Friday, 6 January 2012

Equity Market Review 2011: Only 3 Countries Survived The Drop!

January 5, 2012
2011 has been an extremely turbulent ride for investors as global markets; equity, fixed income and commodities, endured what can only be described at the very least as a volatile year.

Author : iFAST Research Team

2011 has been an extremely turbulent ride for investors as global markets; equity, fixed income and commodities, endured what can only be described at the very least as a volatile year.

1H 2011 got off to a good start for investors as most equity markets extended 2010’s spectacular year-end rally. However, the markets encountered severe turbulence as natural disasters afflicted Australia (floods and a hurricane) and Japan (earthquake and resulting tsunami) while the Middle East and North Africa (MENA) region witnessed mass uprisings and the dethroning of several hardmen such as Hosni Mubarak while commodities suffered a flash crash, led by silver which fell -28.4% in a week in early May, following the raising of margins by the Chicago Mercantile Exchange. In the emerging markets, many of the central banks tightened monetary policy by raising interest rates, hiking bank reserve requirement ratios, allowing their currency to appreciate against the developed nation's currencies (chiefly the USD and the EUR) as they kept a keen eye on inflation. Of interest in 1H 2011, was the withdrawal of monies from the emerging markets which measured USD 8.9 billion on a year-to-date basis as of 22 June 2011.

2H 2011 provided investors with no respite and even ratcheted up the ante on global investors. The European sovereign debt crisis decided to reignite itself as the crisis spread from Greece to the more crucial nations of Spain and Italy, with even France nearly finding itself in the crosshairs of global markets. Fixed income markets went frenetic and equity markets started to bleed, with wild intraday swings of as much as 8%, resulting in investors pulling their money out of capital markets in an attempt to protect their capital.

Across the Atlantic, America was not able to sit back and watch the serial drama unfolding in Europe. The downgrade of the US sovereign rating in August by Standard & Poor’s by a single notch saw the world’s largest debtor lose its AAA-rating, spooking markets and heightening risk aversion. The political bickering and eleventh-hour passage of the raise of the deficit ceiling had contributed its fair share to market volatility prior to the downgrade although the end result was never in doubt. Despite the downgrade in the rating of the US, US treasuries have been the best performing bond sector in spite of the words of many doomsayers.

As summer came and went, so did the heat investors were facing the tricky months of July – August. 4Q 2011 has, thankfully, brought some respite for investors. US economic data has started to provide positive surprises and lent markets some much needed optimism, as their European counterparts were busying themselves buying time with various measures to afford fiscal integration which would not happen overnight.

With the global cooperation by several major international central banks to provide unlimited USD liquidity to the financial system, particularly targeted at Europe, the credit crunch in Europe has been given a dosage of medicine to alleviate the symptoms of its illness. On a more significant note, the European central bank’s rate cut to bring the refinancing rate back to 1% (as it was at the beginning of 2011), and more specifically; the introduction of unlimited 3 year loan program has been a success in terms of banks taking approximately EUR 490 billion in loans. The funding program should aid the finances of banks; ease the credit crunch and liquidity crisis in the financial sector.

As we close the chapter on 2011 and turn the page to 2012, let us take a closer look at the key factors that have provided the support or pressure that has attributed to the performances of the top three (Indonesia, US and Malaysia) and bottom two (Brazil and India) performing markets.

Table 1: Market Performance (In RM Terms)
2011 Returns
S&P 500
MSCI World
Nikkei 225
Stoxx 600
S&P / ASX 200
Asia Ex-Japan
MSCI Asia Ex-Japan
HSML 100
Hong Kong
Emerging Markets
MSCI Emerging Markets
Source: Bloomberg, iFAST compilations (As of end December 2011)

Indonesia (+4.2% In RM terms)

Indonesia’s Jakarta Composite Index (JCI) index was left relatively unscathed in 2011, rising marginally by 4.2% (in RM terms) despite global equity markets suffering major setbacks in varying degrees. The JCI managed to reach its highest point of 4,193 in early August, a rise of 13.2% since the start of 2011 right before the deterioration of the global economic outlook and unresolved European sovereign debt crisis roiled the market. On 21 September alone, the Indonesian market dramatically dropped by 8.9%, the largest single day drop in 2011. Subsequently, JCI rebounded quickly and moved steadily in upward trend to close at 3,815 points to mark the end of 2011.

On the economic front, Indonesia has been seen as a resilient economy where domestic consumption contributes approximately 62% of the economic output. According to Bank Indonesia, Indonesia is expected to achieve 6.5% GDP growth in 2011 and 6.3% in 2012 on a year-on-year basis. Inflationary pressures have eased to 3.8% in December, the lowest since April 2010 while the reference interest rate was kept at record low of 6%. We believe Bank Indonesia has sufficient room to accommodate economic growth given high rates of inflation is no longer an imminent threat.

