The first quarter of 2017 has been pretty decent to investors all around the world, with both equity and bond markets on aggregate posting positive returns year-to-date. Global equity markets, as represented by the MSCI AC World Index, posted a 4.9% return, while in the global fixed income markets, the JPMorgan Global Aggregate Bond Index delivered returns of 0.1% over the first quarter (1.5% in USD terms as of March 2017). Breaking down the equity markets regionally, we saw that the developed markets, while posting positive gains year-to-date, have generally lagged behind emerging markets. The MSCI Emerging Markets Index posted a 9.6% gain, while the MSCI Asia ex Japan Index rose close to 11.6%, driven by a broad-based rally across Asian equity markets like China, India, South Korea and Taiwan.
The highlight of the quarter was in the US, where the Federal Reserve has once more raised benchmark policy rates in the US, this time to a range of 0.75% – 1.00% in its March FOMC meeting, making it the third rate hike in its current monetary tightening cycle. The Fed retained its forecasts for the Fed Funds rate for 2017, implying that it is staying with its stance of 3 hikes for the year (2 more on the cards). Additionally, the Fed also reaffirmed its outlook on the US economy, stating that "household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat", and added that inflation has risen in recent months, revising its core PCE target higher to a 1.8% – 1.9% range for this year. The Fed also reiterated that they would wait for further clarity on potential policies coming out of Washington before readjusting its forecasts and stance.
Across the Atlantic in Europe, data indicates that growth on the continent is improving, and despite the heavily-loaded political calendar and development, equity markets there have taken in their stride and continued to climb higher over the quarter. The Dutch elections are now over, with the Eurosceptic factions getting less support than expected. Across the English Channel, UK Prime Minister Theresa May has triggered Article 50, officially signalling that Britain will leave the European Union (EU) by end-March 2019. The ball is now in the EU council’s court, with negotiations now on the agenda over the next few months as European politicians prepare for an EU without the UK in it. Financial markets remained concerned over the upcoming elections in France in late-April, as polls indicate that Euro-sceptic candidate Marine Le Pen has a possible shot at the Presidency. Meanwhile in Germany, federal elections are scheduled to take place in September.
In Asia, economic data from many countries indicate broad-based improving economic momentum. This trend is seen across markets like China, South Korea, Japan, India as well as in Southeast Asia, and has buoyed investment sentiment lately, leading to relatively strong equity market performance over the quarter. Exports data across the various markets in the region also suggests a pickup in demand, and corporate earnings estimates have also continued to see broad-based improvements in many markets under our coverage. As we have pointed out and emphasised last year, with economic stabilisation in China, we expect Asian economies and markets to continue their gradual recovery this year, benefiting asset markets across the region.
Table 1: Market Performance (In MYR Terms)
|1Q 17 Returns (%)
|Asia ex Japan
MSCI Asia ex-Japan
||MSCI World Index
Source: Bloomberg, iFAST compilations as of end-March 2017. Price
returns in MYR terms
As we head into the second quarter of 2017, we take a closer look at some of the top-performing markets for the first quarter of this year (India, South Korea, Singapore) as well as those on the bottom of the performance table (China-A, Japan, Russia), identifying some of the key reasons for their performances and providing our outlook for each market.
Nevertheless, towards the 3Q of 2016, we have seen an improvement in the demand for fixed deposits (FD), implied by the positive growth in total deposits and FD deposits towards the end of 2016 after two-year of contractions (see Figure 5). The comeback of appetite for fixed deposit is likely to ameliorate banks’ asset base, leading to a better loan-to-deposit ratio, which will allow banks to lend out more funds going forward.
[All returns in MYR terms unless otherwise stated as of end-March 2017]
India (+15.0% in 1Q 17 in MYR terms)
A quarter which was expected to be the worst hit on the account of demonetisation turned out to be one of the best for the Indian market. The Indian equity market, as represented by the S&P BSE SENSEX Index, was the top performing market of markets under our coverage in the first quarter of 2017. Demonetization, the largest anti-corruption measure launched by government on 8 November 2016, was expected to negatively impact the growth momentum of the economy. Nonetheless, the earnings of Indian companies came in better than expected and GDP grew 7% in the last quarter of 2016, signalling that concerns regarding demonetization may have been overblown.
