector have been viewed as attractive for bottom-fishing.
Technology and poultry
Technology stocks that provide services are resistant to any downturns.
Ang of Phillip Capital says that technology gives these stocks constant earnings.
Pointing to the likes of Green Packet Bhd, Ang says that such stocks provide services that connect people with the government. Over time, the stocks’ earnings will grow as they broaden their base.
On the poultry sector, Ang says that the companies are subject to seasonal earnings rather than economic cycles.
“The cycles are short and seasonal, but the sector as a whole is growing amidst consolidation, ” he says.