The decision of Fitch Ratings to upgrade Indonesia sovereign ratings from BB+ (non-investment grade) to BBB- (investment grade) was attributed to the improved economic performance, better fiscal position and strengthened economic fundamentals of the nation. Both the Indonesia GDP deficit and gross government debt to GDP are expected to remain low at levels of -0.6% and 25.2% respectively in 2011 as compared to -0.6% and 27.3% in 2010. Based on our estimates, JCI is trading at a forward PE of 13.7X and 12X for 2012 and 2013 respectively. However, due to limited upside potential by end 2013 as compared to other markets, we maintain Our “Neutral” rating of 2.5 stars for Indonesia.

US (+3.5% In RM Terms)
The US market (as represented by the S&P 500) managed to end 2011 at almost the same level as it started the year – 1257.60 on 30 December 2011, compared with 1257.64 on 31 December 2010. Nevertheless, this was enough to make the US equity market the second-best performing equity market under our coverage with the market delivering a 3.5% return in RM terms, even as global equity markets were roiled by Eurozone debt crisis concerns. The US economy started the year on a relatively bright note, with growth expectations for 2011 rising to as high as 3.2% in February 2011. However, a potent combination of soaring energy and commodity prices crimped consumer spending, the largest segment of the US economy. Following just a 0.4% growth rate (on a quarter-on-quarter annualised basis) in 1Q 11, commodity prices eased, and growth recovered to 1.3% and 1.8% (annualised quarter-on-quarter) in 2Q 11 and 3Q 11, with the economy now forecasted to post 1.8% full-year growth in 2011.

High unemployment and a weak housing market have continually been cited as issues weighing on the economy, but there has been much more cause for optimism as data improves on both fronts. Initial jobless claims have declined to non-recessionary levels, while payrolls data indicates that jobs have continued to be created, despite ongoing global economic uncertainty. Conditions also appear ripe for a housing market rebound, given that affordability is extremely high while current depressed new housing activity is (in our estimates) insufficient to cope with normalised demand due to population growth. With commodity prices having eased off their 2011 highs, we think the US economy may surprise on the upside in 2012, which has positive implications for corporate earnings and the stock market.

As of 30 December 2011, US earnings are expected to post 15.8% growth from 2010, a figure which appears easily achievable given that only 4Q 11 earnings have yet to be reported. With the market unchanged since the end of 2010, the strong growth in earnings has correspondingly made the US equity market cheaper, driving valuations down from 14.7X at the end of 2010 to 12.7X as of 30 December 2011. Consensus expectations are for further growth of 13.7% and 10.4% in 2012 and 2013, which will drive down valuations further. We expect the US equity market to re-rate to a significantly higher multiple of earnings which will provide considerable upside, and retain a 4.0 star “very attractive” rating on the US equity market.

Malaysia (+0.8% In RM Terms)
The Malaysia equity market gained 0.8% (in RM terms) in 2011, sending Malaysia to rank third on our top performing market list once more from 2010. The rise in the FBM KLCI was mainly supported by the telecommunication and oil & gas sectors, while the banking sector was the laggard of the year with most of the banking stocks in FBM KLCI reported a double-digit loss in 2011.

Our outlook for 2012 suggests that Malaysia economic growth will slow down but remain resilient, despite weaker external economic conditions that could dampen the exports demand. Domestic factors such as private consumption and private investment are expected to be the main drivers for the Malaysia economic growth. We estimate the Malaysia economy to grow by 4.0% - 4.5% in 2012.

Going forward, monetary policy is expected to switch from tightening to easing in view of lower inflationary pressure in 2012 as inflation is likely to have peaked in 2011. This provides ample headroom for policy easing to sustain economic growth. In our view, if the economic conditions deteriorate further, Bank Negara Malaysia is likely to cut the Overnight Policy Rate by 25 – 50 basis points in 2012.

The resiliency of the Malaysia equity market during the recent market crash and its moderate earnings growth prospects (to grow at 8.3% and 13.0% in 2012 and 2013) make it looks less undervalued and less attractive when compared with North Asian countries such as China, Hong Kong, Taiwan and South Korea. As indicated by the valuations, the 2012 and 2013 estimated PE for FBM KLCI stood at 15.1X and 13.4X respectively (as at 30 December 2011), which are just marginally lower than its historical fair PE of 16X. We estimate its upside potential by end-2013 to be around 19.5%, which could be decent returns for investors although it is not as exciting as those in North Asia. Overall, we maintain a 3.0 stars “Attractive” rating for Malaysia equity market.

India (-34.4% In RM Terms)
The Indian equity market (Sensex Index) was down by 34.4% in RM terms and by 24.6% in local currency (INR) for 2011. This poor performance has witnessed the market take the worst performing spot amongst the markets under our coverage as the country has underperformed against all major emerging equity markets and most of the developed economies as well. The underperformance by the Indian equity market is mainly due to macroeconomic factors such as a stubborn high inflation and it’s after effects and the crisis in developed economies specifically European countries.

