24-12-2008: OSK investment strategy 2009
A special report by OSK Research
Email us your feedback at fd@bizedge.com
2008 – A year to forget Caution was already in the air at the start of the year as the valuations of certain companies started to look stretched although the market PER as a whole was still reasonable at 16 times to 17 times. As the global financial turmoil worsened, the deleveraging by hedge funds which had been caught flat-footed led to capital flight from emerging markets back to the US. This in turn bolstered the US dollar, which strengthened from a low of RM3.13 to a high of RM3.63 on Nov 20. The stronger US dollar consequently brought about a weakening in commodity prices. Crude oil touched a peak of US$147.27 (RM515.45) per barrel in July and then plummeted by some 60% while crude palm oil (CPO), which hit a high of RM4,206 per tonne in March, lost 70% up to October. When commodity prices slid, so did commodity-related sectors such as plantation, oil and gas (O&G) and steel. While the plantation sector constituted some 21% of the KLCI's weighting in January, this had fallen to 15% by October given the dip in plantation stocks. A busy year for news. Undoubtedly, the biggest news in 2008 was the outcome of the March 8 general election. With the ruling Barisan Nasional returned to power on only a simple majority and five states falling into the opposition's hands, the market had reacted negatively, plummeting 123 points in its largest single-day drop in 2008. Other key events that sparked strong reactions in the market were: Defensive nature returns. In line with previous years, the defensive nature of the Malaysian market returned to the fore as the KLCI outperformed all its major regional peers. Even as political turmoil gripped the local market, news flow from the region was equally poor with political unrest in Thailand, recession in Singapore, natural disasters and a massive food scare in China and political uncertainty in Korea. Markets in East Asia performed even worse than the US largely due to deleveraging by US-based funds. Relief rally peters out. At the time of writing, as we had been predicting since 3Q, the KLCI had indeed staged a relief rally, taking it off its low of 800 points towards the 900 level. However, this rally petered out in the second week of November and selling pressure re-emerged across the region with the ringgit hitting new lows against the US dollar. 1H09 – Not a pretty picture Malaysia will not be spared. While our house forecast for gross domestic product (GDP) growth may appear relatively optimistic at 2.7%, this must be viewed in light of past growth rates of 5.9% in 2006, 6.3% in 2007 and 5.3% in 2008. The fall in commodity prices, especially oil and CPO, will take its toll on government and corporate revenue. As the global drop in consumer con?dence and spending will reduce demand for Malaysia's electronic exports, we will also see domestic consumption shrinking sharply in 1H09. All in all, 1H09 will not be an easy time for corporate Malaysia. Spending patterns will change. As the economy slows down, we see the rakyat being squeezed by lower disposable income. While the issue for most of 2008 was high inflation brought about by high petrol prices and electricity tariff adjustments, the concern for 2009 appears to be of reduced income. From SMEs that would have to cut back on exports and production to the man-in-the-street who faces possible retrenchment, there seems to be very little reprieve for the domestic consumer, who has yet to recover from the high price pressures in mid-2008. For 2009, spending patterns would definitely shift with non-essential items likely to drop out of most consumers' shopping list. We see Malaysian urban spending shift closer to rural spending patterns with reduced spending on recreation, restaurants, hotels and miscellaneous items. Not cheap on a regional basis. Looking at the stock market, the pessimistic view on the economy is reinforced by Malaysia's standing as an outperformer during the recent selldown that has rendered it a relatively expensive market compared with its peers. As it currently stands, Malaysia is the third most expensive market in Asia behind only China and Japan. Our saving grace is the relatively high dividend yield, which reinforces the view of Malaysia as a defensive market. 4QFY08 results season likely to be ugly. While we are hopeful that the 3QFY08 results will be relatively benign given that commodity prices had remained largely firm during the quarter, the collapse in commodity prices and the subsequent global slowdown should hit 4Q numbers rather hard. With the 4Q results reporting season falling in February 2009, we expect the KLCI to hit a nadir around this period. We see a correlation between the results being announced and the performance of the local market. Our expectation for a benign 3Q fits in with our view of a 2008 year-end flattish performance for the KLCI but expectation of a weak 4Q results season ties in with our view of a poor 1H09. 