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STAR RATINGS REVIEW & UPDATE FOR END 1ST QUARTER 2012 April 17, 2012
Following strong market performance in 1Q 12, we have adjusted ratings on several markets to take into account the normalisation of return expectations
Author : iFAST Research Team


STAR RATINGS REVIEW & UPDATE FOR END 1ST QUARTER 2012

Star Ratings Methodology

At the end of each quarter, we review our calls on the various regional and single-country equity markets under our coverage to assess each market’s attractiveness as an investment proposition both on a standalone basis, as well as with respect to other markets. In our quarterly star rating exercise, we look at key valuation metrics like PE and PB ratios, expected earnings growth, as well as excess earnings yield to determine how attractive a particular market is. In addition, we consider the economic outlook utilising both consensus forecasts, as well as our own assessment of longer-term economic prospects. Our methodology not only incorporates both top-down and bottom-up forecasts, but also includes qualitative adjustments where necessary to achieve reasonable estimates of target upside for each market under our coverage over a 3-year horizon.

Changes to Star ratings

The strong performance of equity markets in 2012 has been a welcome breath of fresh air for investors, following a rather disappointing 2011. Global equities posted a healthy 8.1% return for the quarter, while Asian and Emerging Market equities fared better, delivering returns of 10.7% and 10.6% respectively. Emerging market performance was led by Russia and Brazil, which delivered returns of 15.8% and 13.5% for the quarter. Within Asia, Thailand, Singapore and Taiwan equities were some of the better-performing markets (up 16.9%, 14% and 13.1% respectively), while Indonesian and Malaysian equities were laggards, but still managed returns of 3.8% and 3.9% respectively. Japanese equities rose a hefty 20.4% (in yen terms) in the quarter, but the weakening of the Japanese yen cut returns in SGD terms to 8.7%.

[Otherwise stated, all returns in SGD terms, as of 28 March 2012]

Europe
Concerns over a potential financial crisis in the Eurozone have ebbed substantially, especially after the successful negotiation for a restructuring of privately-held Greek debt which saw bond holders undertake losses in the region of about 70%. While the restructuring was ultimately considered a “credit event” which triggered credit default swaps on Greek bonds, investors appreciated the orderly nature of the restructuring; a “disorderly” default would have placed the financial system under significant strain. The ECB has also played a crucial role in maintaining financial market stability, lending European financial institutions approximately 1 trillion euros for up to 3 years via its Long Term Refinancing Operation (LTRO) programme to soothe financial sector refinancing concerns.

US
While economic data out of Europe is consistent with recessionary conditions, the US economy has been gaining strength, with the job market seeing healthy growth. Private sector nonfarm payrolls have risen for two consecutive years (since March 2010), offsetting weakness in public sector hiring; this has resulted in over 3 million jobs being created in the current economic recovery. Even as home prices still languish at low levels, the housing market finally appears to be turning the corner, with improving homebuilder sentiment, falling inventory levels, rising housing starts, and multiyear-high affordability all set to fuel a recovery in the sector. Consumer spending remains on track for modest growth, but rising gasoline prices remain a key threat at this juncture. 

Asia
Supply-chain disruptions were a major theme in 2011, as key markets like Japan and Thailand were impacted by natural disasters. The effects manifested in the form of weakened exports, which weighed on growth of several export-oriented Asian economies in 2H 11. Alongside the domestic natural and nuclear disasters, the strength of the yen hurt Japanese exporters, resulting in deep losses for major Japanese companies like Sony and Panasonic. The yen has weakened significantly in 1Q 12, improving the profit outlook for Japanese companies, while exports in other Asian countries have begun to recover, an indication that trade disruptions have begun to normalise.
China’s focus on sustainable growth has led to a lowering of the country’s official long-term growth target from 8% to 7.5%; while the announcement has hurt investor confidence, we think that the move is a form of “low-balling” by the government, as historically, China’s GDP growth rate has exceeded its official target over the past 10 years. From our perspective, the lowering of the growth target also makes sense as progress towards boosting domestic consumption is a long-term process which will require pro-consumption policies to be implemented – these are likely to detract from growth as imports rise. In our opinion, the move towards improving the sustainability of growth in China should be viewed positively, and we do not view the latest development as detrimental to the China market’s long-term prospects.   

Emerging Markets

Higher oil prices have seen Russian equities outperform in 1Q 12, as the Russian market (about 55% of the RTSI$ index is in the energy sector) is often perceived as a key beneficiary of higher energy prices. The Brazilian equity market has also posted a substantial rebound, following a series of larger-than-expected rate cuts by the Copom, which highlights the central bank’s intention to keep monetary policy accommodative in support of economic growth. Even as industrial production in Brazil remains lacklustre, consumer spending has been healthy, evidenced by strong retail sales figures. Alongside the trend in healthy consumer spending, credit growth has also been on a tear, with outstanding private sector loans having risen more than 6-fold over the past 8 years.

