But can market continue fine run?
FOREIGN funds are coming to Malaysian shores, bumping up valuations but keeping the party at the FBM KLCI going strong.
With penny stocks back to dominate the volumes list, the heady scent of fear and greed is once again palpable.
Could this be the last round of song and dance before the “feel good” budget is announced on Oct 31?
To be fair, the festivity in Malaysia, is also happening in Asia – mainly fuelled by a weaker US dollar. The euro has strengthened by some 12.4% against the US dollar on a year-to-date basis, while the ringgit has strengthened 6.68% over that same period.
Now look at the correlation between the euro-dollar exchange rate and the MSCI Asia excluding Japan index. That pairing has been close to 90% this year. As the dollar cheapens, Asian central banks with dollar reserves become richer. Concurrently, liquidity has flowed into the region.
Beliefs that the US Fed will not tighten much this year have further softened the dollar, and thus the money pours in.
Malaysia though has always been more of a political market.
It’s true that most market players are getting jittery as valuations are pricier and elections are lurking.
It is every market player’s intention to make their money and exit the market before the elections are announced. It’s a fact that markets fall quite drastically the moment the announcement is made.
For now though, the FBM KLCI is up 8.93% or 146.61 points on a year-to-date basis at Thursday’s close of 1,788.42. It’s also trading at a price earnings ratio of 16.85 times (x).
Are stocks in Malaysia still worth holding at its current valuations, especially with a domestic environment that isn’t too strong?
Or is it simply holding up now because of the torrent of foreign inflows?
For the week ended Sept 8, foreign funds mopped up RM362.6mil net, ten times more than the preceding week, based on transactions in the open market, excluding off market deals. The amount acquired by foreign funds last week was the highest in 17 weeks.
MIDF notes that foreign funds were net buyers on every single day of the week, with Thursday recording the highest inflow of RM153.1mil net, the highest in a day since July 13, coinciding with the strengthening ringgit and increasing Brent crude oil price.
It also noted that Malaysia’s inflow was in line with Thailand, bucking the trend in Asia which experienced an outflow.
Last week’s foreign buying had brought the cumulative year-to-date net inflow to RM10.7bil.
Foreign participation rate was also strong. The foreign average daily trade value (ADTV) surged by 29% to reach above the RM1bil mark for the first time in 10 weeks.
Gross trade for the week ranged from RM936mil to RM1.5bil.
Likewise, retail participation edged higher for the week. The retail ADTV increased by 9% to RM880mil, staying above RM800mil for six weeks in a row.
Now the bad news…
Fundamentally though, corporate Malaysia posted very subdued results for its recent reporting season, hence throwing a spanner in the works on whether earnings can sustain the pricier valuations of stocks moving forward.
Just to quickly recap on the second quarter earnings, there were more sectors that saw disappointment compared to the last two quarters causing most analysts to revise downwards their 2017 earnings estimates.
The sectors that saw positive growth in earnings were the banks, aviation, construction, property, technology and gloves.
Sectors which saw overall weaker earnings were plantations, oil and gas (O&G), healthcare, auto and building materials, which fell into the red during the quarter.
Earnings from the media sector, apart from Astro Malaysia Holdings Bhd, remained weak.
Kenanga Research head Chan Ken Yew says that based on the posted results, he has made minor adjustments to his earnings estimates, lowering his 2017 net earnings growth estimate for the FBM KLCI to 0.4% (from 2.5% previously) but upgraded his 2018 earnings growth to 4.7% (from 2.5% previously).
“The higher growth rate for 2018 is partly due to the lower base in 2017 and we have also revised up our banking sector earnings marginally,” says Chan.
Chan explains that FBM KLCI earnings growth has been leading real gross domestic product (GDP) growth by one quarter.
“And, based on Bloomberg data, we have seen FBM KLCI earnings growth registering a peak in the first quarter of 2017, which is in line with the high second quarter real GDP growth of 5.8%.
Based on our in-house real GDP forecasts, we reckon that the domestic economic growth should be lower, say 5% to 5.2%, in the second half (5.7% in 1H17). As such, we expect a fairly flat corporate earnings growth rate in the third quarter.
Consensus is also forecasting the FBM KLCI to grow at a rate of 2.9% in the third quarter and decline by 11.3% for the fourth quarter.
It’s a buying opportunity though…
Certainly, its harder to find undervalued stocks on Bursa Malaysia today compared to nine months ago.
“Its very hard to find ‘cheap’ stocks on Bursa Malaysia right now. Most stocks have had a good run earlier this year. So should we buy now or should we wait? There are many instances that the high PE stocks remain with their high PEs. If many had waited for the PE of the tech stocks to weaken before buying, well they would be still be waiting today,” says Rakuten Trade research vice-president Vincent Lau.
On this note, Lau feels that the selower second quarter earnings season is presenting a good buying opportunity for those who had missed the rally in the first half.
“I would view any pullback as a buy opportunity for the next leg up,” he said.
Kenanga’s Chan shares the same opinion and feels that investors should capitalise on any weakness and start to position for the next two quarters.
