1H 2011 got off to a good start for investors as most equity markets extended 2010’s spectacular year-end rally. However, the markets encountered severe turbulence as natural disasters afflicted Australia (floods and a hurricane) and Japan (earthquake and resulting tsunami). The Middle East and North Africa (MENA) region witnessed mass uprisings and the dethroning of several hardmen such as Hosni Mubarak while commodities suffered a flash crash, led by silver which fell 28.4% in a week in early May, following the raising of margins by the Chicago Mercantile Exchange.
In the emerging markets, many of the countries continued to be the economic engines of the world in spite of a generally poor showing by their local bourses. With many of the central banks of the said engines of economic growth tightening monetary policy by raising interest rates, hiking bank reserve requirement ratios, allowing their currency to appreciate against the developed nation's currencies (chiefly the USD and the EUR), it is clear that these central banks were remaining vigilant over inflationary threats which threatened the likes of Brazil, India, China and Korea. As a result, most of these emerging markets stock performances were hampered by the monetary tightening conditions amidst other factors such as risk aversion towards the end of the quarter.
Despite emerging markets leading global economic growth in 1H 2011, investors pulled money from the emerging markets. Financial firm EPFR recorded over USD 8.9 billion worth of outflows from emerging market funds (as of 22 June 2011). Among the emerging markets, the equity markets of Brazil and India were the worst performers with returns of -8.7% and -11.8% respectively (in SGD terms) on a year-to-date basis. Indonesia and Russia deviated significantly from this emerging market trend to post a first half return of 4.7% and 2.6% respectively (in SGD terms), with the latter suffering heavy losses of -9.1% in 2Q 2011, which wiped out a significant portion of its 12.9% gains it recorded in 1Q 2011(in SGD terms).
In the US, softening economic data began to worry investors over the strength of the recovery as the International Energy Agency sent a statement of intent to OPEC and speculators with its release of 60 million barrels of oil from its strategic reserve. Over the Atlantic basin in Europe, the world saw worries reignite over a potential sovereign debt default by Greece (which was feared would lead to the possibility of contagion to other peripheral nations), which was finally allayed in the last week of 1H 2011 as the government pushed through austerity measures and programs to ensure the receipt of the next tranche of funding by both the IMF and the EU.
The developed markets surprised investors with a relatively strong performance given the weakness in other markets. European markets posted gains of 2.8% on a year-to-date basis (in SGD terms), a return driven by currency gains. American equity markets did well with a performance of 5.0% in local currency terms but saw the USD depreciate against the SGD to result in a net 0.50% return in SGD terms. The US equity market was boosted by fresh equity fund inflows of USD 50.1 billion on a year-to-date basis (as of 22 June 2011). Japan, having endured a massive earthquake and destructive tsunami was the laggard of 1H 2011 amongst the developed nations for obvious reasons.
Let us take a closer look at the key factors that have provided the support or pressure that has led to the performances of these top three (Indonesia, Korea and Europe) and bottom two (Brazil and India) performing markets.
|Table 1: Market Performance (in SGD terms)
||S&P / ASX 200
||MSCI Asia Ex-Japan
||MSCI Emerging Markets
|Source: iFAST Compilations
Data as of End June 2011
Top performing markets
The sell-off by foreign funds in the beginning of this year had caused the Indonesian equity market to drop from the list of top performing markets in 1Q 2011. The JCI index underperformed most of the equity markets that we cover in 1Q 2011, returning a -0.67% (in local currency terms) or 0.14% (in SGD terms) for the first 3 months in 2011.
However, the outbreak of the political turmoil in Middle East, the Japanese earthquake as well as the ongoing sovereign debt issues in Europe have weakened investor’s confidence towards the developed markets. Foreign funds flowed back to the Indonesian equity market in 2Q 2011 on concerns that other countries which are more export-reliant were more susceptible to greater losses. This can be evidenced by the amount of foreign investments in the Jakarta Stock Exchange as of end March 2011, which was a net sell of USD 304.9 million as compared to a net buy of USD 2.17 billion for the quarter ending June 2011. The reversal in the outflows of foreign funds pushed the Indonesian equity market to gain 5.71% (quarter-on-quarter basis) in local currency terms in 2Q 2011, leading the JCI index to returns of 5.00% (in local currency terms) in 1H 2011.
