Thursday 28 Mar 2024
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THE plunge in global stock market indices in the last two weeks has proved believers in the October jinx right.

Last Wednesday, the Standard & Poor’s 500 Index nosedived, losing over 58 points or 0.3% in the morning trading session. It rebounded but ended lower at 1,862.49 points, extending its decline for yet another trading day. Such intraday movements have not been seen since 2011, commentators say.

The Dow Jones Industrial Average plunged 673.15 points or 4% between Oct 8 and 13, its steepest three-day drop since 2011. The benchmark has rebounded since, losing 7.1% from its record intraday high of 17,350.64 points to last Thursday’s close of 16,117.24.  

Market observers are unable to predict how much further the indices will fall, except to say that the correction this time around is not about to end soon. The correction could be timely, or even “healthy”, given that the indices have been rallying since 2009, they add.  

The investing community sees the falling crude oil prices as a trigger for the stock sell-off. Brent crude has been declining gradually from its 52-week high of US$115 per barrel in June. It plunged on Oct 14 after the International Energy Agency slashed its forecasts for this year and 2015, indicating weak demand and a sudden increase in supply.

At press time, West Texas Intermediate is trading at US$82 per barrel and Brent crude at US$84.47.

According to Diane Sobin, head of US equities at Threadneedle Investments, the lower oil prices have impacted the energy sector, which makes up around 10% of the S&P 500. In fact, the S&P 500 Energy Index has declined 9.54% since Oct 8.   

This round of market correction is also blamed on the International Monetary Fund’s recent revision of its global economic growth forecast for 2015 to 3.8% from 4% previously and the winding down of the US quantitative easing (QE) programme and impending interest rate hikes.

The Chicago Board Options Exchange Volatility Index (VIX), a benchmark for investor nerves, stood at 26.25 points on Oct 15 — its highest level since 2012 and slightly more than half the level of volatility seen in mid-2011 when the VIX stood at 48 points.  

Threadneedle Investments has forecast a rise in volatility in the last quarter of this year as the US Federal Reserve ends its latest QE programme, says Sobin. She highlights the fact that markets had been volatile around the end of previous QE programmes and that they were unusually quiet during summer, when the VIX dropped to a record low.

“We see the current period as part of the markets’ transition from a focus on monetary policy to a focus on fundamentals and corporate earnings. We believe that this is a necessary and healthy development for equity markets and that fundamentals are strong enough to support current valuations,” she says.

For all the uncertainty in its stock market, US data points to economic recovery. The unemployment rate for September hit a six-year low of 5.9% while housing starts gained 8% in August year on year, although the figure was 14.4% lower than in July. However, consumer spending fell 0.3% in September.  

“The US economy is recovering, but the pace is slow. We expect gross domestic product growth of 2.2% for 2014, which is similar to 2013’s. The labour market is indeed improving but still not back to pre-crisis mode,” says Edward Lee, regional head of research, Southeast Asia, at Standard Chartered Bank. “Wage growth remains suppressed at around 2% y-o-y. More importantly, despite the improvement in labour data, the improvement does not appear to be in line with the weaker growth numbers.

“The discrepancy is explained by low productivity growth, partly due to job additions in low productivity sectors. Growth is recovering but the pace is not as strong as what one may hope for.”  

Global economic growth wanes

The eurozone is gripped by fears of a triple-dip recession because Germany has slashed its growth forecast to 1.2% for 2014 and 2015, down from 1.8% and 2% respectively. Lee opines that the sheer size of the eurozone will impact the global economy should there be a sharp fall in growth in the region. Geopolitical tensions this year have also jolted investment sentiment in the eurozone, says Lee. The Russia-Ukraine crisis remains unresolved while fresh fights have emerged in Iraq.

Nevertheless, he is expecting a slow recovery in Europe, not a return to recession. “We expect growth at 0.7% this year. This is not strong but considerably better than 2013’s 0.4% contraction. In addition, factors such as a cheaper euro, low inflation, accommodative ECB (European Central Bank), few contractionary fiscal impulses and easier credit conditions will help.”   

Recent data from China reveals that consumer prices rose at their slowest pace of 1.6% in September from a year ago — their lowest growth since January 2010, raising the risk of deflation in the economy.

“We think China can still register growth of above 7%. The government is balancing growth and reforms, and the economy remains in transition from investment-based to consumption-based. The government has already sanctioned various targeted measures to support growth and we expect more, such as a 50bps (basis point) cut in the reserve requirement ratio,” says Lee.

Buying opportunities?

