As if a mockery to the whole tranquillity of 2017, the first quarter of 2018 saw a sudden return of volatility as risk aversion came back to the forefront of markets. Global equity markets tumbled in February before struggling again in the middle to the end of March, while the safer segments of fixed income enjoyed a brief respite during this period of risk aversion, after seeing yields rise in January. The MSCI AC World Index posted a -6.0% loss in the first quarter, while the JPMorgan Global Aggregate Bond Index posted a -4.0% loss (0.9% in USD terms). Breaking down the equity markets by region, we saw that developed markets generally lagged behind their emerging market counterparts in 1Q 18.
In the States, the Federal Open Market Committee (FOMC) policy-makers raised the benchmark Fed Funds rate by 25 basis points to a range of 1.50% – 1.75% in March, a move which was by and large expected by the consensus. The Fed also raised its projections for GDP, with 2018’s GDP forecast upgraded by 20 basis points to 2.7% and 2019’s GDP raised 30 basis points to 2.4%. Inflation projections (represented by the Core PCE forecast) for 2018 were left unchanged but 2019’s forecast was raised by 10 basis points to 2.1%. More crucially, the updated ‘Dot Plot’ suggests that there while there are at least two more hikes on the table for 2018, the committee has actually raised its expected rate path in 2019. In his first press conference, new Fed chair Jerome Powell struck a balance between being data-dependent and the need for policy-making to be effective in the current economic backdrop. We believe that the pace of policy normalisation in the US will continue to be the gradual moving forward.
In Asia, we saw economic data confirming a broad-based recovery in the region, and leading indicators continue to suggest robust expansion. Corporate earnings as a whole also enjoyed upgrades, consistent across Southeast Asian countries as well as North and East Asian markets. 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.
Despite an increasingly protectionist Trump administration, we do not think that a full-blown trade war is on the horizon, as the outcome of the tariffs and potential negotiations are not set in stone yet as hearing and consultation sessions are due before implementation. The negotiation process between the US and China is likely to drag on for weeks and even months, and as such, we believe investors should not overreact and make knee-jerk reactions to dynamic political news. Moreover, investors should also note that not every economy would be affected adversely if trade tensions escalate and a full-blown trade war materialises.
Market Performance (in MYR terms).
||MSCI Emerging Markets
||MSCI Asia ex-Japan
Bloomberg, iFAST compilations. Returns in MYR terms, excluding dividends, as
of end-March 2018.
As we head into the second quarter of 2018, we take a closer look at some of the top-performing markets for the first quarter of this year (Brazil, Malaysia, Russia) as well as those on the bottom of the performance table (Europe, Indonesia, India), identifying some of the key reasons for their performances and providing our outlook for each market.
[All returns in MYR terms unless otherwise stated as of 30
Brazil (+6.4% in 1Q 18 in MYR terms)
Brazil’s equity market stood resilient and climbed upwards to clinch the crown in 1Q 18 as a return of volatility wobbled equity markets worldwide. The Bovespa Index initially fell around -4.0% in February before recovering to register a 6.4% gain for the full quarter (11.7% in BRL terms). The pulp and paper industry saw the strongest share-price gains (Fibria Celulose, Suzano Papel), followed by Brazilian banks such as Banco Santander Brasil, Banco do Brasil and Itau Unibanco. Energy titan Petrobras was also among the top performing stocks with its share price rallying 38.1% in local currency terms on the back of rising crude oil prices over the quarter. On the other hand, BRF, Kroton Educacional, CCR and Cielo are some of the bottom performing stocks this time round.
Over the quarter, Brazilian corporations (as gauged by the Bovespa Index) enjoyed earnings upgrades as a whole, with 2018’s earnings estimates revised 11.0% higher while 2019’s estimates got upgraded 7.0%. On a sector basis, the materials and industrials sectors have seen the strongest upgrades thus far, with the pulp and paper industry seeing strong upward earnings revisions. Upgrades in earnings of mining titan Vale pushed up the materials sector as well as sell-side analysts grow more confident of its deleveraging and cash return prospects. Energy juggernaut Petrobras also contributed to the headline upgrades with a bump up in its EPS estimate for 2018. The Brazilian real estate and telecommunication services sectors saw earnings downgrades as a whole. Earnings revisions among the consumer discretionary and consumer staples sectors were rather mixed over the quarter, while the financials sector enjoyed upgrades as banks like Itau Unibanco and Banco Bradesco saw EPS for 2018 revised higher.
