Sunday, July 08, 2007

KLCI At 1,600 By Year End

Finally, after debating in my head for the longest time, this is my new target for KLCI. First and foremost, I have to be convinced that the global equity markets platform is OK: and they are. While major markets have been wrestling with rising rates (except USA), most are just looking at max one rate rise for the rest of the year (ECB, UK). BOJ should do at least one, maybe two, but from where they are at now, that's nothing, in fact it shows the return of Japan's consumers and the benefits of having an undervalued yen for so long. Japan's markets should do even better over the next 6-12 months.

But does that bode well for KLCI, after all, its the second best performing bouse in Asia already in the first half. Nobody can touch the China markets, but the KLCI is up there with Hang Seng. The HK market had a brilliant run. You don't get good prolonged runs if you do not have the necessary catalysts. HK's allure was prompted by the swift developments in China's QDII, which brought up H-shares and will boost buying in HK shares as well now that new QDII funds are allowed to do that. HKSE topped the world in IPO raised over the last 12 and 18 months, surpassing London and New York. That's significant. Although there will be big IPOs heading for Shanghai bourse over the next 12 months, the wheels are in motion. HKSE is boosted by their enormous warrants market as well, ticked over by H-shares warrants. That derivative market has now reached the status as being an excellent platform to play the China markets without the capital hurdles of investing in China. There is a growing realisation that you don't need pure China stocks to get into the China plays. Many HK stocks have a decent China exposure and their valuations are less than half that of China companies - throw in the fact that they are more professional and no restrictions on capital movements, HK shares have found a new lifeline.

After two halfs of excellent performance by the KLCI, there are more doubters as to whether the market is sustainable. Looking at earnings valuations, it is only fairly valued. Are there bubbles, not at all, just look at the broader property markets: there is some froth in the higher end but its not excessive at the moment. Inflationary concerns are there but we still have a strong hold on controlled items esp on necessities. Bank Negara has improved the country's balance sheet scorecard. We now have reserves at 11% of GDP (while other Asian nations are at only 2%-3% of GDP, other than China), way too much if you ask any economists, but that has removed anyone silly enough to try to short the ringgit. The base currency outlook is a very important guiding factor for equity investments. Ringgit is headed the right way. I am looking at 3.30 by year end and 3.10 as the high in 2008. The stronger ringgit significantly reduces imported inflation. Wage growth has been good and will still be good for the next 2 years.

Local investors have largely shown lower participation rate in Malaysian stocks after the index has gone past 1,300. Even local institutions have done the same. However, trends have indicated that local funds have stopped taking funds from the table, and in fact has readied themselves to re-enter the bourse in the second half. EPF has stopped foreign investing as of last month.

I forsee a highish range for oil prices for the next 6-12 months which ties in nicely with the oil & gas theme. US70-85 would sustain the expansion to go for deeper wells and tougher areas. Look for stocks with capacity and unique assets. Higher oil prices on balance sees Malaysia as a net beneficiary. The other natural resources / plantations outlook are still pretty good (oil palm and timber).

Upcoming elections, enough said. Upcoming budget should see a generous reduction in personal tax rates, and maybe corporate rates. Better budget balancing via oil royalties and tax collection methods would allow for those cuts.

IDR wheels are in motion and we cannot underestimate the economic multiplier effect once that moves on. There is still a general disbelief among local investors on whether the CI deserves to be at current levels, ... don't even tell them at higher levels. If we were to look at the Top 50 market cap companies in 1996 and compared them to the current crop in 2007, what are the differences. Huge... top companies are now significantly more professionally managed. They are more regional and global in strategy and planning. Even GLCs have made large steps to improve accountability and returns. Just look at IOI Corp, Genting, Petronas ... the way they were in 1996 and now.

More significantly the connected, political counters of the past such as Renong and Idris of the 90s are now no longer. Even if you are political and connected, you have to deliver some sort of results - look at MRCB, Media Prima, Ranhill, UEM World ... Sure there are still connected counters who run on pure gas and hot air, but they no longer take the centerstage. Its an evolvement process, and its good.

Finally, the one stumbling block for foreign investors, which has left a very sour taste in the past, has now been removed substantially - capital controls. While foreign investors have bashed up and criticised countries with capital controls in the past, now there is a new perception and understanding - the countries least affected by 97 implosion were China and India, with hardline capital controls. Hence the aggressive build up of foreign reserves over the last 5 years by most Asian countries. The experience has shown that some managed control is preferred than an totally open current account management, esp among smaller countries.

So, I am firmly of the opinion that local investors have been too pessimistic on Malaysian stocks and the inherent economics. Its hard to change your mind when many have been so fixated on the transgressions and excesses of the past.

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