How low can the market go?

by **Cals** Sun 23 Aug 2015, 22:53

How low can the market go?

Saturday, 22 August 2015
By: TEE LIN SAY

Strategists say there could be more downside to the FBM KLCI
OVER the past one year, the FTSE Bursa Malaysia KLCI Index (FBM KLCI) and the domestic market have been taking hits from numerous angles. Concerns over the drop in the price of commodities and politics, together with the imminent increase of rates by the US Federal Rerserve, have battered the market and the ringgit.
The confluence of factors has eroded investor sentiment. The biggest impact has been the fall in the price of Brent crude oil for oil-producing Malaysia. Since last June, Brent is down more than 50% to its current level of US$48.
Meanwhile, Malaysia’s other important produce, crude palm oil is also down some 20% to its current level of RM1,987 over that same period.
With the country primarily being an exporter of petroleum and palm oil-related products, the rout in commodity prices is already impacting the earnings of oil and gas (O&G) as well as palm oil-related companies.
Nonetheless, latest trade figures are surprisingly firm. Up to the latest trade figures announced in June, overall export and import figures are still surprisingly firm. In fact, Malaysia’s trade surplus increased by RM2.5bil to RM8bil as of that period.

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“For investors taking a long-term approach, this difficult environment provides a good opportunity to bottom-fish.” – Terence Wong

Then there is the issue of politics.
Malaysia is first and foremost a political market. Linkages between politics and business take a different dimension in Malaysia. Afterall, government-linked companies command a substantial portion of the overall market capitalisation of the stock market.
When there are issues involving politics, the market will find them difficult to withstand. Also with concerns mounting over commodities and the ringgit, no amount of pump priming or good news can overcome the raft of bad news.
Underlying the entire backdrop of the economy is a crisis of confidence stemming largely from the 1Malaysia Development Bhd issue that has been dragging down the market and battering confidence.
Foreigners have sold some RM3bil worth of Malaysian equities and assets, and this has driven the ringgit to surpass its RM3.80 peg level back in 1998. The ringgit is nearing a 17-year low against the US dollar. Not only has the currency weakened by about 15% since the beginning of the year, the depreciation has been accelerating over the past few weeks and it has gone past the RM4.15 level.
“The fall in the ringgit has also been linked to all that political noise. If you ask me, the political noise peaked with the Cabinet reshuffle. I think that noise is now starting to soften,” said an observer.
On a year to date basis, the market is down 10.59% to 1,574.67. It is down 16.09% from its 52-week high of 1,878.89 on Aug 21, 2014. Interestingly, it the same level that the FBM KLCI was back in June 2012. Could this be a strong indication that the fall in the market is indeed beyond fundamentals?
Is the worse over?
Undeniably, the currencies and markets of most emerging countries have depreciated and fallen on the back of the strengthening US dollar and more recently, the devaluation of the yuan.
Officials at the Fed are almost ready to raise rates because they expect the economy’s continuing upward trajectory to eventually push prices up. The Fed has held its benchmark rate near zero since December 2008.
A decision to raise interest rates next month by the Fed will remove a lot of uncertainty that has been plaguing global markets.

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“What is driving the market down now is sentiment and rumours.” – Danny Wong

Strategists feel that there could be more downside to the market, as the adjustment and the cutting of excesses in key sectors such as O&G and property have not been completed.
“We have to see the cutting of excesses among the O&G and property players first. We are now undergoing a period of adjustment. So I would expect more downside first. I would not say it is time to buy, but it is time to start looking,” said one retired fund manager.
He says many companies have over-geared themselves when oil prices were at the US$100 level. This is the same scenario with the property players. Many had over-expanded when times were good.
He says that a good indicator of when it is time to buy is when earnings of the banks start to stabilise. For now, earnings of the major banks are still falling, and this is a direct impact from lower earnings from commodity-related companies and reduced lending in the property sector.
He does, however, concede that Malaysia’s macroeconomic fundamentals have far improved from the 1998 levels.
Terence Wong, research head at CIMB Research, feels that the drop in the FBM KLCI is an isolated case driven by Malaysia’s domestic issues. “While it is anybody’s guess how far the ringgit can fall and in the process drag down the stock market with it, bargains are starting to emerge with many stocks falling 30% to 50% from their April highs. For investors taking a long-term approach, this difficult environment provides a good opportunity to bottom-fish,” says Terence.
Terence says that investors should not lose sight of the fact that Malaysian companies are, in general, beneficiaries of a weaker ringgit.
The key difference this time is also that corporate Malaysia is far more prepared for any crisis with their strong balance sheets and minimal foreign currency debt.
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Terence adds that exporters of commodities and manufactured products will become more competitive while many companies have successfully ventured overseas and will gain from the currency effect.
Exporters that are beneficiaries of the weak ringgit including glove makers, condom manufacturers, plantation firms, semiconductor producers and timber companies are the clear winners.
“Some of these companies will likely enjoy bumper earnings this year as they will gain from expanding margins given that not all the currency gains will be passed on to the buyers,” says Terence.
Meanwhile, the net debt to equity of corporate Malaysia before the Asian financial crisis was around 90% to 100% but that ratio stands at only 15% as at 2015.
What has risen though, is the household debt level, which stood at 87.9% in 2014 compared with 44.4% in 1998. Nonetheless, low default rates are expected as household consumption is supported by low unemployment, as well as stable and positive income growth.
Areca Capital CEO Danny Wong feels that the market is now oversold.
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“What is driving the market down now is sentiment and rumours. Based on data and economic figures released in the last four quarters, the Malaysian economy isn’t doing as badly as perceived. For instance, Malaysia is still in a trade surplus position. People assume that with oil prices coming down, this would massively increase the country’s deficit. But in actual fact, no,” he said.
Malaysia’s exports in June 2015 grew 5% from a year ago to RM64.3bil, exceeding economists’ expectations of a 2.2% decline, boosted by higher exports to China, Taiwan and the United States. When compared with May, the exports were up RM3.8bil, or 6.3% on a month-on-month basis, according to the Statistics Department.
Meanwhile, imports rose RM1.3bil (2.4%) to RM56.3bil compared with May.
Malaysia’s trade surplus of RM8bil in June 2015 is an increase of RM2.5bil, or 44.7%, from RM5.5bil in the previous month. It also grew 94.4% or RM3.9bil from a year ago.
Furthermore, Danny added that the few times the FBM KLCI faced negative shocks, the market would drop to a price earnings ratio (PER) of between 13 times and 14 times.
At 1,577.02 points, the market is trading at a 2016 PE of 13.5 times
“Oil prices have been down since last June. Hence there is a year or four quarters of economic data to examine the state of the Malaysian economy,” he says.
He says that the data has shown that Malaysia is not that bad.
Nobody will be able to guess the bottom of the market. However historically when the market starts to reverse from its downtrend, the most profitable segment is always at the initial stages of the “V” reversal.