In terms of economic data, industrial production in Brazil beat estimates in January, and is reflective of improving conditions within the country, with earlier months of data enjoying upward revisions as well. While retail sales data for January came in below expectations, the overall outlook for domestic consumption in Brazil remains bright. Leading indicators such as the manufacturing and services PMI rose strongly in February, suggesting improving confidence in both the manufacturing and non-manufacturing areas of the economy. Latest inflation data also suggests that inflationary pressures are more or less aligned with what economists are expecting (prices have been disinflationary). The Brazilian central bank has went ahead with one more 25 basis point rate cut to the benchmark Selic rate on 20 March 2018, announcing that the current easing cycle has ended. Despite the new stance adopted by policy-makers, we do not think that monetary policy will be tightened anytime soon, given disinflationary trends in the country. An accommodative stance is still expected to be maintained in order to stimulate the economy, supporting the outlook for growth moving forward.
At current levels, Brazil’s equity market trades at 12.8X and 11.3X 2018’s and 2019’s estimated earnings respectively, as compared to its fair PE ratio of 11.5X.
We maintain a 2.5 Stars “Neutral” rating for the Brazilian equity market.
Malaysia (+3.7% in 1Q 18 in MYR terms)
Malaysia’s equity market showed strong resilience with the FBMKLCI index posting positive returns over the first quarter of 2018 despite the return of sudden volatility amid uncertainties trade tensions between the US and her trading partners. The FBMKLCI index rose 3.7% in MYR terms over 1Q 18 to end the quarter as the runner up among the markets under our coverage. The continuing foreign inflows (reflecting the improving fundamentals of the local economy) and recovering corporate earnings was one of the main factors that lifted the local equity market over the last quarter.
Besides that, healthy earnings growth was also one of the drivers for the local equity market. As of 30 March 2018, the earnings estimates of Malaysian companies have been revised upwards slightly by 0.7% and 0.8% for 2018 and 2019 respectively over the quarter. The financials sector, which accounts for about 34% of the benchmark index, saw strong earnings upgrades of 2.6% over the quarter. Overall, we believe that the financials sector is likely to emerge as one of the top performing sectors this year as the robust economic environment is likely to further enhance the earnings of these players.
On the macroeconomic front, Malaysia's GDP grew at 5.9% year-on-year in the last quarter of 2017, outperforming the consensus estimate of 5.8% expansion. Although the overall economic activity moderated in 4Q 17 due to the high base effect, robust private consumption, which accelerated at the fastest rate over the past two years, remained as the main driver for the local economy. The better-than-expected 4Q 17 data also pushed Malaysia’s 2017 full-year growth to 5.9%, the highest in three years. Despite the unfavourable base effect, we believe that the local economic activity is likely to remain strong in 2018, with the country’s GDP expected to grow more than 5.0% this year.
Moving forward, we believe that consumer spending is likely to further improve due to the cut in personal income tax rates and the several measurements proposed by Prime Minister Najib Razak during the last budget presentation as these measures are likely to increase the average household disposable income. On top of that, government spending is likely to pick up prior to General Election 14, underpinned by recovering crude oil price which may subsequently lead to a higher revenue for Malaysian government.
As of 30th March 2018, the KLCI index was trading at estimated PE ratios of 16.6X and 15.3X for 2018 and 2019 respectively, which is slightly higher than our fair PE of 16.0X. We continue to have a positive view on the local equity market supported by strong fundamentals of the local economy. With the expectation of better corporate earnings and an improving economic backdrop, the local stock market is expected to deliver a rather reasonable return over an investment horizon of 3 years.
As such, we maintain the star ratings for Malaysia at 3.0 stars “Attractive”.
Russia (+2.9% in 1Q 18 in MYR terms)
Unlike many other equity markets worldwide in the first quarter of 2018, Russian equities held up generally better, registering a gain of 2.9% (8.2% in local currency terms) to make it to the top of the ladder. Buoyed by rising energy prices over the quarter, energy-related stocks such as Tatneft, Gazprom and Novatek were some of the top performers. Airliner Aeroflot, Yandex and the banks (Sberbank and VTB) were also some of the best performing stocks in 1Q 18. On the other hand, Mechel, United Co. Rusal, Rosseti and PhosAgro were some of the bottom performers.
Russian corporate earnings estimates on aggregate were revised upwards over the quarter, with 2018’s and 2019’s estimates upgraded 7.1% and 6.5% respectively (as of end-March 2018). On a sector basis, the energy sector contributed most to overall earnings upgrades, with companies such as Lukoil, Gazprom, Rosneft and Novatek all seeing their estimated EPS upgraded throughout the past three months. The financials sector, dominated by Sberbank and VTB Bank also saw earnings upgrades over the quarter. However, earnings revisions among the materials sector were more mixed, whereby certain iron and steel-related companies saw earnings downgrades and other commodity-related producers or dealers saw slight earnings revisions in 1Q 18.
