Market Strategy – Growth Valuation
Low growth-high valuation conundrum. KLCI: 1,810.00 (2013 Year-end Target: 1,800 points
Liquidity renders the market “sticky” downwards
QE3 is ending. At a hearing of the Joint Economic Committee on May 22 2013, the US Fed Chairman first acknowledged the plan to gradually taper the USD85 billion monthly bond purchases under the QE3.
Hence prospect of reversal in liquidity flows may drag valuation lower...The equity markets around the region reacted negatively to the acknowledgement despite no official announcement then on the matter (which eventually came almost a month later on 19 June). The apparent market nervousness is understandable as the QE3 taper may mark the apex of massive post-2008 eastward portfolio liquidity flows. And the subsequent westward reversal will certainly be a drag to the region’s risk asset valuations going forward.
...as reflected by the recent retracement in regional indices. The anxiety was reflected by the circa 15% retracement in the regional benchmark MSCI Asia-Pacific ex-Japan (MSCI APxJ) during the ensuing month, before it recovered some ground. Our neighbouring peers, namely Jakarta Composite (JCI) and Bangkok’s SET (SET), behaved similarly to the broader MSCI APxJ.
But somehow the FBM KLCI was least affected by the taper talk... The performance divergence between FBM KLCI and its other regional peers are rather glaring, and it seems decoupled with the rest of the region. While the peers are still teetering from the June selloff, the local benchmark has recovered fully from its relatively shallow retracement. It even subsequently recorded successive new all-time day close highs.
...despite its comparatively lower earnings growth prospects...The fundamental justifications for the FBM KLCI recent outperformance are nevertheless rather elusive. First of all, if we look at the consensus 2014 earnings growth estimates of the various indices, the FBM KLCI is expected to record the slowest year-on-year expansion at only 9.7%. In contrast, the MSCI APxJ, JCI and SET are all expected to register double digit earnings growth next year of between 12-19%yoy.
...coupled with subdued earnings sentiment... Furthermore, even the current year earnings sentiment of FBM KLCI failed to reflect the bullishness in its stock prices. Since early this year, the consensus earnings for 2013 have been revised in an almost consecutive downtrend fashion. Consequently, the current year earnings estimate for FBM KLCI now stands at 107.9, or nearly 3.8% lower than what it was in early January.
...and relatively dearer valuation, both historically... Valuation expansion is the sure outcome of declining earnings against rising stock prices. Accordingly, the FBM KLCI saw it 2013 PER expanded from less than its longterm mean of 14.8x in mid-January to more than its +1-standard deviation (SD) of 16.4x as we enter the latter half of this year. This was despite the rather tepid earnings growth expectation until at least 2014. By historical comparison, based on its empirical data, the current high valuation is unlikely to be sustainable as it is not supported by commensurately high earnings growth in the visible future.
...as well as against its regional peers. Moreover, by comparing to its peers, it is clearer that FBM KLCI is certainly not cheap. In fact, at +1.2-SD, its valuation is the highest vis-à-vis the broader MSCI APxJ, JCI and SET. Even nominally, at current year PER of 16.7x, its valuation multiple exceed the others.
Liquidity is rendering the market “sticky” downwards. Since early this year until 22 May 2013, our local investors took out circa RM18.5 from the domestic equity bourse. In our Strategy report dated 23 May, we stated that “We are sanguine that the billions of ringgit of local money on the sidelines may sooner rather than later re-enter the
market especially after the lifting of cloak of political uncertainty...” Since then on until 23 July, we saw net injections of local money totalling RM3.9 billion into the domestic equity market. More importantly, from 23 May onwards, the level of average daily market participation (gross purchase and sale, a measure of market liquidity) among both local and foreign investors increased by 21.5% and 15.2% respectively against the prior period since early January this year. We reckon the returning local liquidity into our equity market may arguably have helped in the recent outperformance of FBM KLCI vis-à-vis other regional indices.
But stay true to fundamental belief... As we remarked earlier in our Strategy report dated 10 May 2013, “…the liquidity equation is a wild-card that may upset even the best laid out fundamental arguments.” The current valuation, while empirically stretched, has not exceeded the tail-end of its historical tolerance. But the history of financial market is nonetheless laden with episodes of fundamental dislocation when valuation gone abnormally high, in most instances, due to prolong intake of excessive financial liquidity. Hence, if and when it happens, in all sobriety, be reminded of the notion that fundamental is a long-time trusted companion and liquidity a passing fairweather friend. As, in each excesses, the euphoria soon (-er or later) ended and the market duly reverted to its fundamental senses.
...and manoeuvre the market waves, only if technically competent. Having said that, in the meantime, the “long cash squeeze” on those underinvested can be asphyxiating. Thus to avoid the feeling of being suffocated in a liquidity-driven but fundamentally-dear market, we suggest catching a breather in technical analysis. Its charting technique, if properly used, is empirically quite useful in assessing market momentum as well as pinpointing its direction, target and reversal. Nonetheless, we ourselves are not a major exponent of the technique.
Expect another round of market reaction upon actual commencement of QE3 taper. The liquidity impact of impending QE3 taper on the local market, FBM KLCI in particular, has so far been more muted than earlier expected. It is conceivably due to (i) the returning local liquidity, and (ii) the follow-up statements by the US Fed on QE3 taper, which help soothed markets edginess. In spite of this, recall that the actual QE3 liquidity rollback is expected to begin only after mid-September this year. Hence we can expect to see a fresh round of market reaction thenceforth, or even slightly earlier.
Maintain FBM KLCI 2013 year-end target of 1,800 points. As outlined above, the FBM KLCI seems decoupled with the rest of the region and is currently trading at both relative and absolute premiums to its past and peers. But as repeatedly alluded to in our past Strategy reports (e.g. dated 22 January 2013), the empirical market behaviour dictates that, “While the local market performance may temporarily decouple from the rest of the region, it would soon re-track the broad regional trend direction.” We reiterate our FBM KLCI 2013 year-end target of 1,800 points, equivalent to 16.7x current year earnings or +1.19SD (15.2x next year earnings or +0.25SD) above its 7-year average from 2006-2013.