Right time to buy equities

WILL the year of the Ox be better for financial markets?

Typically, the Ox signifies prosperity achieved through fortitude and hard work.

The Ox is unswervingly patient, tireless and capable of enduring hardship without complaint. So, it is less surprising when JP Morgan chief Asian and Emerging Markets Equity Strategist Adrian Mowat says that the Ox holds better prospects than the Rat.

So strong is his conviction, that at about this time next year, he says investors will be having a banquet because equity markets have improved, and investors are feeling better about life.

“2008 was a horrible year for investors. The D word was not decoupling, it was deleveraging,” says Mowat.

Hence, just when everyone is giving up on fundamental analysis, Mowat says, it’s time to pay even closer attention.

Now, he says, is the best time to look at equity markets, as confidence is low and economic data have yet to show an improvement.

“You want to own equity. Come Chinese New Year onwards, you need to be having the right stocks. You need to start looking at stocks with resilient earnings. When the turn comes, the dispersion is going to be very high. Get out there and do the analysis,” urges Mowat.

He says Asia is right smack in a situation where there is a crisis happening in the West, hence asset prices in Asia are suffering.

“Investors can now buy stocks with good earnings stream at heavily discounted prices because of the crisis in the West. This crisis only makes the Asian economy stronger. Emerging markets will outperform other markets,” he says.

On a valuation basis, stocks are now cheaper than they were during the Asian financial crisis and the tech boom bust.

When the recovery sets underway, price earnings (PE) of stocks will trade above their discount levels.

“We’re potentially going to be seeing large dispersion of returns. This is going to be good for equities,” he says.

Mowat says investors are seeing the worst down leg this quarter.

The first quarter of 2009 won’t be as bad as this quarter.

He sees the recovery happening below potential growth rates because the US will be in the process of rebuilding its balance sheet.

“Yes, we’ll still be seeing bankruptcy and defaults, but these are lagging indicators and have already been priced in.

“What we’ll be seeing is a stabilisation of policy in the US. Incoming US president, Barack Obama has been quick to announce the people for his administration.

“This gives the market some comfort, and also helps confidence,” he says.

Mowat says it won’t be a surprise if technology stocks make a comeback.

As expectations in the sector have been so beaten down, it takes only a small change in demand to see a big difference.

“Technology stocks in emerging markets will return, and it won’t need to wait for demand from the US and Europe to return,” he says.

He advises investors to stay underweight on the cyclical and material stocks as in current times, one needs to invest in resilient companies.

“Companies that say, yes we are affected and we’re modifying our plans to cope with the challenging environment – buy these companies.

“Companies that say, no we’re not affected – sell these companies, as they have no sense of realism!” says Mowat.

Recovery soon ...

Emerging markets may be seeing a powerful V shape recovery in the making. Boosting this recovery is an environment of lower interest rates and fiscal stimulus policy.

He says the world is cyclical, and 2008 is what he calls the big ugly experiment.

In the US and the developed economies, consumption was holding up pretty well until the recent quarter.

Initially, US exports were holding up due to the growth in emerging markets up until the final quarter where demand and growth dropped.

He says the economy was losing momentum because of the measures taken to counter inflation.

“The derating happened because of a monetary derating policy, and we subsequently saw declining industrial production. Companies needed to get rid of their inventory. How do you do that? You stop production,” says Mowat.

The problem was made worse with the credit crunch unfolding. It was harder for companies to get letters of credit and working capital to finance their operations.

He says what investors are seeing so far is government policies responding to the market turmoil, and these include aggressive monetary policy and fiscal stimulus such as tax cuts.

When it comes to some of the measures taken, Mowat cautions to be careful of new infrastructure projects that are only just beginning.

“If these projects were only just implemented, it’s not going to make a difference until 2010. So unless they have already started, the people aren’t going to feel anything.

“If governments announce an infrastructure project, be critical. Make sure it can make a difference.

“Tax cuts are more important because it puts more money in people’s pockets,” he says.

An important indicator he notes is that in the last few months, investors have been in a situation where equities were dropping as economic data were worsening.

The cycle has now changed where capital markets are improving even as economic data had yet to improve. Inflation is also no longer an issue.

“We are now seeing a V shape recession. Things are beginning to improve. We’ve seen the worst selling in October. I think its time to position oneself in the market,” says Mowat.

“Don’t be surprised if markets are 50% higher in 2009 as we see a gradual normalisation of risk appetite. I don’t believe in paradigm shifts. I believe in long and short term cycles.”

Mowat, who tracks China closely, says that the biggest risk is if China fails to respond to its four trillion yuan stimulus package. However, he believes, the Chinese economy will respond.

Countries in financial surplus, he says, will clearly have a funding advantage as it means they have not over borrowed or over consumed.

With emphasis on that, Mowat favours China, Singapore, Taiwan, Thailand and the Philippines. On the other hand, countries in a savings deficit namely India, South Korea, Russia and Indonesia, he says, may see a “very uncomfortable credit cycle.”

“For emerging markets that have relied too much on commodities, you’re going to be seeing growth that was initially supernormal to almost non-existent.

“I worry about material and energy stocks. These are stocks from the last bull market and a lot of people still own them,” says Mowat.

Malaysia good but unlikely to lead

Malaysia will unlikely be the leader in this recovery. China will lead the story as it makes up some 30% of emerging market’s GDP.

In Malaysia, Mowat sees an acceleration in loan growth, aided by lower interest rates.

He says Malaysia is in a good position, as it has a meaningful surplus, and also the flexibility to adjust its monetary policy.

“It’s a story of pent-up demand, and the fiscal benefits that are coming through.

“Consumers now have more money to spend because of the lower petrol prices. Confidence is returning and the political risk aversion has also reduced,” says Mowat.

He says the stock market is typically 3 months ahead of the economy.

At end 2007, equity markets were falling when data were still strong.

“Right now, equity markets are climbing while data are still weak. So maybe the recovery is already happening.

“In Malaysia, I feel that the political risk is already priced in, hence the market may even surprise (to the upside),” Mowat says.

He is neutral on Malaysia. This is because when the recovery takes place, funds normally head first to the big liquid markets.

“Malaysia also has the issue of uncertain politics. For some of the commodity companies, you may see a very dramatic contraction in profits,” says Mowat.

“As countries move to a zero interest rate policy, what we’re seeing is a situation of the wheels spinning, but no traction because the appetite for risk is zero.”

“As risk appetite increases, we’re going to start seeing the ringgit appreciate. We’re now seeing a low point in currencies but by mid-2009, I see an improvement,” he says.

Mowat says redemptions are not leading indicators of an economy.

Nonetheless, with the amount of outflows Malaysia has seen, it’s equal to the 2006 and 2007 outflows combined.

So in essence, Malaysia is back to 2005 levels.