In terms of economic data, industrial production data rose 1.5% year-on-year in February, down from a prior 2.9% year-on-year rise. While the latest data has come in below consensus estimates, the overall trend in industrial production is still healthy. The overall outlook for manufacturing remains supported as PMI readings remain firmly in expansionary territory (rebounded in March). Services has also held up well, indicating the robust momentum in the services portion of the Russian economy at this juncture. Domestic consumption also remains supported as real wages in Russia improve (rose 9.7% year-on-year in February) given improving economic conditions and the current disinflationary environment in the country. Official consumer confidence indicators have held up well in 2017, and the Levada sentiment indexes also indicate an uptrend year-to-date. The consensus expects Russia’s economy to grow by 1.9% in 2018, which we think is achievable barring any unforeseen adverse shocks in the global economy or a complete collapse in energy-related commodity prices.
At current levels, the Russian equity market trades at 6.3X and 6.2X 2018’s and 2019’s estimated earnings respectively, as compared to its fair PE ratio of 7.0X. We note that geopolitical tensions are still present, and remain a factor that could affect investment sentiment and asset prices.
We maintain a star rating of 3.5 Stars “Attractive” for the Russian equity market.
Europe (-7.2% in 1Q 18 in MYR terms)
European equities struggled in 1Q 18 alongside other equity markets as volatility returned with a vengeance mid-way into the quarter. The Stoxx 600 Index fell -7.2% over the past three months (-4.7% in EUR price terms), landing a place at the bottom of the performance table this time round. Sartorius, Elekta, Ocado Group and William Demant are some of the top performing stocks, while Air France, Deutsche Bank, Inmarsat and Hennes & Mauritz were found among the bottom performers.
Corporate earnings estimates for European corporations on aggregate were relatively unchanged over the quarter, with 2018’s and 2019’s estimates revised 0.05% and -0.2% respectively (as of 29 March 2018). On a sector basis, the basic resources sector saw the strongest earnings upgrade as a whole (+10.4%), while financial services as well as the oil and gas sector were the runner ups over the quarter. On the other hand, the healthcare and media-related industry saw aggregate earnings for 2018 being lowered over the quarter. Thus far, more earnings upgrades have been seen in the cyclical sectors in general as compared to what we have seen in the defensive sectors – a consistent development as recovery on the Euro-region is increasingly entrenched.
In terms of economic data, trends in the labour markets across Europe remain constructive, with continued job gains and unemployment generally improving (with the periphery seeing a faster rate of recovery than the core). Preliminary composite PMI numbers from core countries such as Germany and France for March came in below consensus expectations, but they remain firmly in expansionary territory. The situation is similar in Italy, but only February’s PMIs for Spain is above expectations, and all components suggest positive momentum for both the manufacturing and services segments in the Iberian economy. In Britain, PMI numbers have diverged from the overall improving trend on the continent since last year (they have been on a downtrend), but February’s numbers saw a rebound, led by services, and have come in above forecasts. A continued deceleration in leading indicators in the UK may start to show up in hard data, whereby capex and consumption on the British Isles may slow as Brexit uncertainties continue to linger.
Regarding political developments, markets are taking Brexit developments in their stride. Both the UK and the European Union (EU) have agreed on the length of the transition period. This period will last from the official day the UK leaves the EU (29 March 2019) to 31 December 2020, and the UK will be able to negotiate, sign and ratify its own trade deals during this period. As of this juncture, further discussions are ongoing for a host of other matters, and as such, the situation is dynamic.
At current levels, the European equity market trades at 14.3X and 13.2X 2018’s and 2019’s estimated earnings respectively, as compared to its fair PE ratio of 13.5X.
We maintain a 2.5 Stars “Neutral” rating for Europe, and advocate investors to remain an underweight exposure to European equities in their portfolios.
Indonesia (-8.2% in 1Q 18 in MYR terms)
Indonesian equities, represented by the JCI Index, fell -8.2% in MYR terms over 1Q 18 to end the first quarter of this year as one of the bottom three performing markets under our coverage. In local currency terms, the index was down -2.6%. The concerns over the escalating threat of a global trade war and massive fund outflows by foreign institutional investors had an adverse impact on the Indonesian financial markets.