2H09 – Hoping for a recovery We see East Asian economies, especially China, as the key to economic recovery while the US government's rescue plans may also take effect later in 2009. On the domestic front, political uncertainties are expected to ease after the Umno election in March 2009 when the deputy president's position will be determined. East Asian economies lead the way. While the recent turn of events have proven that the theory of economic decoupling remains a theory, East Asian economies are nonetheless in a much stronger position to assist in the global recovery. China's foreign reserves exceeding US$1.9 trillion far outweigh those held by any other developed economy, perhaps with the exception of Japan's more than US$900 billion. While its trade surplus should narrow somewhat given its dependence on exports, we believe an aggressive monetary policy by the Chinese government could see it slashing interest rates significantly to prop up domestic spending. While a double-digit growth rate will likely be out of reach in 2009, most estimates still point to GDP growth of 7% to 8% for China. China still had the capacity for growth during the 2000/2001 tech-bubble recession in the US. China is not a country to shrink from aggressive interest rate cuts, as evident in 1997/1998 and 2000/2001. From a high of 7.47% in 1H08, China has cut its interest rates to 5.58% and we believe it could well be slashed further to 5.3%, which was the low in 2002. The Chinese government has also indicated that it is not averse to aggressive stimulus packages, having unveiled its own package valued at US$586 billion (RM2.05 trillion) through 2010, a sum equivalent to some 18% of its US$3.3 trillion annual GDP compared to the US' US$700 billion package, which amounts to only some 5% of its annual GDP. US not going the way of Japan. The current turmoil in the US has been compared with Japan's situation in the early 1990s. While both recessions appear to have been triggered by easy liquidity that led to an asset bubble that eventually burst, the reaction of the US government appears to have been much quicker than the path taken by Japan in the 1990s. While housing prices in the US fell before the stock market, giving the US Fed more leeway to cut interest rates much faster and more aggressively, it was the other way round in Japan, with the stock market falling before asset prices, leading to the government keeping its interest rates high even as markets tumbled. The Japanese government was also less aggressive in disbursing stimulus packages that could have spurred a recovery in its economy while the US has already given a US$150 billion tax rebate, US$700 billion in the Troubled Assets Relief Program (TARP) and is now considering another stimulus package. As such, combined with China's ability to spur domestic consumption via interest rate cuts and other stimulus packages, we believe the global economy will recover towards end-2009. Commodity prices to stabilise. While we had earlier hoped to avoid a global recession and the corresponding collapse in commodity prices, the reality now is quite different, with the World Bank having cut its GDP growth forecast to 1% for 2009 - a recession in all but number. This, coupled with a reversal in speculation sentiment, drove down commodity prices across the board with CPO and crude oil taking a bashing, albeit at a different pace. For 2009, we see commodity prices gradually stabilising despite the forecast drop in demand. With the Organisation of Petroleum Exporting Countries (Opec) having cut supply by 1.5 million barrels per day (bpd) since early September, it is expected to announce another cut of one million bpd by end-November, with a possibility of more cuts in December if oil prices do not stabilise. Some Opec countries have indicated that a price range of US$70 to US$90 per barrel is an acceptable range. Consistent with our house view of a weakening US dollar after global deleveraging ends, commodity prices should recover in 2009. Since early 2007, oil prices have been showing a strong negative correlation to the US dollar, as indicated by the Dollar Trade Weighted Index. With a slew of Treasury bills to be issued to fund the US$700 billion bailout plan and further interest rate cuts in the pipeline by the US Federal Reserve, we see a weakening in the US dollar and strengthening oil prices in the coming months. As for CPO prices, we see a decoupling from oil prices given CPO's far steeper fall in the last few months. With soybean prices at breakeven level, the planting of soybean will ease, which should help support vegetable oil prices. The mandatory use of biodiesel in Indonesia should help reduce the inventory of CPO while the cutback in the use of fertilisers will eventually have an impact on production come 2010. Our house view on commodity prices is for oil to average at US$60 to US$70 per barrel in 2009 while our average CPO price assumption is RM1,650 per tonne. Given that plantation counters still account for some 15% of the KLCI's weighting, stable CPO prices should allow the KLCI to arrest any further selling pressure. Malaysia - no repeat of 1998. On the domestic front, Malaysia is in a much better position than it was in 1998 or even 2001. With our foreign reserves having grown four-fold since 1998 and three-fold since 2001, we are in a better liquidity position than we were 10 years ago. Our non-performing loans level has also fallen significantly from 13.6% in 1998 to 2.4% currently while our loans to deposit ratio is also much healthier at 74.3% compared with 92% in 1998. As such, our banks are not at risk of major defaults and we feel that the entire financial system is much healthier than it was 10 years ago. We are still looking at a 4% loans growth for 2009. Inflation easing. While the concern starting from 2Q08 was of stagflation as inflation rates in Malaysia hit a high of 8.5%, we believe this will ease significantly in the coming