SINGAPORE (Dec 10): Last Monday’s rally turned out to be short-lived, underscoring persistent volatility in equity markets, but the outlook for emerging markets may have just brightened some.
Of significance, US Federal Reserve chairman Jerome Powell said that the benchmark interest rate is now “just below” the neutral level. This is in stark contrast to his use of the words “a long way from neutral” in early October.
Although the Fed offered no further hints as to what is the neutral rate or if there even is any change in its policy considerations, investors cheered the language shift to mean a more dovish stance. One last 25-basis point rate hike in December is currently seen as almost a done deal, but expectations for 2019 are being pared back.
This could be tacit acknowledgement that the US economy will slow into 2019, once the boost from tax cuts and fiscal spending wanes. Meanwhile, the anticipated pickup in business investments has, so far, been patchy, weighed down by global economic and trade war uncertainties. Additionally, monetary policies typically take some time to filter down and the Fed will surely want to monitor the impact of this year’s rate hikes before moving more aggressively forward.
It has indicated that further rate decisions will be data-dependent, including future readings on inflation. Inflationary expectations, at least, appear to have turned more modest. Benchmark US bond yields have fallen back below the 3% level and the yield curve has, once again, flattened.
If US interest rates were indeed nearing the peak, this would suggest a more stable greenback and good news for emerging-market currencies and stocks.
US stocks have far outperformed the rest of the world for the better part of this year, underpinned by a strong economy and corporate earnings, rising rates and the strengthening US dollar.
This has resulted in diverging valuations — while the Standard & Poor’s 500 is now trading at around 16 times forward earnings, the MSCI Emerging Markets Index is hovering at just about 11 times.
Forecasts for 2019 are more tempered. The International Monetary Fund estimates growth for the world’s largest economy at 2.5%, down from the projected 2.9% this year. Meanwhile, US corporate earnings are forecast to grow in the high single digit compared with the projected 20.6% expansion in 2018. In anticipation of the slowdown, there is a small but growing voice among brokers for investors to switch to cash and Treasuries, on the basis of risk-adjusted returns.
All of the above could mean that the time is ripe for the return of portfolio funds into beaten-down emerging markets. Indeed, we did see tentative fund inflows into select Asian markets last month, including Indonesia and the Philippines.
There is an interesting point to note about prevailing stock valuations. Table 1 shows the average valuations for all companies listed on Bursa Malaysia, excluding financial institutions (banks and insurers) and real estate investment trusts.
Companies in net-cash positions are trading at steep discounts, on average, compared with those with net borrowings. For instance, the former are priced at EV/Ebitda of only 8.8 times while the latter are accorded valuation of nearly 13 times.
Whether this is due to the sharp rise in passive investing (where underlying fundamentals become secondary) or some other reasons, the market seems keenly focused on earnings but is failing to attach as much value to balance-sheet strength.
It seems to me there is one clear conclusion to draw from this: Management can maximise shareholder value by paying out the excess cash and if need be, take on some borrowings. It will have minimal impact on profits, but yields will boost investor interest and share prices.
The Global Portfolio ended in the red for the week, in line with the global selloff. DIP Corp was among the worst performing while Nine Dragons Paper Holdings managed to buck the downtrend to close higher by 3.4% from the previous week.
Total Global Portfolio returns since inception have dropped to -11.6%. The portfolio is underperforming the benchmark index, which is down by a lesser 2.8% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
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