The key government objectives covered in the Union Budget on 1 February 2017 included reviving growth momentum in rural India and the implementation of measures for improving sectors such as the infrastructure, financial, and digital sectors to name a few. The government's decision to maintain fiscal discipline was commendable given the fact that Jaitley and team had decided to increase public expenditure with the aim of reviving the economy. Market participants heaved a big sigh of relief as the Finance Minister decided not to make any changes to the long term capital gains tax on equities. Another cause for cheer was the Government's all out efforts in clearing the hurdles that are interfering with the implementation of the Goods and Services Tax (GST), which will finally be implemented on 1 July 2017. In addition to the well-received Union Budget and announced government plans, the BJP had won the majority vote in Uttar Pradesh, the largest state in India, indicating that the Modi Government will likely be able to continue passing reforms with little stress from the Upper House of Parliament.
There was a time when the Indian equity market used to dependent on the support provided by Foreign Institutional Investors (FIIs). This time around, we saw huge participation from domestic investors in Indian equities on the account of the uncertainty in physical assets like gold and real estate. Domestic investments, coupled with the FII inflows, had provided ample liquidity to the market which helped the index to inch up further during the quarter.
The SENSEX Index currently trades at estimated PE ratios of 17.4X, 14.7X and 14.7X for FY 2017, 2018 and 2019 respectively as compared to its fair PE ratio of 15.0X. We retain India’s star rating at 3.5 Stars “Attractive”.
South Korea (+13.6% in 1Q 17 in MYR terms)
As of 31 March 2017, KOSPI index which represents the South Korean equity market rose 13.6% (6.6% in local currency terms) year-to-date, with returns further amplified by a 6.5% appreciation in the KRW against MYR, with the KRW supported by strong exports growth lately. For the stock market, the recent rally has been on back of strong exports growth with a boost in sentiment resulting from former president Park Geun-Hye's official impeachment.
Thanks to strong demand from China phone manufacturers, chips exports from South Korea surged and lifted overall exports in first two months of the year, which ends up reporting 11.2% and 20.2% year-on-year growth respectively. Although prices of memory chips have stopped rising since February, demand for it stays strong and likely will help companies like Samsung Electronics and SK Hynix to post strong earnings result in 1Q 17, the market has been pricing in that positive expectation into stock prices. Sentiment wise, the stronger than expected earnings for Samsung electronics 4Q 16 has amplified investors’ optimism towards the chip making business. The fact that former president Park Geun-Hye was officially impeached also lifted investor sentiment, with the KOSPI Index rising immediately after the announcement, and continuing to rally over the next few days.
Although the semiconductor business remains solid in our view, South Korea is facing its own risk which constrains the upside of its equity market. Household debt remains high, weighing on household spending, and the high domestic debt combined with a leadership vacuum suggest the government has limited options to help the economy in recent times, all of which increases the market’s reliance towards external trade and demand. The outlook is also somewhat uncertain given political tensions with China which could affect tourism, and the export-oriented consumption product manufacturers.
The South Korean equity market is trading at 9.9X estimated PE ratio for 2017 and 9.3X for 2018, comparing favourably to its fair PE ratio of 11.5X. Interested investors are advised to keep track of the market’s earnings announcement, especially for Samsung Electronics’ earnings in 2Q and 3Q 17, which can further clarify the potential return of South Korea’s equity market. We retain a 4.5 Stars “Very Attractive” rating for South Korea.
Singapore (+12.6% in 1Q 17 in MYR terms)
Back home, Singapore's equity market (represented by the benchmark STI Index), rose 12.6% in 1Q 17, as a combination of improving external and domestic economic data buoyed investment sentiment. Top performing stocks over the first quarter include maritime company Yangzijiang and conglomerate Keppel Corp, as well as several real estate companies such as Hongkong Land Holdings, City Developments as well as CapitaLand. The heavy-weight banking sector also saw decent share price gains over the quarter as the Fed's interest rate hike in March supported expectations of a rising interest rate environment. Of the 30 stocks in the benchmark index, only a handful ended the quarter with losses, including Golden Agri-Resources, Wilmar International, and Hutchison Port Holdings Trust.
Singapore's equity market saw minor adjustments to aggregate corporate earnings estimates over the quarter, with 2017's estimated earnings revised -0.5% lower while 2018's earnings estimates got revised 0.9% higher. The consensus is expecting Singaporean companies to grow earnings by 4.3% this year before increasing by 7.5% in 2018. In terms of earnings revisions, companies which saw the greatest upward earnings revisions over the quarter were from mixed sectors, including Genting Singapore from consumer discretionary sector, Wilmar International from consumer staples, and CapitaLand, which was one of the few real estate companies to see strong upward revisions in earnings estimates. Companies which saw the largest downward earnings revisions over the quarter were largely from the real estate sector, although the lifting of some cooling measures in March had led to an increase in their estimated earnings in that month.
