Cover Story: Bubbles, bubbles everywhere?

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on November 20, 2017 - November 26, 2017.
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In recent years, market watchers have increasingly observed bubble-like conditions in various asset classes around the world. This “everything bubble” phenomenon has made investors apprehensive. Will the asset prices be sustainable or will there be a drastic correction soon with far-reaching repercussions?

In mid-October, the market capitalisation of the Standard & Poor’s 500 index breached the 23,000-point mark for the first time. This came only a few months after the index broke above 22,000 points in August, which led research firms to declare that the stocks were overvalued.

Technology stocks, for instance, have seen high valuations in recent years. Facebook, Amazon, Netflix and Google (also known as the FANG stocks) alone make up about 7% of the S&P 500’s market capitalisation. In Asia, Tencent Holdings Ltd is one of the highest valued stocks in the world, having surged 2,636% in the past 10 years. Meanwhile, the technology sector has surpassed finance as the largest component of the MSCI All Country Asia Pacific Index for the first time since the dotcom bubble.

Some investment experts say while many assets are looking expensive, they have not yet reached a bubble-like stage. “The quantitative easing exercises of major central banks over the past eight years have resulted in asset prices rising sharply. Now, valuations are no longer cheap in many equity and bond markets. However, they are not exorbitant either and nowhere near the valuations seen during the dotcom bubble of the early 2000s,” says Vasu Menon, vice-president and senior investment strategist at OCBC Singapore.

Patrick Chang, chief investment officer at CIMB-Principal Asset Management, says the market is currently not at exuberant levels, so there is no reason for investors to be alarmed. “If there was a bubble, the S&P 500 would be trading above a price-earnings ratio (PER) of 23 times. Today, it is only at about 19 times based on current forward earnings. Its equity risk premium is quite limited at 6% compared with the typical equity risk premium of close to 4%, which means the market participants are quite sceptical about this value,” he adds.

Historically, most bubbles are observed as bubbles in the aftermath. But Chang says while the “everything bubble” scenario cannot be dismissed entirely, it is highly unlikely.

“We have a scorecard that we have monitored since September and it has a checklist of the risks in the market. The things we monitor include the US Federal Reserve rate hike, the US yield curve, unemployment rates, valuations, earnings per share growth and China’s GDP,” he adds.

“If we were to compare all of these indicators today with those in October 2007, only two of the 12 indicators would be flashing. So, it is not alarming when they are historically compared.”

Lim Chia Wei, assistant portfolio manager at Affin Hwang Asset Management Bhd, says while US assets are looking expensive, Asia is not in a bubble territory. “Shiller PER (share price divided by the average of 10 years of earnings, adjusted for inflation), which has been quite reliable as an indication of long-term performance, is now at 31 times — a high we have not seen since the dotcom bubble. Typically, if the Shiller PER is very high, the overall return of the market in the next 5 or 10 years will be lower,” he adds.

“However, this is not the case here in Asia. The forward PER of the MSCI All Country Asia ex-Japan is at about 13 times, which is not a huge stretch. What could be considered a stretch in this region is 16 times and above.”

The dotcom bubble — one of the biggest in history — was the result of easy capital, market overconfidence and pure speculation during the rise of internet companies. At the time, companies that had yet to generate profit, revenue or even a finished product went to market with initial public offerings that saw their share prices triple or quadruple in a single day. Eventually, companies that reached market capitalisations of hundreds of millions of dollars became worthless in a matter of months.

There will not be a repeat of this today as technology is more heavily consumed than before, says Chang. “We are living in a world where technology is a really big part of day-to-day life and one of the biggest drivers of earnings globally. For example, previously only 15% of the MSCI China was in technology. Today, due to companies such as Tencent, Alibaba Group Holding Ltd and Baidu Inc, 35% of the index are technology stocks,” he adds.

“These stocks are still growing. So, I think that as long as the earnings continue to support and grow in this environment, where there is a lot of liquidity and margins continue to expand, the markets will continue to go up.”

Nevertheless, there are still risks.  According to an Oct 20 Moody’s research report, real gross domestic product growth has slowed to 1.9%, annualised on average in conjunction with the 229% average debt-to-GDP ratio since 2001.

“People are quite concerned about the slowing economic growth resulting in more leverage. But to put things into perspective, this can only be an issue if we believe that the Fed, the European Central Bank or the Bank of Japan is going to tighten more significantly than it should,” says Chang.

