As we move into the fourth quarter and the year's end, we take a closer look at some of the top performing equity markets in 3Q 17 (Brazil, Russia, China) as well as the laggards (India, Taiwan, Indonesia) to understand some of the drivers of performance and provide our outlook for each market.
[All returns in SGD terms as of 30 September 2017 unless otherwise stated]
Brazil (+21.6% in 3Q 17, +18.6% Year-To-Date in SGD terms)
Brazilian equities, as represented by the Bovespa Index, rose 21.6% in SGD terms over 3Q 17 to end the quarter as the top performing market of markets under our coverage. On the 20 September 2017, the Bovespa index had reached an all-time high of 76004.15 points, helped by its rally since the 21 June 2017. During this period, the increase in the share prices of companies in the index was relatively broad-based, with 56 out of 59 companies seeing an increase in share prices. Companies in the consumer discretionary and materials sectors saw the largest increase in share prices over the quarter.
A significant driver of the surge in Brazilian equities in aggregate over the quarter was the slew of political events which occurred, as well as the Brazilian government's announcement of the privatisation of state-owned electric utilities giant Electrobras as well as 57 other state-owned companies. Investor sentiment in the overall market was boosted by a perceived reduction in political risk facing current president Michel Temer, which raised hopes that he would likely remain in office till the end of his term in December 2018 and would thus better be able to follow through with his planned reforms and privatisations.
A look into the earnings estimates of Brazilian corporations revealed a -3.9%, -3.2% and -2.8% downward revision in the 2017, 2018 and 2019 estimated earnings of Brazilian companies respectively in 3Q 17 despite the index's rally over the same period. The latest trend in earnings estimates signal that the rally in Brazilian equities over the quarter may not have been fundamentally driven. Nonetheless, while earnings estimates have been revised downwards, the estimated earnings growth of Brazilian companies in 2017, 2018 and 2019 continue to come in at double-digit levels of 30.7%, 11.6% and 20.7% respectively as it remains widely expected for the Brazilian economy to emerge from its recession.
Economic releases over the quarter continued to suggest improving economic conditions. Brazil's high unemployment rate had continuously dipped over the quarter while consumer price inflation had extended its downward trend, boding well for consumption appetites ahead. Services PMIs, while still slightly below the 50 neutral reading, had ticked upwards. Meanwhile, manufacturing PMIs have trended at or above the 50 neutral reading, thus showing some signs of expansion. In 2Q 2017, Brazil's GDP, which grew 0.3% year-on-year, had exited contractionary territory.
As of 30 September 2017, the PE ratios based on the estimated earnings of Brazilian corporations in 2017, 2018 and 2019 stood at 14.3X, 12.8X and 10.6X respectively, compared to their fair PE ratio of 11.5X. While we retain Brazil's star rating at 3.5 Stars "Attractive", we are keeping an eye on overall valuations which are currently trading at a significant premium.
Russia (+11.9% in 3Q 17, -7.5% Year-To-Date in SGD terms)
Through the course of 3Q 17, Russian equities, as represented by the RTSI$ Index, rose 11.9% in SGD terms. Similar to Brazilian equities, Russian equities have rebounded from their weaker performance in 2Q 17 to end-3Q 17 as one of the top performing markets. Share price gains over the quarter were led by companies in the materials sector amid the uptrend in the prices of commodities in aggregate. The heavy weight energy sector, as a whole, also saw decent share price gains as oil prices rose by 12.2% over the quarter to USD 51.67 per barrel, supporting investor sentiment in the quarter. Apart from supported oil demand, the quarter had also been met with favourable supply-side events such as news of the fall in OPEC oil output for the first time in 5 months in August, recent hurricanes which disrupted US crude production, as well as Turkey's threat to cut oil flows from Iraq in late September.