Singapore's January retail sales rose 2.0% year-on-year, buoyed by the increase in sales from supermarkets (13% year-on-year increase) and food and beverage outlets (12% year-on-year increase) as consumers' prepared for the Lunar New Year. For the month of February 2017, Singapore's volatile Non-Oil Domestic Exports (NODX) rose on a year-on-year basis (by 21.5%) for the fourth consecutive month, amid an increase in the exports of both electronic and non-electronic products. Headline inflation came in at 0.7% year-on-year in February 2017, extending January 2017's 0.6% year-on-year increase, and has become the third consecutive month in 2 years in which consumer prices have increased on a year-on-year basis. Inflation is expected to rise modestly in 2017 given the continued stabilisation in oil prices but slackened labour market which may dampen domestic consumption slightly. As of 23 March 2017, the MAS and MTI maintained their stance that headline inflation is expected to pick up to 0.5–1.5% in 2017.
As of 31 March 2017, Singapore’s equity market trades at an estimated PE ratio of 14.8X and 13.8X for 2017 and 2018 respectively, compared to its fair PE ratio of 16.0X. Despite the recent rally, valuations remain compelling on both an absolute basis as well as relative to her neighbours in Southeast Asia. The earnings growth of Singapore companies would likely improve from that in 2016 in view of improved global and domestic economic conditions as well as a possible bottoming out of the private residential property sector and a supported oil & gas sector. We think a 4.0 Stars “Very Attractive” rating on the Singapore equity market continues to be warranted at this juncture.
China A (3.9% in 1Q 17 in MYR terms)
As represented by the CSI 300 Index, the China A-share market was one of the bottom performers under our coverage over the first quarter. The CSI 300 Index rose by 3.9% in 1Q 2017, dragged down by the performance of financial sector. Among the 10 sectors of CSI 300, the consumer staples and materials sectors were the best performers on aggregate, gaining 12.62% and 6.55% returns respectively, while the financial and telecommunications sectors were underperforming, rising 0.59% and 2.31% respectively. After going through a highly volatile condition in 2015-2016, investors in China A-share now prefer the “one belt one road”, “state-owned enterprise reform”, “Public-Private Partnership”, “consumption upgrade “and “value growth” themes, which can provide a more certain improvement in earnings.
Although the local Chinese equity market’s performance was not as good as the other countries we covered, it was far better than it was in the previous year. The main driver of the current rebound was the improvement of economic data in China in 1Q 2017. Several industrial-related data came in better than expected, indicating improving demanding and earnings momentum. The profits in January-February for China’s industrial enterprises rose 31.5% year-on-year, reaching a 71-month high; January-February’s industrial production growth rebounded to 6.3%, reaching a 5-month high; the steel output growth hit a 3 year high at 5.8% and coal consumption for power generation increased to 15.9%; manufacturing PMI and Caixin PMI have been over 50 for seven months. All those indicators showed that industrial production was under a mild recovery in China.
But caution should be paid to monetary policy and the real estate policy in China. In 1Q 2017, the PBOC increased several money market instrument rates to change monetary policy from easy to neutral. We believe the aim is to de-lever. Deleveraging is the main task of the PBOC for this year but we expected the PBOC to maintain its money market operations to maintain market liquidity. The real estate tightening policy implemented among the Tier 2, Tier 3 and 4 cities (Xiamen, Changsha, Shijiazhuang etc) recently was to avoid real estate prices from increasing too fast. Therefore, we believe the central government will carry out an asymmetric real estate policy in China, to avoid some real estate markets in some cities’ to overheat. We estimate that the growth rate of sales volumes will decrease in the near future.
Although the Chinese A-Share market lagged its other peers in 1Q 2017, the economy has continued to improve. We expect the equity market to gradually rise higher moving forward. As of 31 March 2017, the CSI 300 Index is currently trading at estimated PE ratios of 13.2X and 11.6X based on estimated earnings in 2017 and 2018 respectively, as compare to its fair value of 13.5X. Given the cheap valuation and a recovery in China's economy, we maintain a 3.5 Stars "Attractive" rating for the China A-share market.
Japan (2.2% in 1Q 17 in MYR terms)
Japanese equities inched a mere 2.2% higher in the first quarter of 2017, making it one of the bottom performing markets under our coverage. In JPY terms, the Nikkei 225 Index is down -1.1%. Over the quarter, some of the top performing stocks were the likes of Tokai Carbon, Mitsui Mining & Smelting, Fujikura, Yaskawa Electric and Tokuyama Corp. On the other hand, Mazda Motor, Toyo Seikan Group and the well-known Fast Retailing were some of the bottom performers this time round, with their respective share prices declining -15.6%, -16.9% and -17.7% in JPY terms.
