Tuesday, October 27, 2009

Are The Markets Overvalued?

GLOBAL stock markets have recovered sharply from their bottom in March 2009. Where will our markets go from here?

To answer this question, we have to consider the prospects of the US market as the correlation between the US and world stock markets is very high especially when major movements occur in the US stock market.

In fact, emerging markets normally exhibit higher beta, moving up more than the US markets in a recovery and falling by more in a downturn.

The price-earnings ratio (PER) of the US market has ranged from a recent low of 6.6 times during the deep recession in July 1982 to over 40 times during the tech bubble in 1999.

The PER of the US market (as measured by the Standard & Poor’s 500 Index) was 22 times when the Dow peaked at 14,164.5 points on Oct 9, 2007, compared with an average 14.6 times from 1895 to 1995, according to Professor J Shiller (see chart).

Shiller’s data also shows that for that period, the market traded between 10 and 20 times earnings for 70% of the time.

According to consensus forecast, the S&P 500 which comprise 500 of the larger stocks in the US (rather than just 30 stocks for the Dow) is trading on a current PER of around 20 times, implying that the market is trading at close to the upper end of its normal trading range.

Does this imply an imminent correction?

The PER of the market cannot be viewed in isolation. Other factors like interest rates, inflation rates, earnings growth and human psychology have to be considered.

Market PERs are normally higher when inflation and interest rates are low.

Low deposit rates will make stocks more attractive as dividend yields of stocks could be higher than deposit rates; and stocks, if chosen well, could provide earnings growth which could boost future dividends.

The PER of the stock market was below 10 times in the early 1980s when inflation and interest rates were high.

The then Fed chairman Paul Volcker, who successfully tamed inflation with a tight monetary policy in the early 1980s, set the stage for falling interest rates and one of the longest bull run from 1982 until the bursting of the tech bubble in early 2000.

With the Fed slashing interest rates to almost zero following the global crisis precipitated by the collapse of Lehman in September 2008, the attractiveness of equities has improved versus bank deposits which pay pitiful interest rates.

Third quarter earnings of US companies have generally outperformed analysts’ forecast with 79% of the S&P 500 companies posting results that exceeded estimates.

Revenues have been lacklustre and earnings have been achieved in part from cost cutting and from a weaker US dollar which has boosted revenues for US multinationals.

More than half of the earnings of US multinationals are denominated in foreign currencies which have appreciated against the US dollar.

The Japanese market peaked at almost 39,000 in 1989 and was then trading on a PE of over 70 times.

Such high PERS cannot be justified or sustained for long and the Japanese market is currently trading at less than a third of its peak value.

The difference between the US and Japanese stock markets is that the US markets were less overvalued when the economic and stock market crash happened in September 2008.

The Dow has surpassed 10,000 points and has recovered almost 50% of the 7,617 points it lost between the peak of 14,164.5 points on Sept 10, 2007 and the bottom at 6,547.1 points on March 9, 2009.

Economic recovery remains weak and hence the excess liquidity resulting from lower interest rates and printing money is finding its way into financial markets (especially stocks and commodities) and properties.

A double dip into a deep recession is unlikely as house prices in US and many other countries have started to recover thereby boosting consumer confidence and bank profits through write-backs and higher valuation of mortgage-backed securities.

A more likely scenario is a lacklustre recovery, dampened by weak consumer spending as US consumers deleverage.

At these levels, the US markets seem to be fairly valued.

Any significant move up may push the US markets into bubble territory, a possibility that cannot be ruled out as central banks and pump-priming politicians are only likely to act when the bubble is obvious.

After all, who wants to spoil a good time that wins votes.

At these levels, investors will have to be more cautious.

Stocks with a high dividend yields that can be sustained offer some protection as investors are seeking yields in a low interest environment.

This would include the utility, telecommunication and food sectors.

The gaming, tobacco and alcoholic beverage sectors should also see stable demand, that is if they are not subject to large excise duty or tax increases in the budget.

Those seeking growth should ensure that the companies’ PER are reasonable and growth can be sustained in a competitive environment where excess capacity may encourage price dumping.

The rubber glove companies in Malaysia have pricing power as they produce 60% of the world’s rubber gloves and sell to the healthcare industry where demand is steadily growing.

Thursday, October 22, 2009

How To Detect Some Early Financial Warnings In Companies

TRADING volume on the stock market has recently been getting higher again. Some retail investors, who were absent from the recent rally, have started to get excited.

Over the past few months, investors were mainly focusing on good quality stocks, selling at a cheap level. However, attention has started to switch to poor quality stocks lately. Even though sometimes investors may be able to make money by betting on those stocks, we still need to be careful about the fundamentals of the companies. In this article, we will look at how to detect some early financial warnings.

A lot of companies like to make corporate announcements during the bull market. We agree that some of the announcements were genuine, but many corporate proposals were simply too good to be true.