A look into the earnings estimates of Russian corporations revealed the earnings estimates to have remained relatively flat over the quarter despite the notable rise in the valuations of Russian corporations. As of 30 September 2017, the earnings estimates of Russian companies have been revised upwards slightly by 0.2% for 2017 and revised downwards by -1.1% and -2.6% for 2018 and 2019 respectively. Sectors saw mixed earnings revisions over the quarter. Companies which saw some of the greatest earnings upgrades over the quarter include the Credit Bank of Moscow PJSC (financials sector), TMK PJSC (energy sector) as well as ROSSETI PJSC (utilities sector); while companies which saw some of the greatest earnings downgrades were Surgutneftegas OJSC (energy sector), PhosAgro PJSC (materials sector), and Sistema PJSC FC (telecommunication services sector).
Economic releases over the quarter pointed towards continued recovery in the Russian economy. Dipping unemployment rate and consumer price inflation bode well for domestic consumption over the coming quarters and industrial production had expanded for the sixth consecutive month in August. While manufacturing and services PMI readings have moderated from their highs in the beginning of the year, they have consistently remained above the 50.0 neutral reading since mid-2016, reflecting relatively resilient expansion in both sectors. The central bank had cut rates by -50 basis points to 8.50% in September and had signalled that a further rate cut is possible over the coming two quarters, and this should continue to provide support to the economy in the near term.
As of 30 September 2017, the PE ratios based on the estimated earnings of Russian corporations in 2017, 2018 and 2019 stood at 7.2X, 6.5X and 6.1X respectively, compared to their fair PE ratio of 7.0X, representing a premium based on 2017's estimated PE ratio. In August, we downgraded our star rating for the Russian equity market by 0.5 stars to 3.5 Stars "Attractive". We believe the said rating continues to be warranted at this juncture.
China (+9.2% in 3Q 17, +19.4% Year-To-Date in SGD terms)
As of 29 September 2017, the HSML 100 Index, a benchmark index for the Chinese offshore equity market, rose 28.3% year-to-date in local currency terms, with 1H 17 and 3Q 17 returns coming in at 15.7% and 10.9% respectively.
The HSML 100 index has had a great run this quarter, with the index rally primarily contributed by property, banking and insurance stocks. The top five contributors of the index's increase are Tencent Holdings, Industrial & Commercial Bank of China, China Evergrande Group, Ping An Insurance Group and China Construction Bank, who together represent 48.3% of the index growth.
There are a few key points investors need to understand so as to comprehend the recent stock rally. In the property sector, although the earnings estimates are looking optimistic, they reflect mostly historic sales back in 2015 and 2016 where the monetary environment remains accommodative. Contract sales seem strong in first half of the year, but a number of property developers reported a sharp deceleration in contract sales' year-on-year growth since June. With real estates' financing activities facing tightening, contract sales figures may encounter challenges in the remaining of the year. Investors are advised to stay cautious regarding the sector.
Amongst Banks, investors are delighted to see the four major banks all report a reduction in their non-performing loans (NPL) ratio, echoing the central government's focus on de-risking the banking sector. As the banks' PB ratios have been suppressed to below 1.0X thanks to concern regarding their NPLs, improvement in their NPL ratios have helped to push valuations higher. We believe the improvement in NPL ratios may persist as the government continues to emphasise the importance of "stability", and this can likely further push the valuations of banking stocks up. We recommend investors who want to benefit from valuation restoration to focus on major banks that are less affected by the interbank deposits' regulation.
With the Index now trading at 12.3X trailing PE and 10.1X estimated 12 month forward PE, the market is no longer as cheap as it was in 2016 and early 2017. The market may still grow with earnings upgrade or further capital inflow from China, but the risk of correction is growing if economic or earnings data disappoint. We remain positive on this market given its sizeable potential upside, but have already written down our degree of optimism on a relative basis to other markets. The star rating for the market is 4.5 Stars "Very Attractive".
