Time to Load Up on Commodities, Don't Count the Stock Market Out, There's Value Yet

Inflation has hit the Euro Zone. Its core inflation hit 2.4% last month and the ECB has announced they are going to hike rate. The only big western nation that hasn't hiked rate is the US. But it will happen sooner than expected. Japan's earthquake and Tsunami will cause the country to turn to refined oil products and thermal coal to run its generators. Oil products, and crude oil will rise. Food prices will rise higher because Japan's food supply is contaminated. The rebuilding of north Eastern Japan will cause copper, iron ore prices to sky rocket. There is no hiding place.

The world must wean itself from fossil fuels if it wants economic growth without the crippling effects of inflation. There are no viable alternatives except nuclear option but the world is now thinking twice after Fukushima. How? We are packed in a corner with no way out. Either we face the deadly effects of global warming or live with the threat of nuclear fallout. We are on a brink of a great human disaster that can wipe out millions of people in this decade. I shudder... I pray this can be avoided. My passport is ready and my family and I will run first.

Published March 19, 2011


Don't count the stock market out, there's value yet

There are blue chips with expected dividend yield of over 6%; that beats keeping money in the bank

By TEH HOOI LING

SENIOR CORRESPONDENT

WE ARE in very uncertain times now and the catalogue of issues is endless: the seemingly intractable sovereign debt problems and persistent high unemployment in the developed world; the financial aftermath of the devastation in Japan following the earthquake last week; rising food and commodities prices which are exacting a big toll on the lowest strata of the economy; widening income disparity, the gradual shift of economic centre of gravity from the West to the East; rapid urbanisation of hundreds of millions of people; climate change; the fast depletion of resources from this earth. The list goes on.

No one can tell for sure how things will pan out. There could be a lot of unknown unknowns just lurking around the corner. History may not provide much of a reference if we are moving into totally uncharted waters. Still, we shouldn't be paralysed into inaction just because there are many uncertainties out there. For one thing, inaction which involves the clinging on to dear cash may turn out to be a losing proposition given that the worth of cash gets eroded by inflation over time.

Yes, what has happened in the past may be totally irrelevant going forward. But there will always be certain things that continue to make sense. For example, if a company is able to create value and make profit, and there is a chance to participate in its business at a reasonably low cost, a rational person would and should consider doing it.

The next question then is, what is a reasonably low cost? For me, it would be one that would give me a significantly higher return than other available alternatives at the moment.

The price would also have to be low enough to give me some assurance that it does not have much room to go down further, and cause permanent loss to my capital. In this respect, history, for better or worse, provides us with some benchmarks to look at. Robert Shiller, professor of economics at Yale University, popularised a market valuation metric where the current market price is measured against the average earnings per share (EPS) of the last 10 years. This will even out the cyclicality of earnings.

Today, the ERP is at 7% - a reasonably good level from which the market had chalked up decent gains, going by the past. We were at similar levels back in July 2009, February 2008, December 2005 and January 2003.

I tested that out on the Straits Times Index, the one calculated by Datastream, which goes way back to 1973. In Chart 1, you can see that from 1983 till now, the STI trades between 10 times and about 35 times of its average past 10 years' EPS. We are now at 17.7 times earnings, or about one standard deviation below the average multiple that the index traded at in the past 40 years or so. Hence, at current levels, stocks can't be said to be expensive, but neither are they a screaming buy. We are now at levels last seen in mid-2003, early 1999, late 1997, and early 1991.

How about the equity risk premium (ERP)? This is a measure of the expected return of an equity investor over and above the risk free rate. I use the earnings yield (the inverse of price-earnings ratio) minus the one-year interbank rate as a proxy for ERP. The higher the ERP, the higher the supposed return for holding equities.

In Chart 2, you can see that the ERP shot through the roof - it went as high as 19 per cent - in March 2009, just before the capitulation of the market following the global financial crisis. That's the highest the measure has been in its 24-year history, and that also proved to be one of the biggest buying opportunities of all time.

Today, the ERP is at 7 per cent. Again, that's a reasonably good level from which the market had tended to chalk up decent gains, going by patterns in the past. We were at similar levels back in July 2009, February 2008, December 2005 and January 2003.

And finally, the dividend yields of a number of Singapore stocks are still expected to be juicy based on analysts' expectations. I downloaded the data from Bloomberg and categorised the stocks based on their market capitalisations.

Among big cap bluechip stocks, we can find more than 10 which are expected to deliver more than 6 per cent in dividend yield. That beats keeping money in the bank, and it outpaced the expected inflation rate for this year as well. Among the stocks are StarHub, Mapletree Logistics and Ascott Residence. There are also many smaller companies which are paying much more generous dividends. The caveat is of course the sustainability of their payouts.

Finally, just a reminder that the list we provided is based on the screening from Bloomberg. Investors are advised to do their own analysis on the individual companies before deciding to pick up any of the stocks.