The Bank Indonesia allowed the rupiah to appreciate as a means to curb inflationary pressures after inflation rates surged year-on-year to 7.02% in January 2011. Therefore, the strengthening of rupiah also helped the JCI index as it aided the subduing of inflation. In addition, the Indonesian government passed a new currency bill on 31 May 2011, which required the use of rupiah for general payments, settlements of liabilities involving money and other financial transactions conducted in Indonesia. This move can be seen as a step towards reducing the reliance on USD in the Indonesian economy, and it is expected to have a positive long-term impact on the rupiah.
Inflationary problems and foreign funds inflow (as the key driver of the equity market) remain the major concerns for the Indonesian equity market. At 15.1X and 12.7X for 2011 and 2012 estimated earnings respectively (as at 30 June 2011), the market is now trading at its fair PE of 15.0X. Hence, we believe that the equity market has priced in its earnings prospects for 2011. We maintain a 2.5 stars “Neutral” rating for the Indonesian equity market.
As represented by the KOSPI Index, the Korean equity market gained 3.2% (in SGD terms) in the first half of this year, sending the North Asian nation to second spot in our top performing markets list.
Despite the Middle East crisis and Japan’s earthquake, the fundamentals of the Korean economy remained strong. South Korea’s consumer confidence continued to rebound while retail sales have sustained a solid uptrend as household incomes have been rising, driven by increasing employment and higher wages. Exports remain robust as the country’s exporters are expanding their market shares in the international markets whilst their major rival Japanese firms' output has shrunk as a result of the blackouts and brownouts. In fact, Korean automakers have been the biggest beneficiaries of the Great East Japan Earthquake thus far.
We retain our positive stance on Korea's economic outlook. The Korean government expects that the export volume will continue to grow throughout the rest of the year and reach its target of over USD 1 trillion by the end of the year. The Organisation for Economic Cooperation and Development (OECD) has also raised its forecast for Korean 2011 economic growth to 4.6% in May 2011 compared with its previous forecast of 4.3%
On the other hand, the estimated PE for the market is at 10.5X and 9.3X for 2011 and 2012 (as at 30 June 2011) which is very attractive when compared against other countries as well as its historical mean. We continue to maintain a 4.5 star “Very Attractive” rating on the Korean equity market.
Despite the ongoing jitters on sovereign debt woes, European equities outperformed most others as they clinched the third spot among the markets we cover. The Stoxx 600 index gained 2.8% year-to-date (in SGD terms as of 30 June 2011). However, the positive return was attributed to the rising strength of the EUR as the index actually fell 0.3% year-to-date in local currency terms.
Greece stole the limelight once again when the country’s solvency was at doubt. With debt figures revised higher (Greece failed to cut overall debt as a proportion to country’s output to target defined by the rescue package’s covenant), Greece was running the risk of not receiving the upcoming tranche of promised funding that is required to avoid a default. With rising probability of potential default, a market sell-off was triggered in mid 2Q 2011. Since then, Greece has re-elected a new parliament and passed through further austerity measures, a pre-condition to receive the promised funding, alleviating some of the tension that has been plaguing investor sentiments. On top of that, a probable second rescue package is currently in the pipeline for discussion among the EU leaders to buy Greece more time to sort out their balance sheet.
While not a resolution, the interim solution saw the market rebounding sharply in the last week of June as investors start picking bargains from an oversold market. However, it is unlikely that we have seen the last of market weakness triggered by the European debt crisis. Since April last year, this is the third time the market has reacted to debt issues within Europe. We expect markets to remain volatile over the next couple of years, but are comforted at the low valuations European equities are priced at (9.8X and 9.0X based on estimated 2011 and 2012 earnings respectively). We believe that a lot of the negativity is already priced into the market and European equities offers investors attractive opportunities with low valuations as a downside buffer.