Lowering ratings for several markets following strong performance

Since we made a host of changes to our star ratings at the end of August 2011, several equity markets have delivered substantial double-digit returns, sufficient to warrant changes to our star ratings at the end of 1Q 12.
We have long held a favourable view on the Technology sector, having upgraded the market to 4.5 stars “very attractive” in late August 2011 on the back of a positive growth outlook and attractive valuations. Since then, the sector has delivered a hefty 23.7% return (as of 26 March 2012), and while valuations remain modest due to high sustained earnings growth for the sector, we have adjusted down our rating on Technology stocks to 4.0 stars, which still represents our positive view on the sector. Brazilian and US equities have also posted healthy gains since our last upgrade in August 2011 (Brazil from 3.5 stars to 4.5 stars, and US from 3.5 stars to 4.0 stars). Since then, the benchmark Bovespa index has delivered a 21.6% return, while the benchmark S&P 500 index has gained 17.1% (as of 26 March 2012). On the back of lowered return expectations for both markets, we have adjusted down our rating on Brazil equities to 4.0 stars, and our rating on US equities to 3.5 stars.
Growth forecasts for Singapore earnings remain muted in 2012 as a series of transitory issues (low domestic interest rates, delayed real estate development profit recognition and high oil prices) weigh on various sectors, and while earnings are expected to post stronger growth in 2013 and 2014, lower forecasted earnings has brought down our projected returns for Singapore equities, warranting a lowering of our rating on the Singapore market to 4.0 stars, still representing a “very attractive” rating. Indian equities have delivered a strong performance in 2012, gaining 12.2% year-to-date as of 28 March. While valuations remain at a hefty discount to the historical average, projected returns for Indian equities are not as strong as before, and we have adjusted down our rating on Indian equities to 3.5 stars “attractive”.
Our latest series of downgrades represents a normalisation of return expectations for several markets under our coverage, rather than a change in our positive outlook on equity markets.

 

Table 1: Star Ratings as of end March 2012

Markets

Star Ratings

Our 3 year view

Emerging Markets

5

Very Attractive

Asia ex-Japan

5

Very Attractive

Europe

3

Attractive

US

3.5 (Downgraded)

Attractive

Japan

3

Attractive

Technology

4.0 (Downgraded)

Very Attractive

Single-Country Markets

Star Ratings

Our 3 year view

China

5

Very Attractive

Hong Kong

5

Very Attractive

South Korea

5

Very Attractive

Taiwan

5

Very Attractive

Russia

4

Very Attractive

Singapore

4.0 (Downgraded)

Very Attractive

Australia

4

Very Attractive

Brazil

4.0 (Downgraded)

Very Attractive

India

3.5 (Downgraded)

Attractive

Thailand

3

Attractive

Malaysia

3

Attractive

Indonesia

2.5

Neutral

Source: iFAST Compilations
Data as of end March 2012

India (3.5 stars – attractive)

Why we like it

1. Valuations are still attractive

  • The estimated P/E for SENSEX as on March 27,2012 stands at 15.85X for fiscal 2012   (Ending March 2012) and 12.80X for fiscal 2013 (Ending March 2013).This is lower than the long-term average P/E of about 17X

2. Inflation has softened to below 7%

  • India’s headline inflation has softened to below 7% (a targeted level by Reserve Bank of India (RBI) at financial year end (March 2012)) and has remained at this level for the last two months. The cooling in inflation will provide room for the RBI to embark on more accommodative monetary policy.

  • The central bank of India has already cut Cash Reserve Ratio (CRR) twice since January 2012. Although the CRR cut was largely for improving liquidity, it also shows probable early signs of further accommodative monetary policy and we expect a rate cut in the next financial year which will help revive corporate expansions plans.

3. India is a domestically-driven economy

  • Given its lowered dependence on exports, a potential slowdown in the global economy will have a lesser impact on the Indian economy

Why we don’t like it

1. High crude oil prices

  • The crude oil prices have risen significantly over the last 2 – 3 months. Crude oil constitutes major part of India’s import bill and the rise in crude prices will worsen the fight against inflation. This will also have negative impact on already high current account deficit and fiscal deficit. 

2. Persistent high interest rate environment has slowed private investment

  • The persistent high interest rate for more than 2 years has severely affected capital expenditure plans for companies in India. If monetary policy does not start to turn benign soon, then it could hurt corporate investment plans which have already slowed

3. High fiscal and current account deficit

  • India is already suffering from high fiscal deficit and a slowdown in the economy will probably widen the fiscal deficit owing to decline in tax collection.

  • Indian government has missed its fiscal deficit target by 1.3% (projected was 4.6% whereas the actual fiscal deficit is 5.9%) for financial year 2012 and the target level for financial year 2013 is 5.1%; if this is not met, it will hamper investor confidence.

4. Inaction of the political system

  • The present government does not have a full majority in the upper houses which is affecting the action plan of the ruling government.


iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.


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