months. The government has already implemented several petrol price cuts to bring the pump price down from RM2.70 per litre for RON97 to RM1.80 per litre. The drop in international coal prices is also giving Tenaga Nasional (TNB) less ammunition to argue for an electricity tariff hike in 2009. In fact, the Energy Minister has stated that if coal prices fall consistently to below US$75 per tonne, there should be a tariff cut. Given the government's move to pressure food outlets and hypermarkets to cut prices, we see inflationary pressures easing significantly by 2H09 for an average Consumer Price Index (CPI) growth of 3.4% in 2009 versus 5.8% in 2008. As such, there may be a pick-up in domestic consumption towards the end of 2009. Malaysians have short memory. Assuming that history repeats itself and a generation spans 20 years, we take a look at the previous bear markets in 1987/88, 1997/98 and 2000/01 and note that the market took an average 18 to 22 months to recover to a reasonable level. In 1987/88, it was 18 months before the market recovered between October ‘87 and March '89. In 1997/98, the bear market stretched some 22 months from August '97 to June '99 while for 2000/01, the bear market lasted 20 months, from June 2000 to February '02. If we take the current bear market as having started from March '08, we see the market recovering by 3Q or 4Q09. But watch out for banana skins Politics Given that foreign direct investment (FDI) is unlikely to return significantly in 2009, any change of government can only lead to greater instability for the nation at this time. At the same time, the long- drawn-out campaign period for the Umno general assembly up to March 2009 could see the domestic political scene continue to remain unstable for some months yet. As such, we only see a market recovery after March '09 when the issue is hopefully resolved. Corridors may not help Forecasting a flat KLCI target of 1,020. 2009 target: 1,020 points. With our house estimates of a 4% loans growth, crude oil at US$60 to US$70 per barrel and CPO at RM1,650 per tonne, and the country's still positive GDP growth, we see corporate earnings growing by some 1.8% in 2009. We derive our 2009 year-end target of 1,020 points after applying a 12 times PER to the KLCI. Over the past 10 years, the KLCI has traded in a wide range with the lows of eight to nine times during the 97/98 financial crisis. Since 2000, the KLCI has traded within a tighter PER range of nine to 30 times with the market reaching a trough in the latter months of 2008. With the market average PER at 16 times, we see a 12 times target PER - which is more than one standard deviation from the mean - as being reasonable as market confidence slowly returns across the globe. Not a pipe dream The sectors we like. Based on our house view of a depressed 1H09 followed by a potential recovery in 2H, the sectors that we are still overweight on are generally the defensive ones. We remain overweight on only five sectors namely gaming, consumer - food, rubber gloves, steel and utilities. Investment strategy Out of this basket of stocks, we have distilled our top five big-cap picks and top five small-cap picks. theedgedaily
FROM record highs to multi-year lows. 2008 was indeed a roller-coaster year for the KLCI with a record high of 1,524.69 pts on Jan 14 before plunging to a four-year low of 801.27 on Oct 28. 
Financial turmoil leads to global slowdown.While the latter part of 2008 was dominated by news of bank failures in Europe and the US as well as a crisis of con?dence, this is giving way to the reality that the global economy faces a sharp slowdown, if not a recession. While the interest rate cuts by various governments worldwide should help ease the pain, the slowdown in consumer spending is certain to take its toll on economic growth, particularly in 1H09. 
Things may turn better in 2H09. Given our expectation that the stock market tends to trade ahead of the economy by six months, we expect a recovery in the KLCI in 2H09 as we believe an economic recovery may come about beginning end-2009. For 2009, we see external factors playing a more crucial role than domestic factors. 
Aside from the risk of the global economy taking longer to recover or developing countries being dragged into a recession, we feel that the greatest risk to a recovering market in 2H09 will be politics. While the credibility of the opposition claim of taking over the federal government had somewhat taken a dent since the September 2008 deadline came and went, we do not write it off completely.
While the growth corridors were generally launched with much fanfare in 2007, the news flow for many of the corridors has slowed down considerably. While we were never too optimistic on the impact of the corridors on the stock market to begin with, the cancellation or postponement of any of the corridors, especially after the political landscape changes in March '09, could create more jitters among foreign investors.
With an upside of some 170 points to our 2009 target, we wish to clarify that this is no pipe dream. Based on the fair value on our buy calls among the top 15 KLCI constituents which make up some 36.8% of the KLCI, achieving our fair values would see the KLCI rise about 89 points. As such, achieving the 1,020-point-year-end target should not be too far out of reach.
Again, based on our market outlook for 2009, we drew up a three-pronged strategy designed to satisfy a broad range of investors:
No comments:
Post a Comment