This article first appeared in The Edge Malaysia Weekly, on October 5 - 11, 2015.

DESPITE the selloff in the local bourse, the FBM KLCI is down 7.2% year to date, we remain cautious on the outlook going forward.

There is no broad-based bargain to be had as the price declines merely reflect weaker corporate earnings rather than a drop in valuations. Indeed, valuations for the broader market are still elevated.

Headwinds remain formidable, both domestic and external. We are bracing for further downward revisions to earnings, which will, in turn, keep a lid on any material and sustainable rebound. As such, it is prudent to stay on the defensive and adopt a very selective stance in stock picking.

Our income portfolio is modelled to be fully invested at all times. Hence, cashing out is not an option. That said, we are confident that our basket of stocks will continue to hold up comparatively well. Dividends are boring but provide a steady income stream.

In times of uncertainties, cash is king. Most of the companies in our portfolio have strong balance sheets and are sitting on cash, which should sustain their higher-than-market average yields, even if short-term earnings fall short.

And corporate earnings, broadly speaking, will fall short.

Earnings results have come in below market expectations for consecutive quarters over the past few years. While there are those that believe in a recovery in 2H2015, we are far less sanguine. In fact, we suspect the malaise will continue for the next few quarters, at least.

No quick rebound

On the external front, the global economy is not going to see a quick rebound. Of the developed world, only the US is showing signs of a strengthening recovery. Emerging markets, on the other hand, are looking at a long period of adjustment ahead.

Much of the global growth in the past decade has been driven by China and its voracious demand for all things ranging from commodities to capital and consumer goods. The strong demand for commodities, in particular, has underpinned growth in export-dependent emerging countries.

But China’s period of rapid growth has, very likely, come to an end. The country is in the midst of transitioning from an economy that is driven by export and industrial to one that is based on services and consumption. Hence, the unfolding slowdown in the world’s second largest economy is structural in nature, not cyclical.

It is not all doom and gloom. China still has ample ammunition in its arsenal, in terms of fiscal and monetary stimulus, to engineer a soft landing. The recent easing of monetary policy should start to have an impact soon. Indeed, the latest reading on factory activities shows stabilisation, though one point never does a trend make.

In the long run China’s transformation — into slower but more sustainable pace of growth — will be positive for the global economy. But it will take time.

Just as it will take time for the commodities markets to adjust to the new norm of lower demand. The pain is compounded by the fact that the commodities boom of the past decade and a half has attracted substantial investments that are now culminating in rising supply. The markets could take months, maybe even years for some commodities, to rebalance.

Hence, we believe outlook for emerging countries will be rough for the foreseeable future.

Fundamentals have deteriorated

The local stock market selloff and steep fall in the ringgit are not purely sentiment driven. They reflect deterioration in our real economy under the confluence of negative external factors.

 Malaysia is a very open economy and the slowdown in global trade will hurt, just as the sharp fall in crude oil and crude palm oil prices — two of our key exports — will negatively impact the country’s finances and growth potential.

Our weakened fundamentals coupled with imminent hike in US interest rates — which will very likely translate into capital outflows from emerging economies — will keep pressure on the ringgit.

The environment for domestic economic growth is weak, with no clear driver.

Domestic consumption is hampered by a rising cost of living — the Goods and Services Tax and higher import costs due to the weak ringgit — and high household indebtedness. As we have seen from the US experience, the recovery period is much longer when households have to deleverage and repair their balance sheets. There will be no debt-fuelled consumption binge to drive growth this time around.

Similarly, government spending is capped by a public debt level that is pushing at its self-imposed ceiling and a commitment to reduce the budget deficit. The target of achieving a balanced budget is already being pushed back due to falling revenue, which is still highly dependent on oil. This translates into limited scope for fiscal stimulus.

Much hope is placed on the export sector to dig us out of the rut. For the moment, though, exports are not seeing much benefit from the weak ringgit on the back of slower global demand and competitive devaluations.

Growing political uncertainty and aversion to risks, meanwhile, are putting dampeners on private investments.

Taking all of the above into consideration, it is hard to envision any broad-based improvements in corporate earnings in the near to medium term. Indeed, the odds are for earnings to fall further, sandwiched between slowing demand and rising costs.

And since earnings will ultimately drive stock prices, the prospect of a sustainable market recovery is poor.

Income portfolio gains 6.9% in September

The InsiderAsia Income portfolio outperformed the market benchmark, FBM KLCI last month amid increased volatility. Total value for our portfolio is up 6.9% compared to the 1.5% gain for the benchmark index.

Last month’s gains boosted our total returns since inception (May 29, 2015) to 4.8% — far better than the benchmark index’s 6.5% decline. This means our portfolio has outperformed the FBM KLCI by a hefty 11.3% over the four-month period.

Several stocks in our portfolio were adjusted for dividends last month. This includes Panamy (RM1.27 per share), Magnum (5 sen), Star (9 sen), Cocoaland (23 sen) and Carlsberg (5 sen). As usual, we adjusted our shares held in these companies assuming the dividends are wholly reinvested.

As for upcoming dividends, shares for YTLE (4 sen) and Maybank (24 sen) will trade ex-entitlement on Oct 5 and 8, respectively. Also Crescendo (2 sen) and Kim Loong (7 sen) will trade ex-entitlement on Oct 28.

We kept our portfolio unchanged.

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