The economy which was growing over 8% year-on-year (it was also the second fastest growing economy in the world) felt the heat of 13 continuous rate hikes since March 2010, an anti-inflationary stance by the central bank, has negatively impacted corporate profitability and has also severely slowed down corporate investment due to the high borrowing costs in 2011. The economy is expected to close the financial year with a growth rate of close to 7% as compared to the optimistic 9% projected by the government at the beginning of the year.

The growing concern over the debt crisis in European economies and a soft patch in the US has prompted foreign investors to exit the riskier markets such as the emerging markets. Foreign institutional investors have sold USD 357.5 million worth of equities in 2011 as opposed to a whopping USD 29.4 billion investment inflow in 2010. The fiscal deficit of India has also grown significantly following the 2008 economic crisis due to the stimulus package offered by government to revive the economy. The high fiscal deficit, high inflation and sell off by foreign institutional investors have put immense pressure on India’s national currency (Indian Rupee, INR) which has depreciated by almost 18% against the USD in 2011, leading the INR to be the worst performing currency amongst the emerging economies currencies. The depreciation of the INR against all major currencies has aggravated the underperformance of Indian equity market.

As per our in-house estimate, the Indian equity market is currently valued at a PE of 13.3X and 11.5X for 2011-12 and 2012-13 (as of 31 December 2011), with potential upside of 49%. Hence, we maintain a “Very Attractive” rating of 4.0 stars for the Indian market. With the prospect of inflation further softening following significant easing in the last 2 months, room for the central bank to look for growth by easing monetary policy is now available. Investors can consider entering into the Indian equity market with a long term perspective.

Brazil (-24.7% In RM Terms)
The Brazilian equity market, represented by the Bovespa index fell 24.7% in RM terms (18.1% in local currency terms) in 2011. Brazil has seen its stock market suffer on the back of a challenging external global environment due primarily to growth concerns in the US and the continuing sovereign debt crisis in continental Europe. With risk aversion plaguing global markets, investors have been quick to pull money out of the emerging markets, which are funnily enough deemed to be “riskier” than their counterparts in the developed markets from whom many of the current problems stem from, as they sought refuge in assets such as US Treasuries and Dollar denominated assets. The massive outflow of capital from Brazil has seen its currency depreciate by 17.75% against the USD by end 2011, a stark difference from a 7.3% appreciation against the USD in the first 7 months of the year. This massive outflow has in part caused the Bovespa index to at one point fall by as much as 30% on a year-to-date basis before staging a mini-comeback which saw the index rally 17.6% from its lows.

The Central bank’s reversal of a series of rate hikes earlier in the year has seen it cut its benchmark Selic rate by 1.5% since August 2011 as it seeks to prioritise growth over price control despite inflation above its stated target of 4.5% (plus/minus 2%). The government has begun to roll-back some of the inflation targeting measures introduced earlier in the year as it attempts to keep the nation’s economy from stalling. Latin America’s largest economy has seen its industrial production contract for almost the entire 2H 2011 (except for the month of July) as a result of the on-going problems and worries in the developed countries. Despite the contraction in industrial production, Brazil’s domestic consumption story remains compelling with retail sales, unemployment as well as wage growth pointing to continued resilience in domestic consumption.

With 59% of the Bovespa index comprising of companies related to the energy, industrial and material sectors, the index has suffered as the prices of most commodities fell in 2011 as industrial output across the world softened, particularly in the latter half of the year. Going into 2012, the Bovespa currently trades at a PE ratio of 9.0X and 7.8X (as of 31 December 2011) for 2012 and 2013 respectively, representing a discount of 47% from our fair value estimate of 11.5X earnings. We maintain our 4.5 Star “Very Attractive” rating on the Brazilian equity market as the domestic consumption factor as well as commodity producer status of Brazil remain the key drivers of a positive long-term investment opportunity.

In 2011, our picks for favourite regional market (Global Emerging Markets) and favourite single country (Taiwan) failed to shine due to bouts of risk aversion as a result of the roller-coaster developments in the developed markets.

The best performing single-country market, Indonesia, has again gazumped our best intentions and outperformed despite it being our least favourite market. Our favourite single-country market, Taiwan, has failed to shine as its export dependent economy has been affected by both poor sentiment as well as a treacherous global environment. Meanwhile, our favourite regional market, Global Emerging Markets (GEMS) suffered as international investors pulled money from these fast growing economies as they feared the repercussions of the West’s problems.

As we enter into 2012, we continue to favour equities over bonds due to the immense value to be found in most equity markets as well as the low yields currently on offer by fixed income.Our Key Investment Themes and 2012 Outlook identifies both the areas of opportunities as well as the potential risks we believe investors can expect to encounter in the coming year. Here’s wish one and all a profitable investment year with less stress in 2012!

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