Earnings forecasts for the JCI Index were revised upwards by 4.6% and 3.8% for 2018 and 2019 respectively as of 29 March 2018. Most of the upgrades are attributable to the Energy and Materials sector, where the former is expected to benefit from the lustrous mining industry along with the picking up commodities prices in 2018. Besides that, the new government regulation permitting Indonesian miners to increase its production capacity by 10% from its initial production capacity constitutes as a positive factor for the mining sector and an opportune backdrop for mining contractors. Meanwhile, the consumer sector (both discretionary and staples) have had their earnings estimates revised downwards by analysts over the quarter, as private consumption recovery on the domestic front remains modest.
Regarding economic data, we saw the Indonesian economic growth picked up to 5.2% year-on-year in 4Q 17 from 5.1% in 3Q 17, driven by higher domestic demand, in particular stronger investment. Private consumption growth also increased marginally, partly due to price inflation easing in the fourth quarter of 2017. On external front, both exports and imports moderated compared to the previous quarter but remained robust due to a sustained recovery in global trade and commodity prices. On the production side, growth in manufacturing accelerated, while construction and other services sectors saw the fastest growth rate, in line with the continued recovery in government spending.
Looking forward, we believe that Indonesia economic fundamentals should remain intact, supported by increasing infrastructure spending and investment, an anticipated pick-up in consumer spending as well as healthy corporate earnings. In terms of valuation, the Indonesian equity market now trades at estimated PE ratios of 15.7X and 14.2X for 2018 and 2019 respectively, as compared to its fair PE ratio of 16.0X. Given that Indonesia’s economic outlook continues to be favourable as the conducive external environment persists and domestic conditions become more positive,
a star rating of 3.0 Stars – “Attractive” remains warranted at this juncture.
India (-9.9% in 1Q 18 in MYR terms)
India has been the worst performing market during the quarter, recording a -9.9% loss (-3.2% in local currency terms). Although the market started the year on a euphoric note, it lost momentum since February and has now corrected.
In January, India’s benchmark index S&P BSE Sensex scaled new highs by crossing 36,000 for the first time. The decision of the government to reduce additional borrowing to INR 20,000 crore instead of INR 50,000 crore, along with positive macro-economic indicators like an increase in the Nikkei India Manufacturing PMI, IIP and the improvement in the quarterly numbers of India Inc, had all contributed to positive sentiments on the street. The market entered a volatile phase since the first week of February, after Arun Jaitley presented the Union Budget. While in an earlier budget, the Finance Minister had increased the holding period of debt funds for imposing capital gains tax, this time around he levied capital gains tax on equities, making one of Dalal Street’s worst fears a reality. The uncertainty on the fiscal deficit target was also a concern for the market participants. The detection of fraud to the tune of INR 11,300 crore at a Public Sector Bank (PSB) further dampened the sentiments of market participants. It led to fears about more improprieties being unearthed in the banking system, which is already weakened by rising Non Performing Assets (NPAs). The month of March did see this happen, with more frauds being detected at other PSBs, which continued to worry investors and affect investment sentiment. Global triggers added to the stress as the US government announced tariffs on imports of steel and aluminium, and the Federal Reserve went ahead to raise rates by another 25 bps, with hints of hiking rates further gradually. Finally, March ended with the concerns on widened fiscal deficit at 120% of the revised estimates during April to February, all of which has led the Indian market to enter a correction phase.
As of end-March 2018, Indian equities trade at 17.7X, 14.8X and 12.9X FY2018, FY2019 and FY2020’s estimated earnings, relative to its fair PE ratio of 18.0X.
We retain a star rating of 3.5 Stars – “Attractive” for the Indian equity market.
The Volatility Regime Is Starting To Normalise
We expect the volatility regime to normalise higher moving forward as central banks gradually scale back on accommodative monetary policy in order to reduce excess liquidity in the financial system. Before 2018, volatility levels have been suppressed and low, and investors should not have been surprised by a return of volatility.
Higher volatility could be expected not just in equity markets, but also in fixed income and currency markets, particularly if the pace of normalisation by various central banks are not simultaneous and differ in pace and duration. This implies that MYR hedges are still relevant for investors, particularly in regards to the fixed income portion of one’s portfolio. The hedge will help to mitigate adverse effects from currency fluctuations vis-à-vis the MYR when volatility picks up there.
Additionally, actively-managed strategies are increasingly vital to navigate this market regime moving forward. Flexible positioning can be adopted in fixed income markets to preserve capital or capture various sorts of opportunities as risk-free rates rise. For equity markets, an active strategy can underweight richly-valued segments and overweight neglected assets, which is a clear advantage over passive investing. Take heed!