BULL RUN YEAR 2007? WHAT ANALYSTS SAY?

SO far, so good. The bullish undertone in the regional stock markets in the start of the year has been inspiring. With an expected soft landing in US, pent up expenditure, healthier corporate earnings and higher domestic consumption, fund managers are expecting a good amount of capital flow into Asia.

Most regional bourses (with the exception of Thailand) started the New Year with a grand bang. Hong Kong's Hang Seng Index continued to challenge new highs, and yet again scaled to another new high of 20, 310 on its first day of 2007 trading. Bourses in Taiwan and Jakarta also recorded their new highs on New Year's Day.

In Malaysia, the big question was whether the stock market would continue with its stubborn laggard legacies, or would there be a change in will? The answer came out loud and clear as the composite index (CI) spurted to life upon its opening bell. The CI gained 20.85 points, surpassing the 1,100 level, thus achieving a new six year high.

This could have been aided somewhat by a shift in investor sentiments towards Thai equities after the government imposed capital controls not too long ago. The rising siren of a military coup in Thailand has also shaved off significant value in Thai equities.
Down south, Singapore, was just fresh off awarding two billion dollar bids for its integrated resorts (IR), in Marina Bay and more recently in Sentosa Island. Malaysia is expected to benefit from the economic spillover effects.

So it seems that Thailand's loss is Malaysia's gain, and Singapore's gain, well, is Malaysia's gain. With that, fund managers opine that 2007 could be the year where Malaysia finally weans off from its laggard qualities.
The macro stage is set A large part of Bursa's 20% growth was achieved in the last two months of 2006. The excitement in the local bourse was palpable, what with the re-rating by foreign investors due to renewed interest in plantation and timber sectors, positive news flow among key blue chips and the potential upside of construction stocks following announcement of projects under Ninth Malaysia Plan (9MP).
On a macro economic basis, economists feel that Malaysia still has the ammunition to support the CI's uptrend.

Domestic demand is set to gain momentum with the acceleration of the 9MP projects and private investments. CIMB Securities expects the country to sustain real gross domestic growth (GDP) growth of 5.6% in 2007 and 6% in 2008, compared with an estimated 5.9% in 2006.

On the interest rate front, the central bank is expected to keep its overnight policy rate at 3.5% in 2007 to support domestic growth amidst ebbing inflation risk. The ringgit is also expected to strengthen from RM3.55 at end 2006 to RM3.45 at end 2007.
Externally, the US economy is headed for a soft landing while crude oil prices are expected to hover at US$60-US$65. Lower crude oil prices and stabilising commodity prices will help improve profit margins.

Expectations of a US interest rate cut by the second quarter of 2007 could also lead to a rebound in growth in the second half of 2007. “While we think growth will be strong in 2007, many believe that growth will be slower than 2006's growth due to external economies, which is expected to slow down, particularly that of the US and China. Having said that, we think the two big themes for the market – 9MP rollout and Visit Malaysia Year – will be good enough reasons for the economy to expand by about 5.5% in 2007,” says Kurnia Insurans (M) Bhd chief investment officer, Pankaj Kumar.

Sharing the same view is UOB-OSK Asset Management Sdn Bhd chief executive officer Lim Suet Ling who is positive on the stock market for a few reasons.
Firstly, government-linked companies (GLCs) reforms, which have been talked about for the last 18 months have “started bearing fruit as evident in the likes of Tenaga, MAS, POS Holdings and the merger of PNB group of companies,”

“With momentum gathering, we expect to see more GLC restructurings this year. Mergers & acquisitions will likely continue to be a theme for 2007 with the possible mergers or strategic alliances of the smaller banks as well as the takeover or privatisation of undervalued companies by locals as well as foreigners,” says Lim.

Alliance Investment Bank director and head of equity capital markets Sherilyn Foong adds that GLC reforms and market liberalisation have drawn positive response from foreign investors and has been a key driver of the CI performance. “Foreign investors will continue to keep Malaysia on their radar as they look for further improvements and more positive news flow,” she says.

While Hwang-DBS Investment Management Bhd chief investment officer David Ng feels that the macro front creates a conducive environment for the stock market, he cautions investors to be mindful that growth is likely to slow down although it won't be significant enough to crunch profits (as inflationary pressures will also subside, and liquidity remains abundant).
“Specifically for Malaysia, increase in private and public investment will also be positive for the economy. Nonetheless, optimism has risen amongst investors and markets have performed well. Hence, the markets will be prone to higher volatility,” he says.

Pankaj says that although Malaysia, in the past year, was marginalised, it is now beginning becoming more appealing to foreign funds, judging by some of the following seen not only among the larger cap stocks, but also the smaller cap stocks. “This is where I think some of the foreign brokers have done an excellent job in promoting Malaysia as they have helped to get small cap stocks on the radar screen. (However) While we may see more funds coming to Malaysia, the effective weighting may still be low as issues on liquidity and corporate governance take precedence,” he notes.

Prudential Unit Trusts chief investment officer Lynn Cheah adopts a more conservative approach, saying that that the impetus for Malaysian equities currently stems largely from regional markets. She opines that Malaysian equities are a beneficiary of the rising tide.
“There is a lot of work to be done and rethinking of goals and policies before Bursa Malaysia becomes a favourite to foreigners again,” she says.