If we analyse further, we will notice that the proposals might be way beyond the capabilities of the companies. Sometimes, the management’s projections of sales and profits were far beyond the past history. The capital expenditure requirements were well above the companies’ borrowing capacities.

Besides, the time required to turn the projects into profits might be too long. Nevertheless, as a result of the announcements, the stock prices would surge and normally, the main sellers behind might be the key owners.

We have also seen some proposals that turned out to be profitable. The companies did make profits in the first few years. However, the high growth in expansion stretched the capabilities of the top management, who might not have the experience and ability to run big businesses. They might have the experience to manage RM100mil turnover businesses. However, when the turnover surged beyond RM1bil per year, they might have problems. In fact, the main concerns to the companies were the top management team which lacked skills and experience to run big businesses.

We need to be careful if there are any changes to the key managers of the companies, auditors or accounting firms. The key managers are referred to the positions like chief executive officers and financial controllers. Besides, frequent changes in auditors provide serious financial warnings, especially the change from a reputable audit firm to an unknown one.

Companies will soon start to report their financial results for the period ended Sept 30. In Malaysia, often good companies will try to announce their results before the deadline of Nov 30. However, if they are having difficulties in providing their financial statements, normally, we will expect some bad news to be announced. One of the possible explanations behind the delay is that the companies need more time to rectify certain financial problems.

Another potential sign of financial warning is when the companies venture into unrelated businesses. Previously, we saw many Bursa Malaysia second board companies going into financial distress in 1997/98 when they departed from their core businesses in manufacturing and ventured into property development activities.

We need to understand that when the company owners enter into areas that are not their core competencies, they might not be able to apply the knowledge and experiences accumulated previously. Instead, they would have to go through the entire learning curve again, which would result in the management taking a lot of time in managing those unrelated businesses.

In such situations, investors will need to pay attention and analyse whether those new ventures will be able to add value to the shareholders’ wealth. Some companies like to change their names after venturing into new businesses. Too frequent name changes may also imply that the companies have been shifting their core business focus and directions, which may not be good news to the shareholders.

Litigation is also another warning sign. We need to pay attention to companies that are involved in litigations, which may be either attributed to the companies being sued or they are suing someone else. These litigations may divert the management’s attention from day-to-day business operations. As a result, they may affect the companies’ performance as well.

One of the common questions asked by shareholders during any AGM is the directors’ fees. We need to analyse whether the fees paid are in proportion to the companies’ profitability. Sometimes, certain companies make excessive perks for owners as well as their employees or the lifestyle of the key owners is simply not consistent with the companies’ profitability.

The above are a few of the more common financial warnings that potential or existing shareholders must pay attention to when analysing the companies for investment. More importantly, we need to remain vigilant at all times and pay attention to the latest development of the companies.

Personal Investing - By Ooi Kok Hwa

Thursday, October 15, 2009

Economy On Track For Full Recovery By 2010

MALAYSIA'S economy is well on track for a full recovery by next year, judging from increasing demand for products and services of late, says Minister of International Trade and Industry Datuk Mustapa Mohamed.

"The business community is telling me that there is some increase in orders, but it will take weeks or months for these orders to reflect the actual numbers.

"The actual delivery (of these orders) is expected either in November or December. That is why we say that by the end of the year or hopefully by next year, our economy will be fully recovered," he told reporters after opening the National Women Convention 2009 in Kuala Lumpur yesterday.

He was asked to comment on Malaysia's international trade outlook for next year.

According to recent trade figures released by the ministry, Malaysia's exports in August fell 19.8 per cent from a year ago but economists are saying that the country's economic recovery momentum is still intact.

On a month-on-month basis, August exports were down 2 per cent from July, while imports also shed 6.6 per cent, resulting in the total trade falling 4.1 per cent to RM38.26 billion.

Mustapa also said the ministry continues to seek more financial assistance from the government to help develop entrepreneur development programmes, including that for women.

"As usual, we will submit proposals to the government for allocation under the annual Budget. We hope for an increase in funding for entrepreneur development programmes in the coming budget presentation.

"But, it all depends on whether the government can afford it. (We will) wait for the budget announcement next Friday," he said.

Earlier in his speech, Mustapa said up to September 2009, a total of RM23.3 million has been spent to train 23,444 workers under the Skills Upgrading Programme by SME Corp Malaysia Bhd and of this, 36 per cent were women.

While under the Women Exporters Development Programme undertaken by the Malaysia External Trade Development Corp, he said 48 women-owned companies have been provided with export assistance involving RM1.6 million since 2005.

SME Corp chief executive officer Datuk Hafsah Hashim said she is confident that the target of having 22 per cent small- and medium-sized enterprise (SME) exporters in 2010 from the current 19 per cent can be achieved, following positive signs that demand for their products is on the rise.