India (-1.4% in 3Q 17, +14.6% Year-To-Date in SGD terms)
In the second quarter of FY18, the Sensex Index declined -1.4% in SGD terms, underperforming several Asian peers such as the Straits Times Index and Hang Seng Index. While the Sensex Index had seen good gains in the month of July, its performance in August and September had been comparatively poorer.
In the month of July, the S&P BSE Sensex and Nifty 50 indices, registered a return of 5.15% and 5.84% respectively. The positive sentiments were on account of the successful implementation of the GST, good monsoons, better than expected corporate earnings and the continuing upbeat domestic inflows into the market. The market participants were also expecting a rate cut in the Third Bi-Monthly Monetary policy review that was held in August on the back of inflation falling below the RBI target of 4%. In the Third Monetary Policy Statement, 2017-18, the Monetary Policy Committee (MPC) cut the policy rate by -25 basis points in line with market expectations continuing to maintain a neutral stance on monetary policy.
In August, however, the Indian market lost steam and entered negative territory with Sensex Index returning -2.41%. SEBI's decision to ban trading in shell companies also impacted the markets. The boardroom battle in India's major IT company, Infosys and weak macro-economic indicators such as inflation and GDP were not taken positively by the markets. On the global front, tensions between the US and North Korea continued to keep the market on tenterhooks. The market also remained volatile during the quarter due to escalating border tensions between India and China, the two major Asian economies. On the 27 September 2017, the market was impacted by the Indian army surgical strike on terrorist locations around the Indo-Myanmar border which led to sharp corrections in the indices. The slow pace of economic recovery and global concerns have led to FII outflows from Indian equity markets during the second quarter of FY18.
As the economy adapts to the new tax system and recovers from the impact of demonetization, the pace of economic growth is expected to recover in the coming quarters. The 1Q FY18 GDP came in at 5.7% which was the lowest in 3 years and has been declining for one year now due to decline in manufacturing, muted private sector investments and sluggish credit growth in the economy. The manufacturing PMI in the month of July dropped to 8.5 year low 47.9 but recovered to expansionary level of 51.2 in the month of August as manufacturers expressed clarity about the new tax regime. Industrial production had indicated a recovery by expanding to 1.2% in July from the contractionary level of -0.1% in June. CPI rose from the historic low of 1.46% in June to 2.36% in July and 3.36% in the month of August driven higher by rising food inflation. The RBI is not expected to reduce the policy rates during the upcoming monetary policy meeting in October and a change in stance to 'accommodative' from 'neutral' also seems unlikely in the near future given the upside risks to inflation. India's current account deficit expanded to 2.4% of the GDP in 1Q FY18, rising sharply from 0.1% of the GDP in 1Q FY17. The rise in current account deficit has been primarily due to the greater increase in merchandise imports relative to exports.
The Sensex index trades at PE ratios of 20.1X, 16.1X and 14.4X for the years 2017, 2018 and 2019 respectively as of end-September 2017 compared to its fair PE ratio of 18.0X. At this juncture, we believe a star rating of 3.5 Stars "Attractive" continues to be warranted for the market.
Taiwan (-1.5% in 3Q 17, +12.2% Year-To-Date in SGD terms)
As of end-September 2017, the TWSE index, which represents the Taiwan equity market, rose 12.2% year-to-date in local currency terms, with 1H and 3Q returns being 12.3% and -0.1% respectively.
Weak performance in the quarter can be mostly explained by weak iPhone 8 sales, which caused Apple suppliers' stock price to plummet in late September. The iPhone 8's sales are expected to be low in face of iPhone X's release which carries a OLED display and edgeless design. Recent selling activities are deemed to be an over-reaction and correction shall be on its way when market once again refocuses on iPhone X's outlook.
Regarding macro data movement, we see exports still growing at a decent pace with double-digit year-on-year growth from June to August. Manufacturing PMIs have remained at high levels, with a stronger increase in output and new orders for the factories in August. The economic environment therefore remains supportive for the equity market.