While Chan acknowledges the rise of external uncertainties, he feels that things should be getting better especially when a meaningful correction materialises. He says that normally, the fourth quarter and first quarter are relatively stronger.
“Furthermore, as the domestic equity market valuation seems undemanding versus its regional peers, we could see milder foreign capital outflow going forward unless the US Fed raise interest rate more aggressively than expected. In fact, the quarterly and year to date net flows are still in positive territory.”
As of end-August 2017, the forward PE of the FBM KLCI only registered a 6% premium over its selected regional peers. This “valuation premium” is considered to be at the lower end of its historical range of 4% to 18%.
Timing wise, the FBM KLCI is still trading at a marginal discount of 4.6% against consensus index target of 1,860, which is slightly below its three-year mean of 4.3%. While it has yet to retrace to Chan’s ideal Buy On Weakness levels of 1,745, it has somewhat shown early signs of turnaround.
The US market remains very strong
Over in the US and much to the chargrin of most investors, the Dow Jones continues to stubbornly charge north (now 22,203.48).
Both US and global price-to-earnings ratios (presently 17.4 and 16.2, respectively) are above-average and continue to increase.
Investors who have been waiting for the Dow to correct to re-enter the market, would be severely disappointed. That correction hasn’t happened in almost 9 nine years now. So not surprisingly too, with close to a decade of the Dow’s uprising, the fear factor is now compounded because of its higher valuations and the barrage of headlines on US President Donald Trumps, North Korea and natural disasters.
This has rendered markets in a perpetual volatile mode.
But sentiment aside, the strength of the US market is also supported by fundamentals.
The second quarter earnings of the companies under the S&P 500 are now underway, and expected to increase 12.4% from the second quarter of 2016. Excluding the energy sector, the earnings growth estimate declines to 9.7%.
Of the 499 companies in the S&P 500 that have reported earnings to date for the second quarter, 73.1% have reported earnings above analyst expectations. This is above the long-term average of 64% and above the prior four quarter average of 71%
The trailing price earnings ratio over last four quarters are around 19.7 times, which isn’t too excessive.
Also as an investor, it critical to separate noise from reality.
And in face there are other positive stock market drivers that are holding up this bull market.
One strong driver is the the Institute for Supply Management’s Non-Manufacturing Index, which represents about 70% of the US economy. It rose 1.4 points to 55.3 in August. “Anything above 50 signals business activity expansion, and this economic measure has been above that threshold for 92 straight months – over seven years and counting. The leading new orders component rose two points to 57.1, which indicates expansion should continue for the near-term future,” says Fisher MarketMinder.
While the earnings of the S&P companies are indeed growing. the concern is rooted in the fact that stocks aren’t ‘cheap’ anymore.
Cheaper valuations stocks are deemed superior to expensive stocks, but if investors were to focus on ‘cheap’ alone, then this also disregards the fact that neither cheap nor expensive valuations last forever.
“Both have periods of outperformance. Higher valuations today are largely a function of growth stocks’ benign emergence, and it wouldn’t surprise us if they keep outperforming as the bull market continues,” says Fisher MarketMinder.
Typical value stock
Sometimes stocks have high PEs for a reason. They are growing faster than a typical value stock and the overall economy.
Fisher MarketMinder said that growth stocks’ outperformance do not explain current valuation levels entirely.
Energy, for example, has the highest PE ratio of any sector, largely due to low oil prices’ wreaking havoc on profits. Nonetheless, most sectors other than the telecoms have above-average PEs today.
“This is typical of a growth-led period. When growth stocks, (with their typically higher valuations) outperform, market valuations overall rise. Growth stocks’ leading doesn’t necessarily signal danger, either. Growth can pace bull markets for years before they end,” it said.
Also, business cycles affect value and growth companies differently.
Value stocks’ economic sensitivity means they tend to benefit disproportionately when the economy rebounds from recession and surprises pessimistic investors. Growth, meanwhile, tends to lead later in a bull, as increasingly optimistic investors favor high-quality companies with strong earnings potential.
“These stocks typically sport higher valuations, so PEs rise. More confident investors are willing to pay up for the fast earnings growth they expect,” says Fisher Marketminder.
It adds that eventually, sentiment will likely reach a point where investors believe they have a clear view of profit growth extending far into the future. This is characteristic of a bubble. As the tech bubble inflated, for example, valuations surged as investors bid up dot-com stocks with allegedly sky-high earnings potential.
“We aren’t at the point in this bull market where folks project profits as far as the eye can see and disdain valuations. But sentiment is warming, and it seems to be lifting valuations and growth stocks with it.
“And sure enough, high-PE companies with innovation-driven revenue streams have led the way recently. If this sounds like Tech, that’s because many (though by no means all) tech companies are growth stocks,” says Fisher MarketMinder.
It adds that ultimately, it doesn’t think investors should sweat growth’s day in the sun.
“It is typical of a maturing bull featuring sustained earnings growth and slowly warming sentiment – and in a world of broad-based growth and stellar earnings in both the US and Europe, it’s rational for investors to pay more for future earnings – and bid up stocks,” said Fisher MarketMinder.