Lead Story: Corporate earnings will still grow, but at a slower rate

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DESPITE the heavy selldown in Bursa Malaysia in mid-October, Pacific Mutual Fund Bhd believes the benchmark FBM KLCI could touch 1,950 points by end-2015.

“We estimate 8% to 9% growth in Malaysia’s corporate earnings for 2015 and 2016. Taking that into account, at the end of next year, we are possibly looking at the 1,950 to 1,960 level,” Pacific Mutual executive director and CEO Gary Gan tells The Edge in a recent interview.

“We are still going to see growth in the next two years but at a slower rate compared with the 12% to 13% in the last few years,” he says.
The FBM KLCI slipped some 6.8% from its record close of 1,892.33 in June this year to a 52-week low of 1,767.77 on Oct 16. It regained some 5% by end-October to 1,855.15 but retreated 2.5% to close at 1,809.13 last Friday.

But Gan deems the selldown as a positive correction, adding that the market has been running ahead of itself. “Even before the recent selldown, we always identified 1,750 to 1,800 points as a very strong support level. The small- to mid-caps have been running for the last one year and it’s about time they took a breather.”

Since the start of the year, the Bursa Malaysia Small Cap Index has risen more than 23% to reach a peak of 19,338.10 in August. But the selldown, in tandem with the broader market’s performance in mid-October, wiped out much of the year’s gains, with the Small Cap Index slipping 17.6% from August to 15,927.29 on Oct 16. The Small Cap Index closed at 16,597.20 last Friday.

Additionally, global equities also took a beating. The Dow Jones Industrial Average fell 6.7% to a half-year low of 16,117.24 on Oct 6. It rebounded 9.7% to a 52-week high of 17,719 at last Thursday’s close.

“We are generally bullish on equities globally, right till year-end. While Malaysia may not ride the wave and will most probably underperform its peers, the local market can still generate returns via selective trading and active allocation,” says Gan.

At its higher levels touching 1,900, the FBM KLCI has been overvalued in contrast to its regional peers as well as against historical averages, he says.

“When you are expensive versus your peers, it is not so bad if you are still cheap compared with your own long-term — 5 to 10-year — averages. But Malaysia fails on both fronts,” Gan says, adding that at this point in time, the FBM KLCI is fairly valued at about 1,860. At last Friday’s close of 1,809.13, this implies an upside potential of 2.8%.

That said, investing at this point in time is not for the near term but with an eye on 2015 and 2016 earnings growth, Gan says. “At present, immediate strong near-term catalysts are none, except for the seasonal strength and potential rebound in the small to mid-caps, which took a beating recently. That said, large mergers and acquisitions could come to the fore again.”

While Gan sees few rerating catalysts for the Malaysian market, he believes the utilities and telecommunications sectors remain fundamentally sound. According to him, a mega trend to keep an eye on is population growth, which will create demand for basic needs. This will be a boon for sectors like health, power generation, infrastructure, water and food. “Some such stocks can be held for the next 20 years, assuming they are well managed.”

Gan declines to comment on some of Pacific Mutual’s stock picks, but says the key to managing portfolios is to consider market themes. “The counters that have given gains this year are not the FBM KLCI stocks but the small- to mid-caps and we have invested a lot in that. Because of that, we have managed to make 5% to 6% gains on some of our local portfolios even though the benchmark FBM KLCI is a negative.” Year to date, the local bellwether has lost more than 3%.

Pacific Mutual is part of the Singapore OCBC Group and managed RM2 billion in funds as at end-March 2014. It was incorporated in 1995 as a unit trust management company and is 70%-owned by Lion Global Investors Ltd (held by OCBC) and 30%-owned by Koperasi Angkatan Tentera Malaysia Bhd.

Global outlook

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At the end of October, the US Federal Reserve put an end to its bond-buying programme. This was quickly followed by the Bank of Japan’s (BOJ) announcement that it was stepping up its qualitative and quantitative easing to ¥80 trillion, from the previous annual rate of ¥60 trillion to ¥70 trillion.

“The recent surprising monetary expansion by the BOJ essentially absorbs whatever remaining ‘fear’ of the Fed ending its quantitative easing (QE) programme,” says Pacific Mutual executive director and CEO Gary Gan.

The end of the US QE programme has no serious impact on global markets as the Fed had clearly indicated its timeline last year, he says.

“What all this is telling the markets is that even if the Fed decides to raise interest rates sooner than expected in early 2015, but in a gradual manner, the impact on global markets may be more ‘normalised’ and major disruptions [will be] absorbed, for now at least,” explains Gan.

“Our position is that the US-led recovery is still valid despite many short-term bumps and any sharp pullback is an opportunity to buy beaten-down quality stocks,” he says, adding that the US economy seems more driven by corporate earnings now, compared with monetary stimulus.
The US economy grew 3.5% in 3Q2014 against 4.6% in 2Q2014 and a 2.1% contraction in 1Q2014.

Pacific Mutual upgraded its position on the US market to “neutral’ from “underweight”. “The US recovery remains in place but as it chugs along, earnings expectations will get even higher while labour and capital costs will trend upwards,” says Gan.

As the US dollar strengthens, exporting economies in Asia are expected to benefit from increased consumption. Pacific Mutual is thus “overweight” on the Asian region, says Gan.

It is, however, cautious on emerging markets, which are heavily dependent on the persistent weak commodity and oil prices. Pacific Mutual remains “neutral” on emerging markets.

However, it has downgraded the European region to “underweight”, citing the possibility of deflation. “Even corporate earnings are showing a weakening trend amid weakening currency. A lot depends on the strength of the US economy,” Gan opines.

This article first appeared in The Edge Malaysia Weekly, on November 24-30, 2014.