SINGAPORE (July 30): The possibility of an impending bear market means that investors should be risk-on and prepared to hedge against short-term pullbacks. They should continue to invest in equities, particularly growth stocks, as well as companies with healthy balance sheets, say fund managers.
Lim Chia Wei, portfolio manager at Affin Hwang Asset Management, is of the view that quality stocks with high returns on investment capital and stable cash flow could help long-term investors trudge through the market conditions. “It is time to be more prudent and selective. Let’s say that in the past you did not mind buying a highly indebted company because it was delivering decent growth and could cover its debt obligations. This year, you have to be more prudent,” he says.
“Amid tighter liquidity, higher interest rates and a slower growth environment, the company may face a lot of problems, which will only get worse if there is a recession. That is why it is important to choose companies with healthy balance sheets.”
There is still a strong case for equities going into 2019, says Lim Suet Ling, CEO of UOB Asset Management. Equities will continue to be supported by above-trend global growth, strong leading indicators and double-digit corporate profit growth, she adds. The earnings per share (EPS) growth of the MSCI All Country World Index, for example, is expected to be 15% y-o-y.
“We are still at the late part of the economic cycle. Until the cycle fully matures, we think a higher stocks-to-bonds ratio should be the way to go,” says Suet Ling.
“The challenge here is valuations. They seem a bit rich due to the rally last year. We feel that earnings growth will be the thing driving the equity market, which means the market will be disappointed if there is no earnings growth.”
Danny Chang, head of managed investments and product management at Standard Chartered Bank (Malaysia), says investors who are worried about a potential market downturn can turn to defensive stocks that are not heavily impacted by market cycles, such as consumer staples, healthcare and utilities.
However, Inter-Pacific Securities CEO Lim Tze Cheng says investors should not adopt a defensive stance for the time being. Instead, they should focus on growth as it is too late to take advantage of attractive yields.
“The average dividend in Malaysia now is barely 3%. Is it worth it at this stage? Investors should not turn to defensive stocks when there is uncertainty or fear in the market because at that point of time, the valuation of defensiveness has already been reflected and the yield would have dropped. They should be defensive when the market is hot and nobody is going into defensive stocks. Then, they can get a good dividend yield of about 6%,” he says.
The US is still the most preferred region for equities. An all-time low unemployment rate and recovering consumer confidence have stimulated its economy, leading to higher corporate profit margins, says Chang.
“We expect EPS growth in the US to be as high as 16%, which is pretty decent considering the size of the economy. Business investment has also picked up, leading to more mergers and acquisitions. This is always a good sign. No company will ever acquire or merge with other companies if they are not in a comfortable position,” he adds.
“We also think the stock market will pick up. The correction early in the year made valuations more palatable at a price-to-earnings ratio (PER) of 17 times. If investors are cautious about venturing into this area, one way to play it is through US small- and mid-cap funds.”
Strong US dollar could pressure emerging Asia
While the earnings outlook for the rest of Asia remains robust, Chang says a sustained rally in the US dollar or further escalation of trade tensions between the US and China could pose growing risks to Asian equities. To balance the upside potential and downside risks, StanChart currently has a smaller allocation to equities in the region.
“Asia’s 12-month corporate profitability growth projection is almost 13%, which is more than decent. However, there are headwinds. First is the expectation of three to four interest rate hikes this year by the US Federal Reserve. Naturally, when interest rates are expected to be higher, money will flow out of Asia as a result of investors holding on to the US dollar for a more attractive yield,” says Chang.
“The second cause is the strengthening dollar, which compounded that exit from Asia and emerging markets as a whole. The view on the US dollar will be one of the key barometers. If you get the US dollar view wrong, you will get the Asia and EMs view wrong. And we have to admit, we got it wrong at the end of last year. We were expecting the strengthening to end, so we were caught up in Asia and EMs.”
Over the long term, however, StanChart remains bearish on the US dollar. Chang says the bank expects the currency’s short-term corrective rally to peak and re-establish its longterm structural decline. This will be driven by narrowing global growth and real interest rate differentials where central banks collectively begin to normalise policies and there is a renewed focus on the US’ budget and trade deficits, he adds.
The opportunity in EMs at the moment is Northeast Asia, particularly the Greater China region, says Chang. “There are two ways to play in this area — onshore and offshore. I think the opportunity lies in the offshore companies that are part of China’s stocks. They are more liquid and less volatile than the onshore companies.”
Meanwhile, in Malaysia, the FBM KLCI is at an attractive level as its PER is below its average valuation while its price-to-book (PB) is even more significantly undervalued, says Inter-Pacific’s Tze Cheng. The FBM KLCI was at 1,687.13 points on July 10, 5.3% lower since the start of the year.
“Decent companies on the stock market have been down 30% on average over the past six to seven months. In this kind of environment, investors should not head to the safe stocks. They should look for big bargains and pullbacks,” says Tze Cheng.
He adds that the recent shake-ups in Malaysia’s government-linked companies are viewed as positive to the stock market in the long term as the changes are expected to make them more efficient. The fund house continues to favour the technology sector as it is the most resilient on an earnings basis.
“Bursa Malaysia’s latest quarterly results have been underwhelming. However, if you look closely, you will see that the stocks that are holding on or are slightly positive are the tech companies. The others — consumer staples, telcos, you name it — every sector but tech is a total disappointment,” says Tze Cheng.
“In terms of share price, tech is the second-worst performer after the construction sector since the general election in May. But in terms of earnings, the tech sector has held itself up. That proves our optimism in the sector.”
Bonds and other asset classes
As the Fed is expected to hike interest rates a few more times this year, fixed-income securities will continue to face the headwinds of rate normalisation, says UOB’s Suet Ling. The fund house expects US interest rates to be rangebound between 2.8% and 3.2%.
“The asset class suffered negative returns in the first half of the year. But in the second half, we think there is potential for positive returns. We are seeing some value in certain bonds, especially the high-yield and Asian rated bonds. We also prefer hard currency bonds in the US dollar,” says Suet Ling.
Meanwhile, StanChart’s Chang says the gradually rising yields across most bonds mean that income-oriented investors are able to achieve a better entry point than what was available in the last few years. However, the bank believes that corporate and EM government bonds offer more attractive prospects than developed market government bonds. Within EM bonds, StanChart prefers US dollar-denominated government bonds over local currency bonds.
Chang is not ruling out the possibility of a trade war, even though he does not believe it will happen. If it does, global stagflation is likely to take place, undermining global growth and putting upward pressure on inflation. In such cases, investors may turn to other asset classes, he says.
“There is not much you can do at that point, as neither equities nor bonds would do well. Some may turn to cash, but it is not a very smart move. They would have no shot at beating inflation,” he adds.
“Gold is one option. If things really blew out of proportion, it might be the one safe haven where investors could seek shelter. However, gold gives no income — only capital gains — so it may not be the most ideal solution.”
However, some fund managers already have exposure to gold. Suet Ling says UOB is currently overweight on gold as a defensive play in times of uncertainty and may buy more during pullbacks.
According to Bloomberg data, gold spot price as at July 10 was US$1,253.42, down 8% from its January high of US$1,358.46. According to a July 10 market commentary by Stephen Innes, head of Asia-Pacific trading at Oanda, gold has a long way to go before it can breach the US$1,300 mark and remains prone to a stronger US dollar.
Khairani Afifi Noordin is a senior writer of Personal Wealth at The Edge Malaysia