At this juncture, we believe the share prices of most Apple's suppliers and the share prices of some of the semiconductor players have already factored in the strong demand for iPhone X. Their valuations are not trading at attractive levels but room for short term speculation still exists if iPhone X's demand fulfil or even beat market's expectation. The Taiwan Stock Exchange Weighted Index (TWSE Index) is now trading at 14.0X estimated 12-month forward PE ratio, slightly higher than the average adjusted positive PE ratio of 13.8X based on a 10 year horizon. The market remains less attractive compared to Korean equities, which have also benefited from the strong iPhone and semiconductor cycle. Nonetheless, the market possesses reasonable expected earnings growth of 16.0%, 7.0% and 7.9% for the years 2017, 2018 and 2019 respectively, as of end-September 2017. As mentioned above, we believe the market still provides some speculative upside, subject to the sales figures of iPhone X. The star rating for Taiwan is currently 4.0 Stars "Very Attractive".
Indonesia (-2.3% in 3Q 17, +5.0% Year-To-Date in SGD terms)
Indonesian equities, as represented JCI Index, gave off some of its year-to-date gains and posted a -2.2% loss over 3Q 17. The lacklustre performance can be attributed to weaker-than-expected earnings results for Indonesian companies against a backdrop of modest economic recovery in 1H 17.
On the economic front, Indonesia's GDP growth was 5.01% year-on-year in 2Q 17 but fell short of consensus estimates. In expenditure terms, government expenditure had picked up favourably amid the disbursement of government budget on infrastructure projects and various rural development plans, which compensated a tepid recovery in private consumption. Meanwhile, exports continued to contribute positively to growth on the back of a global economic recovery. Looking into sectors, we saw higher growth contribution coming from the Mining, Construction and Financial sectors; while the Agriculture and Fishery sectors slowed down.
JCI Index's earnings estimates for 2017 and 2018 were revised upwards by 0.7% and revised downwards by -0.1% respectively over the quarter. Most of the upgrades are attributable to the Industrials and Real Estate sectors, where the latter is expected to benefit from the on-going urbanisation plans and infrastructure spending from the government. Industrial and Energy sectors were among other sectors that have witnessed upgrade in their earnings estimates. On the other hand, consumer-related sectors have had their earnings estimates revised downwards by analysts over the quarter, as private consumption recovery on the domestic front remains soft and gradual.
Over the course of 3Q 17, Bank Indonesia had surprised the market twice by slashing its benchmark reverse repo rates consecutively in its August and September monetary policy meetings. The main objective of the rate cut was to induce economic growth, as growth figures have trended sideways over the recent quarters. The central bank also hopes that a lower interest rate environment will give a boost to lending and investment activities moving forward. While we do not rule out the possibilities of further rate cuts, we think it is unlikely for the central bank to cut its policy rate again in the near term, as further rate cuts may worsen the volatility of the Rupiah.
In the coming months, we expect private consumption to resume its gradual pace of recovery. Continued disbursement of government funding for infrastructure development, together with the recent rate cuts may potentially give a leg-up to Indonesia's economic growth. As of 28 September 2017, the JCI Index is trading at estimated PE ratios of 17.3X and 15.3X for 2017 and 2018 respectively, sitting at a slight premium compared to its fair PE ratio of 16.0X. As the macroeconomic picture and growth story remains intact, we maintain the star rating for Indonesia at 3.0 Stars "Attractive".
Still Overweight Equities Vis-à-Vis Fixed Income
Equity market valuations have risen year-to-date, with emerging and Asian markets generally outperforming the developed markets. Corporate earnings revisions have also been strong (to the upside) across Asia ex Japan, and as such, we maintain our positive view on the Asian space. Relative to fixed income, equity markets are still more attractive, given the tighter spread levels seen across the global fixed income markets and the lower level of yields available as compared to levels seen in the first half of 2016. We continue to remain defensive in positioning in the fixed income market, while maintaining our slight overweight in the global equities at this juncture.