Tuesday, November 07, 2006

Market Outlook

Readers of this blog would be aware that I have been bullish on all equity markets, yes, even Malaysian equity market, since the beginning of the year. The correction in oil prices was a boost to the underlying strong tone for equities. I did mention that if oil and gas prices fell too fast, it could hasten a more hawkish Federal Reserve. Thankfully, the biggest factor which is US housing has shown some weakness despite the dip in oil prices. The decline in residential construction could reduce GDP by 0.5 to one percentage point over the next 12 months. That’s not enough to push the economy into a recession but could easily persuade the Fed to leave rates alone for now and even to nudge it lower come 2Q2007. However, firm labour costs is the other side of the coin as many companies are reporting strong earnings growth and bonuses should be substantive and that may cause the Fed to leave rates alone for now.

The way it is now, markets will bring one another up, and naturally it will lead to some over valuation but is there any negative triggers in the horizon. Not any that I can see. If there are no negative triggers, chances are the party will continue with more drinking and merry making. Flushed with liquidity, it takes a while to wind down the party. Even when there are pullbacks, it should not be severe because I still think we are only in the middle of a bull market, one that is quite silent and not as voracious or loud as the bulls of the past.

For the bigger markets, they should continue to chug along even though, every now and then you have doom sayers. One has to get the big picture right. The big picture is the developed economies are outsourcing a lot of stuff to cheaper cost nations, and this has enabled many of these companies to post good earnings growth. Of course this will reach a climax but not so soon as the per labour cost differentials are still wide, and that means companies in developed countries will be able to maintain and massage their profit margins. The opening up of markets in China and to a lesser extent India and South America spell of substantive growth opportunities for the big companies. This reinvestment and liquidity recycling thing will prompt better demand from these poorer nations. We are seeing the benefits of globalisation.

If the big boys do well, they also import more from smaller nations, and that cycle is underway. The recent boom and bust of commoditie is but a side effect of the confluence of these factors. You will also note that the markets tend to be careful in their increments as many are still wary of being caught by a market slide. These has kept most markets within reasonable valuations still.

The other big developments to consider is the amount of cash residing in many big companies, and the way they have been buying back shares and cancelling them to boost eps. As mentioned before the amount of cash within listed US firms has never been at a higher level. Another factor is the rise of hedge and private equity funds, they now tend to be more carnivorous and bigger. Any mis-pricing in any stock will be noticed by these firms which can only bring up valuation of these companies. Correlated rise within same industry due to M&A activity also brings up prices and valuations of similar companies. For example, you see private equity bidding for Bally, and then the rush for Stanley Leisure abd London Clubs, followed by a takeover notice for Harrah, all conspiring to lift valuations for all gaming companies. These activity cannot be underestimated owing to the size of funds under private equity now.

p/s while the KLSE will also go higher, it does not detract from the fact that the Malaysian bourse is still lagging its regional counterparts in market velocity, status, new listings and strategy

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