Singapore market still deemed healthy

Published May 14, 2011


Show me the money

Singapore market still deemed healthy

It seems that high profit margins do not translate into high PE ratios

By TEH HOOI LING

SENIOR CORRESPONDENT

CO-FOUNDER and chief investment strategist of Grantham Mayo Van Otterloo, Jeremy Grantham, was in Singapore last week for the 30th anniversary conference of the Government of Singapore Investment Corporation.

MR GRANTHAM

'It's administered profit margin, administered by the Fed's deliberate behaviour, particularly pushing up financial profits' on the PE ratio relative to profit

I had the opportunity to have a chat with him after the conference. During our chat, Mr Grantham said the S&P 500 is worth only about 925 points. It's now about 1,350. 'It could go to 1,500. In fact, I thought it probably would by Oct 1,' he said. 'But too many things have gone wrong in Libya, in Japan and so on, plus the end of QE2 (the Federal Reserve's bond buying programme). Everything's going wrong. So I thought better throw in the towel and be a little more conservative.'

Then I asked, but in terms of price-earnings (PE) ratio, we have not gone beyond the normal historical range, right?

He asked: 'So PE is price times what? You can't take a spike in profit margin and look at the PE without taking into account that that's a spike, a peak. Because profit margins are more mean reverting, they have a stronger tendency to go back to normal than PEs do.

'So what you have to say is, fair price is a normal PE of normal profit margin. And today's market, there's more damage from profit margin going back than the risk from PE. So you have a moderately higher than it should be PE, and a much higher profit margin. Both of them working in the same direction means a badly overpriced stock market,' he said.

'You could have had a higher PE on lower profit margin and it would actually be cheaper. And that's the way to do it. That is truly the way to do it.

'People who talk about PE without normalising profit should be taken out and shot. They are just trouble makers. Profit margin now, relative to history, is very high. Think how strange that is in America,' he said.

'There is a lot of unemployment, and there is a lot of spare capacity. And yet you have pretty much peak profit margin. What's that? Tell you what it is? It's administered profit margin, administered by the Fed's deliberate behaviour, particularly pushing up financial profits, and the Treasury and the stimulus programme. All working to inflate profit margin on a temporary basis.'

So can we see this in the charts if we plot S&P 500's profit margins versus PE, and the subsequent performance of the index?

Well yes. From the S&P 500 charts, you can see that profit margins in 1999 at 15.6 per cent was at its highest point in the last 13 years. PE, at 30 times, was at its peak too. That, as it turned out, was one of the biggest stock market bubbles in recent memory.

In late 2001 and early 2002, profit margins sank to just under 9 per cent. PE at that time was relatively high, at 25-26 times. In the following 12 months or so, as the margins recovered, the PE got compressed. The margins recovered even further, and the market ran away after that.

That is until 2007, when again margins were peakish, having risen to above 14 per cent. PE at that time was moderate, at 16-17 times. This was soon followed by the global financial crisis.

Profit margins hit a low again at just over 8 per cent in September 2009. Since then, the S&P 500 has gained 29 per cent.

Today, the net profit margin for S&P is about 13 per cent - rather near the peak. PE, however, is not exorbitant, at about 15 times.

Return on equity and return on assets, which are also mean reverting, are at 24 per cent and 8.7 per cent respectively. That's again near the peak of 27 per cent and 10 per cent in the last 13 years. But to be fair, the market's profit margins and return on equity and assets are just slightly above the median of the last 13 years.

Only in price-to-book (PTB) is the S&P 500 now slightly below its 13 year median of 2.8 times. It is now trading at 2.3 times book. So on the whole, I think we are still not in an excessively overvalued territory.

The tendency of the market to value stocks higher when companies are enjoying fat profit margins is also observed in the Singapore market.

I averaged out the profit margins of the three banks here over the years, and plotted that against their average PE, and their stocks prices. The chart shows high stock prices coincided with periods of high margins.

The average net profit margin has risen from 35.5 per cent from 2009 to 37.4 per cent in 2010. But it's still some way to the peak of 49.9 per cent registered in 2006. For all the measures - from profit margin to ROE and ROA to PTB and also PE - our banks are now in the median of their various ranges in the last decade.

How about industrial and commercial companies? For this, I averaged out the numbers of City Development, Fraser & Neave, Jardine Cycle & Carriage, Jardine Matheson, Keppel Corp, Neptune Orient Lines, Singapore Airlines, SembCorp Marine and Singapore Press Holdings.

For this group of companies, there appeared to be a counter-cyclical pricing. When the profit margins are high, the PEs are low, and vice versa. Currently, net profit margins for this group at 15 per cent is near the peak. PE, however, averaged 12 times. That's below the median.