She also cited that the number of active SMEs have risen from 600,000 last year to 700,000 presently, while the number involving women entrepreneurs has reached 100,000.

Monday, October 05, 2009

Timely Boost For Market?

IN the past three decades of the Kuala Lumpur Composite Index’s (KLCI) memory, the third quarter of the year had typically been the weakest. That is why some investors shun the market from August right up to October (Black October, remember?).

Maybank Investment Bank senior manager, head of retail research equity markets Lee Cheng Hooi has proof to substantiate that. “Month-on-month (MoM) returns from 1977 to 2009 show that the months with the highest risk are the worst performing. Based on over 32 years of observations on MoM returns, we have identified a common trend for the FBM KLCI index as well as the Dow and Hang Seng indices. All three markets are weak in the August to October months,” says Lee.

For that reason, Lee recommends investors to “Sell” over this period and “Buy” in December. He expects the market to remain volatile as it is still in the “very high risk” zones.

A potential catalyst (or not) could be the upcoming budget 2010 which to be tabled in parliament on Oct 23. Do pre and post budget market swings present an investment opportunity?

Positioning for upside
Based on the past five years, the stock market tends to show a slight downward dip in the aftermath of the budget as investors generally have high expectations, and as such, end up getting somewhat disappointed over the lack of goodies.

But as this will be Prime Minister Datuk Seri Najib Tun Razak’s first budget as he is also the Finance Minister, don’t be surprised to see market-friendly measures, despite the Government saying it is looking to reduce operating expenditure while maintaining fiscal discipline.

Important to note too, is that compared to the regional bourses on a year to date basis, the FBM KLCI remains the second worst performer at 40.7%, only ahead of Japan.

TA Securities senior technical chartist Stephen Soo says that October has been touted as a negative month, more so because many of the global negative events in the past, took place during these months. “Without these negative events, it’s actually quite a random trend,” he says.

But there’s opportunity in crisis.

JF Apex Securities Bhd chief operating officer Lim Teck Seng is prepping himself for more upside as he expects more liberalisation and investor-friendly measures to come out of the budget.

He says the tone has already been set by Najib’s previous moves which includes the call to pare down Khazanah Nasional Bhd’s stakes in government-linked companies and bringing Maxis Communications Bhd back to the local bourse.

“There may be a pre-budget rally. The objective is simple. The market needs to move. Najib appears very serious in attracting foreign investments to the market,” he says.

KAF Securities research head Chehan Perera, in his strategy report dated Sept 30, expected the 2010 budget to be a follow-through of the expansionary policies announced in the past year, while continuing to focus on stimulating consumption.

“Structural adjustments to the composition of the government profit & loss are unlikely although the Prime Minister has hinted at a need to manage expenses more efficiently. Overall, the budget should be market friendly and provide a nice trigger ahead of the third quarter reporting season,” says Chehan.

Analysts also point out that the present correction may provide a good chance to buy quality stocks.

“Our markets have corrected ahead of the global market ... we had the Hungry Ghost Festival in September. So, the CI’s downside is limited. If you look at the second and third liners, there is hardly any correction,” says Lim, who believes the market is looking for a reason to move to the next level.

Potential catalysts from the upcoming budget may come wrapped in the form of bigger construction projects to be awarded including the extension of the light rail transit lines estimated at RM7bil and the new Low Cost Carrier Terminal.

Soo expects more of a post-budget rally, as he anticipates investors to accumulate on confirmation of news.

“The market is now correcting along with global markets. I would let the market dip a further 50 points before positioning myself for the year-end rally,” says Soo, who has a 1,250 target for end-2009.

A technical analyst says the short-term impact and direction of the budget on the economy and stock market are irrelevant. After all, market often reacts with knee-jerk speed and over-zealousness.

“The clever investor will think: Expectations are still pretty bearish. The green shoots everyone has been talking about may turn to to dead leaves. This year, everyone is still complaining about a recession, the lack of execution and political uncertainty. Maybe it’s a good time to buy,” says the technical analyst.

He says this bearish mood will hit good stocks with high dividend yields. Solid stocks will also be hit and be fleetingly cheap.

For example, consumer stocks with high dividends and reputable management such as AEON Co (M) Bhd, Nestle Holdings Bhd and Parkson Holdings Bhd will inevitably correct with the rest of the market.

Nonetheless, this does not change their growth rates.

“During recessions, people still buy toothpaste, coffee, biscuits, soaps or cleansers. This correction gives you a chance to pick up your favourite stock at a lower premium. It’s very unlikely that the budget will change their prospects,” he adds.

On this note, Lim likes food-based and consumer-based companies, as these companies tend to do well during recessions.

“Their profits may even double up, as consumers cut down on expensive food and alternate with cheaper foodstuff,” he says.