Bottom performing markets
The Brazilian equity market, represented by the Bovespa index fell -7.5% in SGD terms (-9.0% in local currency terms) in 2Q 2011 on a quarter-on-quarter basis. On a year-to-date basis, the index has fallen by -8.7% in SGD terms (-9.9% in local currency terms), firmly cementing its position in the bottom performers in the markets under our coverage. This negative performance makes it the second worst performing equity market under our coverage in SGD terms on both a quarter-on-quarter and a year-to-date basis.
Latin America's largest economy has seen its stock market suffer on the back of a series of rate hikes in the government's attempt to prevent inflation from running amok. Inflation in Brazil last measured a 6.55% year-on-year growth rate in May 2011, above the government's target of 4.5% (plus/minus 2%). In response to inflation's threat, the government has hiked interest rates 4 times, or, by 1.5% since the start of the year, raising the Selic benchmark interest rate to 12.25% as of end June 2011. With inflation being driven by Demand-Pull factors such as strong domestic consumption (spurred by low unemployment and rising real wages), it remains to be seen if the government can curb amongst other things, consumer credit which has grown by 7.89% this year thus far, and cool its over-heating economy.
With 59% of the Bovespa index comprising of companies related to the energy, industrial and material sectors, the index has suffered as the prices of most commodities fell in Q2 2011. Despite inflationary fears and correcting commodity prices, corporate earnings growth estimates continue to be healthy with estimated 2011 and 2012 earnings growth of 17.0% and 14.9%. The Bovespa trades at PE ratios of 10.2X and 8.9X (as of 30 June 2011) for 2011 and 2012 respectively, representing a discount of 22.6% from our fair value estimate of 11.5X earnings based on 2012’s estimated earnings levels. We continue to maintain a 3.5 star “Attractive” rating on the Brazilian equity market as we believe the nation's inflationary worries are close to peaking.
The Indian equity market performance in 1H 2011 was negative at -11.8% in SGD terms. This poor performance has seen the market take the last spot amongst the markets under our coverage. The deep negative performance is primarily on account of macroeconomic factors such as rising inflation and it's after effects. The Indian economy is one of the fastest growing economies in the world and was one of the earliest to recover from the effects of the global financial crisis. The sustained high level of economic activity has increased fuel consumption (both diesel and coal) and had already led to higher price increases. Further fuelling higher domestic energy prices were the rising costs of higher global crude oil and coal prices, which only served to exacerbate the inflationary pressures and add salt to injury.
The Reserve Bank is at its wits end to tackle the menace of inflation. India is one of the few countries which began a monetary tightening policy in early 2010 to control inflation and after 10 rate hikes since 2010, inflation, which initially showed signs of moderation, has now reversed its direction and is on an upward march. Presumably with more interest rate hikes on its way, the RBI has targeted to bring inflation down from its current level of 9.1% (as measured by the Wholesale Price index in May 2011) to reach 6% by March 2012. The earlier rate hikes have started showing their negative impact on economic growth. It is expected that economic growth for 2011-12 would be lower in comparison to the economic growth of 2010-11 due to the growth dampening effects of the rate hikes. Even on the Foreign Institutional Investor (FII) front, it has been a silent first half of the year. The FIIs have invested USD 494 million in 1H 2011 (as at 29 June 2011), in comparison to an investment amount of USD 6.7 billion in 1H 2010. The muted inflows are widely interpreted to be another reason for the poor performance of the Indian equity market as traditionally; higher inflows from FIIs have led to better performance from the Indian equity market.
The Indian equity market is currently valued at a PE of 16.01x and 13.59x for 2011-12 and 2012-13 (as at 30 June 2011) and investors can consider entering into the Indian equity market with a long term perspective.
In 1H 2011, our 2011 picks for favourite regional market (global emerging markets) and favourite single country (Taiwan) have yet to shine due to bouts of risk aversion resulting in the developed markets stealing the limelight.
As we move ahead into 2H 2011, the late charge by markets in the final week of 1H 2011 is hopefully a realisation by investors that the recent global sell-off was overdone as there were no new legitimate concerns. We retain our conviction in favouring equities over bonds and believe that there is still room for strong equity market performance ahead with earnings growth and valuations remaining strong and undemanding in several countries. We remain confident in our favourite regional market and single country picks, as well as our key investment themes for 2011, which we believe will drive equity markets higher.