As much as Malaysia is deemed a defensive market, it is not insulated from the tremors felt in the US equity market. The benchmark FBM KLCI erased one-year gains when it tumbled to 1,767.77 points last Thursday.  The index had fallen 6.9% from its intraday peak of 1,896.23 points in August.  

The broader market too felt the impact. As at last Friday, the FBM Emas Index had slid 7.69%  from its intraday peak of 13,186.45 points to end at 12,360.3 and give back its one-year gains.

Both indices rose along with the regional bourses last Friday, led by an overnight rebound in US stocks.

Some market experts remain unperturbed by the declining indices, saying it is merely sentiment that is driving the sell-off, which thus will not last.

“Malaysian fundamentals are still intact. Is it a buying opportunity now? It sure is. The benchmark FBM KLCI has fallen below 1,800 points and this is a good time to buy. I believe there is money to be made in the market until the first quarter of 2015,” says an equity researcher.

Interpac Securities head of research Pong Teng Siew, however, urges investors to be cautious. “When valuations fall, the usual market practice is to invest in defensive sectors, such as utilities, consumer and healthcare. However, we find that now even on a downswing, defensive stocks are not ‘safe havens’ anymore because valuations in these sectors are high. The usual game doesn’t work anymore.”

He adds that it would be best for investors to hold on to their cash in anticipation of more declines and thus cheaper valuations. He does admit though that valuations may remain expensive even after a downswing, given the rise since early this year.  

Nonetheless, market experts agree that 2015 presents new challenges for the local market with the implementation of the Goods and Services Tax and higher interest rates leading to higher borrowing costs for companies and consumers.

AllianceDBS Research head of research Bernard Ching says the challenging outlook for corporate earnings in the near term is not surprising because of the fiscal reforms the government is undertaking. “These will lead to higher inflation, which will dampen consumer sentiment. This then will impact companies that rely on domestic consumption. Top-line growth will be challenged while margins will be under pressure.”

Market experts also do not have high hopes for third-quarter corporate earnings, which will be announced soon.  

“Malaysian corporates have missed analysts’ forecast for the last 18 quarters. Will that change? Maybe what we will see is a better ratio of outperformers to underperformers. But I don’t think the estimated earnings growth of 6% this year and 7% next year is healthy,” says an equity analyst.    

Pong points out that Malaysian corporates, on average, have not been growing in real terms. Their growth cannot compensate for inflation, he says, adding that he is not expecting third-quarter earnings to be better.

According to Ching, the only good thing now is that lower crude oil prices may benefit certain sectors or stocks. “One of the beneficiaries of lower crude oil prices is the aviation industry, which we expect to report better margins in its seasonally strong fourth quarter.”

Manulife Asset Management head of equities Tock Chin Hui says their strategy is focused on growth. “We believe global recovery will eventually drive corporate earnings. Nonetheless, given that growth remains relatively subpar historically, the focus will be more bottom-up stock picking. Themes that are on our watch list are global recovery, the government’s subsidy rollback, beneficiaries of inflation and rising private investment.”

No more natural stabiliser

Julius Baer chief investment officer Burkhard Varnholt does not think the bull market cycle is near its end. “The current sell-down in the market would just be a footnote in economic history. We would have forgotten about it by the year-end,” he said at the private banking group’s summit in Shanghai. “The correction in the [equity] markets will not last long; it will probably go on for just a few more days.”

Varnholt is not concerned about the recent drop in the global markets. In fact, he sees this as a buying opportunity. “It [selling pressure] is not because the world economy has hit a great wall.”

According to him, the current sharp fall in the global markets is mainly due to the absence of market makers, which are usually the investment banks. “The liquidity that served as the natural stabiliser [of equity markets] is gone because investment banks are losing their warehousing ability for market making … when their clients are selling, they don’t have much liquidity to buy from them. The stabiliser has been removed from the equation.”

He noted that tighter regulations underpinned by higher capital requirements after the 2008 global financial crisis have taken away from banks the liquidity that they used to deploy for market-making activity.

Varnholt, who is bullish on equities, believes global economic growth is on track. “The strong dollar will make US consumers spend more as their cost of import is lower. China will benefit from this. Also, the lower crude oil prices will benefit the world economy.

He also pointed out that Asian markets have underperformed in the past three years, although the region outperformed others in terms of economic growth.

He said equities are a better asset class to be in now, considering the substantially low bond yields. “The global equity valuation is at about 15 times compared with (government) bond yields of as low as 1%. Based on this, equities are pretty much undervalued.”

This article first appeared in The Edge Malaysia Weekly, on October 20 - 26, 2014.

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