Hwang’s Ng would hesitate to use the word “favourite” as the Malaysian market now carries a very small weighting in the regional indices. “Their participation will likely be limited to large caps and liquid themes. But measures by the government to liberalise the financial services will be viewed favourably. Increase in infrastructure spending, and more M&A activities will also stimulate interest amongst investors,” he says.

Ng adds that Malaysia’s strengths lie in its natural resources especially in the oil palm and the oil and gas industries. “The former especially, has been, and continues to be a major pull for foreign investors, as Malaysia will continue to remain as the target market for such investments,” he says.

While Standard & Poor’s (S&P) vice-president of Equity Research Lorraine Tan feels that Malaysia's economic fundamentals are relatively sound as a net exporter of oil, the government's spending constraints and gradual removal of petrol subsidies have taken a toll on consumer confidence. “The planned development of the South Johor Economic Region, the Penang infrastructure improvements, and the proposed merger of government-owned plantation companies should help boost confidence, although a lack of details has led to scepticism on the success of these plans,” she says.

Areas that need to be addressed

While Malaysia appears to be on sturdier footing, entrenched GLC cultures, protectionism and the lack of transparency in corporate Malaysia continues to weigh heavily on Malaysia's competitiveness, say some observers. If Malaysia is serious on becoming an investment haven, the political will to change and improve is paramount.

Tan remains concerned that Malaysia's regional competitiveness is slipping, which could limit growth, particularly when the country becomes a net importer of oil, estimated to occur in the next 11 years. “GLCs and the government need to ensure returns on invested capital are optimised to positively position the country for continued development particularly given that it enjoys favourable demographics, with 60% of the population below the age of 35.”

Financial markets wise, Pankaj thinks that it is important for the regulators to address some of the key concerns that the foreign fund managers have with respect to Malaysia.
“Chief among them are the liquidity issue, transparency and consistency in economic and financial policies. Freeing up ownership on some of the state-owned companies via cleverly structured derivatives or outright sale is welcome as it will encourage free float as well as improve liquidity,” he says.

Ng would like to see less protectionism and more transparency. “We need to harness the advantages of the country’s peoples and resources and enhance our competitiveness. Having said that, a more efficiently run delivery system with minimal red tape will make it easier for investors to get things done at a quicker pace.” Ng adds that Bursa Malaysia's recent move to introduce the FTSE Bursa Malaysia new indices provide a better reflection of global standards as they take into consideration the liquidity and free-float of each stock.

He opines that this will help improve the attractiveness of the local investment scenario.
Foong says that while Malaysia has been able to sustain investor interest in the face of this competition, as well as with the outflow of domestic funds from the unit trust industry, more needs to be done. “Broadly speaking, the key to portfolio investors is Malaysia's weightings in the benchmark MSCI indexes. Increasing the free floats of our large companies and well as new large initial public offerings will be an important step in this direction,” she says

Lim would like to see the government implement policies that are in line with embracing globalisation with continuous improvment on efficiency and transparency.
Public Mutual Bhd’s Lam Kam Yin says that due to increasing competition from low cost ASEAN neighbours as well as China, the domestic manufacturing sector has to focus more of its resources in higher-value added products. “At the same time, Malaysian companies providing tourism, education, financial and healthcare services have to continue enhancing their services to compete globally and regionally, he says.

Earnings expectations

Pankaj says that it is rather ironic that one end, market is effectively expecting a slower economic growth than the projected 5.8%-6% for 2006 while earnings growth on the other hand for most analysts in the market is in fact higher than 2006 projected growth of about 15.4%.
“Based on data compiled by us, the market is expecting earnings to expand by about 16.1% in 2007 while the market average Kuala Lumpur CI index value is about 1,255points,” says Pankaj. He explains that if one were to assume that the earnings delivery for 2007 would reach about 16% growth and based on average price earnings ratio (PER) values of about 16 times (x), the market’s fair value is around the 1,200 level.

“As we move forward in the year, investors will begin pricing in market expectations for 2008 and that could drive valuations higher again (similar to the 2006 year-end momentum) to the 1,280-1300 points mark. Also, as we have seen the market driven by liquidity factors over the past few months and the momentum that has been built-up could drive the market higher by another 5%-10%,” says Pankaj.

S&P's Tan says that although the current 17x PER is at the average since the Asian crisis, it is below the 20x-25x seen before 1997-1998. She adds that the downward re-rating is understandable given the historically lower interest rates and slower relative GDP and earnings per share growth. “As we believe the 17x PER average is the result of market capitalisation dominance by the national utility companies and banks, the broad market is actually cheaper,” she says.

UOB-OSK's Lim expects to see the broad market performing in 2007 with mid-small cap stocks outperforming big caps given the formers’ cheaper valuations and stronger earnings growth.
“From a bottom-up perspective, our 12-month CI target is between 1,150 and 1,200. However the current liquidity rally in the region could drive share prices higher than their fundamental values. Previous liquidity rallies have driven the CI to PERs of above 20x before correcting. Pegging the market at 20x PE would translate to the CI at 1,533,” says Lim.

Hwang's Ng predicts a bold target of 1300 for 2007, although he does admit that index targets are notoriously difficult to forecast.

Source : TheStar (Tee Lin Say, http://thestar.com.my/news/story.asp?file=/2007/1/6/bizweek/16471277&sec=bizweek)