Mar 14, 2016

Follow The Money: The Long And The Short Of It

2016 Year-end Target: 1,800 point

One of the basic equity investing strategies is to “follow the money”. In the longer-term, the word ‘money’ is almost invariably refers to the underlying corporate earnings, while in the shorter-term it may mean the flow of liquidity.


Curious observations of foreign liquidity behavior… Empirical evidences suggest that foreigners tended to sell on rumor, i.e. Taper Tantrum, but turned buyer/neutral on fact, i.e. Actual Taper. Thenceforth, it is notable that foreigners were again selling on yet another rumor, i.e. Countdown to Rate Liftoff, hence they were anticipated to turn buyer/neutral upon the fact, i.e. Actual Rate Liftoff.

Malaysia Foreign Equity
Changes to Foreign Equity Net Purchases (since Jan-2011)
…which suggested near-term market support. As the actual rate liftoff took place in mid-December last year, a repeat of past behavior should result in a fairly supported equity market during at least the first half of 2016. On this score, the equity market began the year in a jittery mode attributable to the further slump in crude oil prices to below USD30pb. However, the FBM KLCI made only a shallow retreat with good support seen at between 1,600 to 1,630 points and subsequently staged a gradual rebound and revisited the 1,700 points levels earlier this week.

Foreign liquidity returning with sentiment buttressed by recovery in crude oil and Ringgit. It must be highlighted that the gradual rebound in local equity prices coincided with the general returning of net inflow of foreign liquidity since the final week of January this year and which also corresponded thenceforth with the improvement in crude oil prices (from ~USD27pb to 40pb) as well as the relative strengthening of Ringgit against US Dollar (from ~USD/MYR4.40 to 4.10).

Bursa Malaysia foreign fund flow

Technically, the market barometer is turning bullish as it broke above the 200-day moving average last week. However, it is notable that a breakout price momentum would normally retest the breakout line as it encounters profit taking activities before the next northward push. Hence we could be looking at the market undergoing consolidation in the interim period with a prevailing resistance-turned-support level at ~1,675 points.

KLCI Moving Average
FBM KLCI: Price and 200-Day Moving Average


Earnings versus price. We reiterate our assertion that empirical observations between earnings and price are conclusive with regard to the nature of their secular direct relationship. This is despite the ever present ‘noises’ from short-term price volatility which is influenced by market sentiment and other situational issues. Hence our assessment on the likely longer-term trend path of the FBM KLCI is highly dependent on the expected earnings growth performance during the similar tenure.

Recovery in corporate earnings growth… On that score, it must be highlighted that the (Bloomberg) consensus 2016 FBM KLCI earnings growth is expected to return to a healthy level of 10.0% partly attributable to the low-base effect from general earnings underperformance in 2015. The anticipated current year performance is in stark contrast to the recent ‘earnings recession’ as attested by 2015 earnings growth of -12.1% as well 2014 and 2013 growth figures of 1.9% and -5.0% respectively.

KLCI consensus earnings growth
FBM KLCI historical and forward consensus earnings growth

…with a reduced risk of forward earnings underperformance. Furthermore, we foresee a reduced risk of material downward revisions in forward earnings estimates due to the already lowered expectation hurdles (with key revenue and cost drivers as well as other assumptions pegged at quite pessimistic levels) pursuant to six consecutive quarters of earnings disappointment up until 2QCY15. In this regard, it is notable that the two most recent results quarters to 4QCY15 have produced aggregate results which met our expectations.

KLCI: Earnings versus Price
FBM KLCI: Earnings versus Price
Macro outlook may restrict market downside. In addition, a bear market generally occurred in reaction to drastic deterioration in the macro economic performance such during the 1998 crisis and 2008 economic downturn. Hence, as the outlook for Malaysia's economy remains rather sanguine with (Bloomberg) consensus GDP growth for this year expected at 4.4%, we do not foresee the equity market turning bear anytime soon. Having said that, we remain mindful of intermittent cyclical pullbacks that may take place due to varied situational issues, even amidst continued healthy macro growth.

Reiterate year-end 2016 FBM KLCI baseline target at 1,800 points. It is notable that FBM KLCI price trajectory since 2013 mimicked the underlying flat to negative earnings performance. On that score, the anticipated earnings growth recovery in 2016/17 may also see the benchmark similarly escaping the recent ‘price recession’. Therefore, premised on the rooted behavior whereby earnings and price are trending broadly hand-in-hand, we reiterate our 2016 FBM KLCI target at 1,800 points.

source: MIDF Research - 10/03/2016