Japanese companies on aggregate saw earnings estimates revised higher over 1Q 17, with FY 2017's estimated earnings revised 3.2% and 2018's earnings revised 4.4%. Sell-side analysts had begun to factor in a weaker JPY in their outlooks, supporting the earnings forecasts of Japanese exporters who derive earnings in foreign currency. While benchmark heavyweight Fast Retailing saw a 11.9% upward revision to its estimated EPS, SoftBank Group saw a 3.0% upgrade in its estimated EPS over the quarter. Japanese automobile manufacturers also saw upgrades, with Honda Motor seeing its estimated EPS upgraded by 11.7% in 1Q 17.
Thanks to the gradual recovery in the world economy and global demand, general expectations on the Japanese economy has improved substantially as compared to early half of 2016. Manufacturing PMIs, economy watcher survey outlook and consumer confidence all witnessed strong improvement. Like Taiwan and South Korea, Japan’s exports demonstrated strong year-on-year growth in recent months, thanks to China and ASEAN countries. Being a cyclical market in nature, Japan will likely benefit from a global economic recovery, and we believe such recovery is now in its early stages, such belief is now further supported by improvements in exports for major exporting countries in Asia.
As of the current juncture, Japan’s equity market trades at estimated PE ratios of 18.0X and 16.4X for 2017 and 2018 respectively, comparing favourably to its fair PE ratio of 18.5X. Valuations remain relatively attractive as compared to the western developed markets of the US and Europe. We maintain our 3.5 Star rating “Attractive” for the Japanese equity market.
Russia (-4.7% in 1Q 17 in MYR terms)
Russian equities, as represented by the RTSI$ Index, fell -4.7% in MYR terms over the quarter and ended the quarter as the poorest performing market under our coverage. The share prices of Russian companies had continued to be swayed by investors’ perception of the impact of US president Donald Trump’s administration on the country’s relations with the west and movements in the global oil market. Of the three months in the quarter, February had seen the index drop by the greatest (by -5.6% in USD terms), but some recovery was witnessed later in March, with the index rising 1.3% in USD terms (as of 31 March 2017).
Economic data have continued to show overall good progress towards economic recovery. While industrial production has contracted -2.7% year-on-year in February 2017, it remains too early to conclude a negative trend in the data, especially given its consecutive 12-month year-on-year expansion from January 2016 to January 2017. With regards to external trade, although Russia’s trade surplus for January 2017 had fallen short of estimates, it had widened 36.8% year-on-year to USD 11.4 billion, which continues to reflect healthy progression in the country’s trade activities. Despite the fall in crude oil prices through March, the gradual improvement of oil prices through 2017 continues to seem likely and should continue to provide good support to the global oil exporter. On the 24 March 2017, the Central Bank of the Russian Federation (CBR), contrary to consensus expectations, had slashed the key rate by -25 basis points to 9.75%, whilst announcing the possibility of cutting the rate further (albeit gradually) in 2Q and 3Q 2017. With inflation falling further to 4.6% in February (and being expected to fall further in March) down from 5.0% in January, the central bank stated that “the risks that inflation will miss the 4% target by the end of 2017 have slightly abated”. Nonetheless, it is worth noting that risks of an increase in inflation remain, given continued volatility in the global commodity and financial markets. A continued easing in monetary policy would be supportive of Russia’s economic recovery given the still moderately tight level of interest rates. As at 30 March 2017, the consensus is expecting Russia’s GDP to grow 1.2% and 1.5% in 2017 and 2018 respectively.
The RTSI$ index currently trades at estimated PE ratios of 6.1X and 5.4X for 2017 and 2018 respectively as compared to its fair PE ratio of 7.0X. In the near future, the market can still be expected to be easily impacted by geopolitical tensions as well as the overall direction of crude oil prices. While we retain Russia’s star ratings at 4.0 Stars “Very Attractive”, we are keeping an eye on overall valuations should there be continued gains in stock prices without overall improving fundamentals.
We Maintain Our Preference For Asia Ex Japan!
For 2017, we are overweight equities vis-à-vis fixed income, and for the equity exposure, we retain our preference for emerging and Asian equity markets relative to their developed market peers (like the US and Europe). Despite their pretty decent returns year-to-date, valuation multiples remain attractive on aggregate, and we expect gradual recovery in corporate earnings across the region, which would support equity market gains going forward. These emerging Asian markets with lower valuations provide a "margin of safety" for investors, helping to minimise the effect of a rise in risk-free rates moving forward.