The writer is a CFA charterholder

Buy Japan: Shifting Fund Flows Are LIke a Balancing Act

The Japanese stock market fell by 20% in the last 2 weeks. I went in to buy several ETF CFDs, the Schroder Japan Equity Fund and call options. Now I am up by 8%. I put in about SGD 20k, but because I leverage 5x, my exposure is around SGD100k. The rebound has already rewarded me with 8k, with an ROE of 40% in 3 days. Very good reward.The Japanese disaster was truly a heartache for all of us. My prayers are with them and I will contribute 10% of my returns to a charity of my choice, perhaps connected to helping the Japanese.

I don't think the bull cycle is over. I always thought this was a mid cycle correction and the disaster in Japan and the unrest in the Middle East triggered the sell down.

MONEY MATTERS


Shifting fund flows are like a balancing act

Flows from emerging to developed markets present good opportunity for long-term investors

By HAREN SHAH

THE tide of fund flows into the emerging markets is receding. The reverse is happening to the benefit of developed markets, which have experienced strong growth in recent months. But does this reversal of fortunes signal a long-term trend, an uncanny aberration or a necessary market correction?

We believe the recent fund flows out of the EMs and into the DMs are more a balancing act rather than a structural shift away from EMs. Inflationary pressures, rising interest rates and political uncertainties in the EM underpin the flowback.

For investors with a medium to long-term view, the flowback may represent good buying opportunities in select equity markets such as Hong Kong, South Korea and Taiwan in Asia. Brazil and Russia, too, particularly for commodity plays.

Fund flows

It was just last year that emerging market (EM) governments were lamenting the prospect of large fund flows into their economies and how these would distort their economies and affect their financial markets. It is only the first quarter of 2011, and how it all has changed. Rather than receiving inflows, EMs have experienced outflows, and most of the funds are reverting to developed markets (DM) like Japan, the US and parts of Europe.

This begs the question, is this the start of a new trend or is this just a normal adjustment to the vagaries of fund flows looking for value and safety?

In the last couple of years, EMs have been attracting inflows mainly due to the more robust growth prospects of these economies relative to DMs. The financial crisis further exaggerated the flows as interest rates remained low and investment prospects were not as attractive in the developed world.

Between 2008 and 2010, EMs saw significant inflows to the tune of US$130 billion while DMs saw outflows of US$350 billion. Moreover, with QE2 announced by the US Federal Reserve late last year, the expectation was that these funds would continue to flow into EMs as their growth prospects remained stronger, interest rates were heading higher and currencies were appreciating.

Inflationary pressures

A primary cause of the reversal in fund flows has been concerns about the build-up of inflationary pressures in the emerging economies. Many of them, especially in Asia and Latin America, have seen inflation surge due to strong growth and high commodity prices, especially food and energy.

This has resulted in interest rate hikes and property curbs to rein in these sharp price appreciations. Recent political tensions and events in Northern Africa and the Middle East have also not helped as risk aversion has further fuelled outflows from EMs. The risk premium on EM assets has risen as investors are concerned that the political problems could spread and affect growth prospects and ultimately corporate earnings. Oil price spikes and food inflation remain key concerns as these could lead to more unrest in EM countries.

EM equity markets attractive

EM equity markets have underperformed DM equity markets by about 10 per cent in this recent move over the past few months. Considering that EMs underperformed DMs by more than 31 per cent in their last period of underperformance in 2008, this raises the question of whether we could see such a magnitude of divergence this time around.

We suspect not, as the underlying fundamentals are currently much better. It should be noted that previous big pullbacks in EM equities occurred when global growth expectations were falling.

On the contrary, we are currently seeing global growth expectations being revised upward on the back of improving prospects in the US, Japan and core European countries.

Also, EM stocks are showing sharp improvements in earnings. So, from a valuations and 2011-12 earnings perspective, the recent underperformance and pullback in EM equities has increased their overall attractiveness.

Tighter monetary policies in Asia

Looking at Asia, the main concerns for investors have been inflation and the prospect of tighter monetary policies. So far, we have seen policy tightening across most Asian countries as governments try to cool price pressures. The fear here is that policymakers will misstep and cause growth to slow dramatically, thereby affecting corporate earnings.

This is of most concern in the region's two largest economies, China and India. Inflation in China, especially property prices, has resulted in the implementation of three policy rate hikes and significant banking reserve tightening measures. With signs that overall inflation is on an uptrend, the government appears very worried about social unrest.

Similarly, with inflation close to 10 per cent in India, there have been six policy rate hikes, with potentially more on the way. Such moves have made global investors nervous and prompted them to reverse their investment flows out of EM economies back to DM economies, where growth prospects and earnings outlooks are beginning to brighten. Nonetheless, we believe this is merely a short-term shift and that Asian stocks are likely to rerate once some of the uncertainties subside.

Against this backdrop, we believe the recent fund flow movements out of EMs and into DMs represent more of a rotation rather than a structural shift away from EMs. Macro concerns stemming from inflation, rising interest rates and political uncertainties will continue to resonate in EM economies.

But for investors who are taking a medium to longer-term view, this pullback may represent good buying opportunities in select markets such as Hong Kong, South Korea and Taiwan in Asia, while Brazil and Russia look like good prospects for the commodity play.

The writer is senior investment strategist, wealth management, Citi Asia Pacific

Disclaimer: Opinions expressed herein should be regarded solely as general market commentary, and may change without prior notice. Past performance is no guarantee of future results.