Menon concurs, saying that the biggest risk for markets going forward is a shift in global monetary policy to a more hawkish-than-expected stance. “This could happen if inflation, which has been unusually low so far, surprises on the upside. The unemployment rate, which is the most understandable measure of excess capacity is close to the lows of previous cycles across the developed markets,” he adds.

“As excess capacity shrinks, wages and inflation could rise and central banks could be forced to turn more hawkish, which may cause a significant correction. If US President Donald Trump manages to push through tax  cuts and reforms and give the US economy a shot in the arm, it could change the Fed’s gradual approach to raising interest rates. This could spook investors and cause a correction down the road as well.”


Market rallies sustainable

The global equity market has done tremendously well this year on the back of improving economic data, compared with the lows seen in the first half of last year. According to Bloomberg data, the year-to-date return of the Nasdaq Composite Index, S&P 500 and S&P Europe 350 Index stood at 25.5%, 15.45% and 7.19% respectively as at Nov 14.

Asia is experiencing an equity rally, with the year-to-date returns of the India NSE Nifty 50 Index, Taiwan Stock Exchange Weighted Index, Shanghai Stock Exchange Composite Index and South Korea’s Kospi coming in at 24.91%, 15.46%, 11.09% and 24.87% respectively.

“It has been a very good year for equities, rallying on the back of higher earnings, particularly in the developed countries. The reason equity markets have done very well is that there is an abundance of liquidity while volatility and inflation are low. If any of these three things start to be out of the norm, it will stall the rally,” says Chang.

Despite the Asian equity rally, Malaysia’s stock market has been underperforming its regional peers. The FBM KLCI has seen a year-to-date return of only 5.83% compared with the double digits of its peers.

“The ringgit is cheap, but I think people are still waiting for the general election to be out of the way. Usually, markets do not like uncertainty. So, when the uncertainty is removed, the markets recalibrate. The budget was expansionary and inflation is less concerning. So, between fixed income and equities, we are more bullish on Malaysia’s equity market,” says Chang.

He adds that the fairly weak US dollar this year has become a positive tailwind for various asset classes, including global equities, emerging market (EM) stocks and EM fixed-income instruments. “EMs were massive underperformers between 2013 and 2016. This year, it is no longer the case. There has been an earnings upgrade, the dollar has been weak and commodity prices have started to stabilise. Led by China, EMs are the biggest global technology and industrial contributors, which are driving changes in the economy.

“So, we are watching the China inflation and monetary policy very carefully. There is also the risk of the US dollar rising dramatically if Trump is able to execute his fiscal policy in a strong manner, which is expected to lead to a US dollar rally and corrections in EMs. But that is not the case at the moment. It is quite benign.”

Chang believes that the growth story will continue, citing the equity PER rerating versus earnings. “The exuberance that we were talking about can only happen if the PER rerates faster than earnings, but this has not happened yet. The bulk of the equities this year has been driven by earnings upgrades rather than a rerating,” he says.

“As long as the earnings continue to deliver, we will continue to see growth. It won’t surprise me if at some point, there is some disappointment on the earnings side. There may be some corrections, but I think this is a natural occurrence in a bull market.”

Most of the rally this year has been confined to the tech sector. But sectors such as financial, industrial and infrastructure are starting to see growth as well, says Chang, especially with China’s One Belt, One Road (OBOR) initiative that is expected to result in better investment returns in the region.


properties and cryptocurrencies

Real estate prices have been rising at an unprecedented rate around the world. In late September, the number of cities that are at risk to a bubble in UBS’ Global Real Estate Bubble Index rose to eight — the highest in three years. The cities included Toronto, London, Hong Kong and Sydney.

Affin Hwang’s Lim says there is no reason for local investors to be concerned, unless they are invested in Canadian or Australian properties. According to a Mauldin Economics report released on Sept 20, the Real Residential Housing Price Index for Canada was 413.9 last year, compared with 36.3 in 2010. Meanwhile, the Sydney Residential Property Price Index was 167.6 last year, compared with 98.9 in 2010.

“If you measure it as a percentage of disposable income — in other words, affordability — property is definitely in the high levels at such places. Here in Malaysia, it is undoubtedly higher than before, so there is a lot of public sentiment that property prices are way too high. But if you compare local properties with the rest of the world, they are nowhere close,” says Lim.

