World equity market: Do not worry – it is climbing the wall

FBM KLCI: 1,785.88    (2014 Year-end Target: 1,900 points)

The world is transitioning to a more normal monetary as well as macro environment.The US Fed is slowly taking away  the  QE3  liquidity  punchbowl  with  the  pace  of  monetary  normalization  “tied  to  what  happens  in  the economy”.  While  the  recovery  in  advanced  economies  has  thus  far  been  rather  measured,  nonetheless  it  is  also uneven  at  times  hence  the  transition  process  will  not  likely  be  smooth  and  predictable.  This  uncertainty  may contribute to intermittent heightened volatility in the world’s risk asset prices.

In  our  Strategy  note  dated  28  June  2013  (para  4&5), we  alluded  to  the  following  outcomes  in  light  of  the normalizing monetary and macro environment:
There  are  instances,  principally  during  a  period  when  the  real  economy  is  gaining  on  its  recovery traction, wherewith the trend in equity prices might turn out to be flat and even scaling up against the backdrop  of  rising  interest  rates  or  of  the  perception  thereof.  This  is  due  to  positive  numerator  effect with  regard  to  corporate  earnings.  In  technical  parlance,  this  situation  could  be  dubbed  as  the  market “climbing the wall of worry”. [emphasis added]

Therefore,  the  QE3  taper  may  have  brought  heightened  liquidity  risk  premium  to  the  broad  equity valuations. Nonetheless, despite the higher cost of capital denominator, expected rising income stream as a result of brighter economic conditions may, all in all, be positive to equity secular pricing dynamics. [emphasis added]

Scaling up the “wall of worry”. Accordingly, major equity markets particularly in the US and Euro region scaled up the “wall of worry” with gusto as evident by spate of new all-time (US indices) and multi-year (Euro indices) highs in  the  final  quarter  of  last  year.  Locally,  the  FBM  KLCI  too  recorded  numerous  new  all-time  highs  in  the  closing quarter of 2013.

In the same Strategy note (para 6), we also suggested that:
Furthermore,  during  period  when  the  market  is  climbing  the  proverbial  “wall  of  worry”,  volatility generally rises due to the flare up in tug-of-war between the so-called optimists and pessimists elements in the market. [emphasis added]

Market  ripe  for  meaningful  correction  after  a  hearty  run. Thus  after  a  gravity-defying  performance  in  the  last quarter,  the  US  (and  European)  stocks  which  were  overwhelmed  by  the  optimists  are  now  ripe  for  a  meaningful correction. An exit trigger was provided by a limited contagion from some emerging economies (particularly those suffering  from  the  twin  deficits  and,  in  some  cases,  coupled  with  domestic  socio-political  uncertainty)  which  are battling with currency depreciation due to heightened pace of liquidity withdrawals of late. Also, the recent below consensus US ISM-Manufacturing number provided the pessimists another exit opportunity that resulted in the Dow Jones  Industrial  Average  (DJIA)  shedding  more  than  300  points  in  a  single  day  on  3  February  2014.  In  unison,  the local benchmark dropped as well.

FBM KLCI is expected to  remain on its secular upward trajectory. While the heightened volatility latterly could be  unnerving,  let  us  be  reminded  that  the  normalizing  monetary  and  macro  environment  may,  “all  in  all,  be positive to equity secular pricing dynamics.” Thus despite the recent volatility, we reiterate our view that the FBM KLCI  is  expected  to  remain  on  its  secular  upward  trajectory  at  least  until  end  of  the  year,  supported  by expectations  of  (i) gentler  yet  still  robust  domestic  growth  momentum,  and  (ii) brightening  external  economic
conditions.  Additionally,  we  do  not  expect  the  recent  capital  flight  from  countries  suffering  the  twin  deficits  and domestic  uncertainty  would  become  out  of  control  that  it  may  result  in  a  full-blown  contagion  to  other  emerging market currencies.

 

 

FBM  KLCI  entry  point  target  at  1,750-1,700  points  range. While  remain  positive  on  the  secular  trajectory  of FBM KLCI, we however do not think the recent correction has played itself out just as yet. Hence, on the downside, we reiterate our view of the local benchmark support levels at between 1,750-1,700 points range.

 

…with market upside capped by liquidity, earnings, monetary and valuation factors. Although we do not expect the  market  to  enter  into  a  bear  territory  this  year,  nor  do  we  expect  the  FBM  KLCI  to  repeat  its  rather  stellar performance  last  year.  In  our  opinion,  the  following  factors  may  put  a  cap  to  the  prevailing  above-mean  market valuation going forward: (i)the incessant albeit generally measured withdrawal of foreign liquidity (pursuant to the commencement of QE3 taper) to continue on in the months to come,  (ii)comparatively muted FBM KLCI expected earnings  growth  of  circa  10%  in  2014,  (iii) market  expectation  of  a  hike  in  the  OPR,  and  (iv) Malaysia’s  relatively weak albeit improving current account situation.

Reaffirm our FBM  KLCI 2014 year-end target of 1,900 points. We  reaffirm our FBM KLCI  baseline 2014 year-end target of 1,900 points, with the upper and lower bounds at 1,980 points and 1,840 points respectively.

 

by MIDF