According to a report by the Ministry of Finance’s Valuation and Property Services Department, the Malaysian House Price Index increased by only 5.3% in the first quarter of this year, compared with 7.1% in the previous corresponding period. In the past five years, the highest number recorded was 13.4% in 1Q2012 while the second highest was 11.2% in 1Q2013.

This is an indication that the Malaysian property market is not in a bubble, says

Zerin Properties CEO Previn Singhe. “A property bubble is caused by a run-up in housing prices, speculation and market exuberance, which we are not experiencing. Asking prices have dropped, which means people are ready for deals. Loans are also cheap, with many saying that Bank Negara Malaysia is expected to raise the overnight policy rate in January next year. So, I think there is definitely opportunity in the market,” says Previn.

It was recently reported that certain segments of Malaysia’s housing market are facing a glut. Unsold completed residential units rose 40% to 20,807 units in the first half of this year (worth RM12.26 billion) from the same period last year. According to news reports, the majority of the overhang were condominiums and apartments priced above RM500,000.

This, however, is not a cause for concern, says Tang Chee Meng, chief operating officer at Henry Butcher Malaysia. According to him, the unsold stock only comprises units that are not sold within a certain period of time — not that they will never be sold.

“It is not surprising because it just indicates that the property market has been sluggish. The largest segment is properties priced at RM500,000 and above, which again is not surprising because the government has been focusing on affordable homes. Even the developers have switched focus and are building affordable homes,” says Tang.

Previn concurs, saying that only 20% of the total transactions in Malaysia is from developers. The remaining 70% to 80%, which currently sustains the sector, is contributed by the secondary market. So, the 40% increase in unsold units just signals the need for developers to change their strategies to get their units sold.

Despite this, there are still a lot of projects that are getting good response from property buyers due to their prime location, says Tang. Generally, if the location is good, even RM500,000 is considered cheap by investors, especially if they compare with the prices in the previous peak market.

“The property market probably peaked around 2013. Although the volume of transactions continued to go up until 2015, it is currently on the downward side of the cyclical curve and has not picked up yet and prices have dropped. So, I do not think that we are leading up to a situation where the market is building up and another bubble is coming. The percentage of loan approvals was still high at 74.2% in the first quarter, so I think it is more a subdued environment than a bubble,” says Tang.

However, Carmelo Ferlito, senior fellow at Malaysian think tank Institute for Democracy and Economic Affairs, says Malaysia is indeed experiencing a housing bubble and the unsold properties are its natural consequence. “What is happening in Malaysia’s property sector happened to the US and Europe about 10 to 15 years ago, just with a time lag. I am not a financial adviser, but I think this is the moment where prices are terribly high and I would wait until the bubble bursts to buy,” he says.

There are two dynamics contributing to the Malaysian property bubble — the tendency of imitation and easy access to credit, says Ferlito. He explains that investors tend to exploit a certain sector when they realise that there are profit-making opportunities, leading to an overexpansion of the sector — in this case, properties.

“When the investments are targeting a certain sector, the positive asset to the rest of the economy tends to be overemphasised because of malinvestment into that sector. Coupled with easy credit, the Malaysian property sector is being driven to a speculative boom,” says Ferlito.

Meanwhile, in the cryptocurrency universe, the most glaring sign of a bubble is the surge in bitcoin prices. The digital currency has risen more than 500% this year.

There was a significant price increase in the last few weeks after it was announced that SegWit2x (segregated witness code optimisation to increase the block size to 2MB) had ended.

Following the announcement, bitcoin’s value rose to an all-time high of US$7,800 before falling to US$7,000 as the market reacted. This prompted many renowned investors such as Warren Buffett to express concern. “You can’t value bitcoin because it is not a value-producing asset ... it is a real bubble in that sort of thing,” he reportedly said.

On Nov 5, Goldman Sachs analyst Sheba Jafari predicted in a note that bitcoin would go past US$7,900. She noted that bitcoin had exceeded an equality target from its July low of US$6,044, indicating the potential of an impulsive advance that could hit at least US$7,941.

Affin Hwang’s Lim is concerned about the surge in bitcoin prices and suggests that investors be extra cautious when investing in the cryptocurrency. “I am definitely not an expert in bitcoin, but I sense that most retail investors do not fully understand what the cryptocurrency is, its underlying technology and its value despite knowing its price history. One common motivation that I have heard from people investing in bitcoin is that there is a fair chance that bitcoin can replace fiat currency, so they want to protect their wealth by diversifying into the digital currency,” he says.

“But I can offer a simple alternative. If you invest in a real asset — for example, Tenaga Nasional Bhd shares — in the long term, no matter how the world operates, whether using fiat or cryptocurrency, you will still get paid. People still need to use electricity, so you will get your dividends.

“I am not against bitcoin investment, but investing in a real asset is always a safer bet compared to jumping in when prices are skyrocketing. You don’t know when the peak is and you face the risk of permanent loss if the asset collapses.”

John Chan, chief operating officer at software development company Crypto Securities, says while he will not call the current bitcoin situation a bubble, any significant price hike fuelled by speculators banking their hopes on a future event will definitely see a correction. “That said, bitcoin has had more than 170,000 pending transactions stuck on the network due to the slow transfer speed. This is the situation that led to the price dropping to US$800 earlier this year,” he adds.

“Going forward, I think it is best for investors not to speculate and invest based on future bitcoin upgrades, as shown time and time before. Speculation in the cryptocurrency space is an extremely high-risk, high-reward type of investment and should be compared to gambling rather than investing.”


Strategies to deploy

Given the uncertainties ahead, OCBC’s Menon says it is important for investors not to concentrate all their investments in one area. Investors should diversify their core investments across asset classes and phase in fresh investments in the market over the next 12 to 18 months.

“There should be a mix of equities, bonds and cash among the investment holdings. Investors can also consider holding a small percentage of gold as a safeguard or insurance against bad news,” he says.

“Those with a stronger risk appetite can have a more significant part of their portfolio in equities and a smaller percentage in bonds, while those with a lower risk appetite can consider having a bigger share in bonds compared with equities.”

Menon says the house view is currently “cautious” on equity markets, “neutral” on US and European equities and “underweight” on Asia. “This does not mean that we are telling investors to sell Asian equities in favour of US and European stocks. It still makes sense to invest in Asian equities if you are a long-term investor looking beyond 12 months. But you want to put more into the US and European stocks on a relative basis because these markets are seen as more defensive.”

In terms of bonds, Menon says high-yield bonds offer some buffer to rising interest rates as central banks around the world could tighten policy down the road and raise rates. Therefore, high-yield bonds should continue to be sought after by investors looking for income and yield.

He also suggests investors have a cash buffer to protect their portfolios, with the intention to go on the offensive if there is a market pullback. “Usually, a cash allocation of 3% to 5% in one’s investment portfolio can be considered when one is fairly confident of the market outlook and sees more upside for equities and bonds.

“But after the kind of rally we have seen this year so far and given the rich valuations currently, it makes sense for investors to be more careful and perhaps take some profit off the table and hold a higher percentage of cash, perhaps closer to 10%, so that the funds can be redeployed in markets should there be a sharp pullback.”

However, Affin Hwang’s Lim advises investors not to increase their defensive allocation and not to be too worried about the possibility of a bear market with a long-term investment horizon. “You should stick to your asset allocation in good times and in bad. Let’s say if sometime in the future, whether it is next year or three years from today, there is a bear market and the stock market corrects by 30% to 40%, you should not panic and continue to invest regularly. It has been proven that if you stick to the plan and stay disciplined, you will be able to meet your financial objectives,” he says.

“I am saying this because when everything is rallying, investors tend to guess the peak and try to match their allocations to their predictions. But in reality, most of us cannot time it. We do not know when the bubble will burst.”

He points out that many highly qualified strategists called for the peak of the market two years ago, but it continued to rally much higher. Therefore, it is not very wise for retail investors to time the market. Even if they get it right, it is most probably due to pure luck.

“Essentially, if you try to predict such opportunities, you will realise that you are often wrong. You will realise that your success rate is very low. That is why I suggest that investors have a long-term investment plan and strategy and maintain it until their retirement. This is how you do it right,” says Lim.

Chang says CIMB-Principal has adopted a balanced view and will continue to advocate a mixed-asset combination of equity and fixed-income funds. “On a month-on-month market basis, fixed income may not do so well. But if the yields start to pick up, it may be interesting. So, investors may get some form of yield in their portfolios on top of reaping the returns of the well-performing equity market. We are not saying we are ultra-cautious, we are just thinking there could be opportunities if investors make the most out of both assets,” says Chang.