Meanwhile, ROE and PTB are already at peak levels. But as mentioned, the market is not valuing them at peak pricing.

So all in all, the Singapore market appears to be still relatively healthy.

The writer is a CFA charterholder

Published May 14, 2011


Is Asia in an euphoric phase?

At the IMAS conference, Julius Baer's CIO presented a markedly bearish view of markets, with some private banks agreeing so too. By Genevieve Cua

ASIAN and global markets are currently in an 'euphoric' phase of 'over-trading' which suggests that investors who buy into markets now may well rue their decision over the next few months.

MARKETS OUTLOOK

Stock indexes of Asian markets at the HKSE on March 11. Other evidence of euphoria include real estate prices in Asia and record issuance of equity and bonds

V Anantha-Nageswaran, chief investment officer of Bank Julius Baer & Co, presented a markedly bearish view of markets to an audience of fund managers earlier this week. He was a panellist at the Investment Management Association of Singapore's annual conference on Thursday.

His views appear to be echoed to some extent by some private banks. Citi Private Bank, for instance, has issued a report that risk aversion in Asia is likely to stay pronounced in the summer months. Clariden Leu's chief investment officer Sandeep Malhotra, is advising clients to stay cautious.

But Russell, in its first survey of 40 Asian fund managers at end-March, found them 'overwhelmingly bullish' on the prospects for Asian equities, despite inflation risks and stronger local currencies.

In his talk, Dr Van set the premise that the issues that have been central to the 2008 crisis - the mispricing of risk and capital - continue unabated and will cause markets to come undone. 'Structural issues are dominant; valuation considerations are given the go-by; real interest rates are negative; and we see a mispricing of risk. (The world) continues to stick to a hydrocarbon model (of energy generation), so inflation and currency debasement are two inevitable consequences.

'No wonder gold is at US$1500 (per ounce), and will continue to rise as long as central bankers talk inflation but do not walk the talk with interest rate rises.' Gold traded yesterday at US$1508.

Dr Van argues that based on inflation-adjusted price earnings multiples, the current PE of the S&P 500 is just below the 1929-1930 and 1999-2000 peaks. Based on the Kindleberger/Minsky cycle of financial markets (refer to graphic) - which posits seven stages - Asian markets are currently in the fourth or euphoric phase. This is likely to be followed by insider profit taking, panic and revulsion, he says. 'Hopefully that sets the stage for a real and more enduring bull market.'

Other evidence of euphoria include real estate prices in Asia and record issuance of equity and bonds.

On the sidelines of the conference, he said: 'We're telling people to buy commodities . . . As for other risk assets, it's very difficult to find value. If you are wading into risky assets, you're buying close to the peak of the cycle. To be honest, there isn't much value in most parts of world. It's a delusion to believe there is value in Asia.'

Clariden's Mr Malhotra notes in a letter that equity performance in the first four months has been 'remarkable', as both S&P and DAX were up 8 per cent in local currency terms. This is equivalent to 24 per cent on an annualised basis. ' . . . the fact is that risks for 2012 have gone up and the probability of tail risk events occurring in 2011 continues to rise.' Oil prices and inflation are high on his risk list.

He tells clients to 'diversify, protect against inflation and focus on absolute return'.

Clients, he says, can choose to continue to ride the wave of liquidity in the hope that the risks will resolve themselves. 'Or, one can recognise the risks as emanating from unresolved fundamental issues and invest to generate an absolute positive return, especially after having already reaped solid gains in markets in the last two years.

'We have chosen the latter path since the beginning of 2011 - in order to preserve capital, protect against inflation and rising rates, and generate returns by taking a lower amount of overall risk, even if it entails giving up some upside.'

John Woods, chief investment strategist (Asia Pacific) of Citi Private Bank, expects equity markets to struggle in the coming months. Asia, he wrote in a May report, will not be able to escape the fallout from problems elsewhere. These include slower growth in the US; Eurozone issues; and even Asian seasonal return patterns.

On the latter point, historical patterns suggest that the bulk of the year's returns are generated between November and April. Investing in the MSCI Asia ex Japan in November-April results in an average gain of 9.4 per cent, with positive results likely 71 per cent of the time. Investing between May and October results in average gains of just 1.5 per cent, with positive returns 57 per cent of the time.

'Obviously every year is different, has its own characteristics and anything can happen. But investment cycles - for whatever reason - can also contain useful information which investors ignore at their own risk. In our case, it adds another layer of reasons to maintain our risk-averse bias.'

Meanwhile, a survey of fund managers by Russell at end-March - amid rising oil prices, Mid-East turmoil and Japan's disasters - found a growth bias among 40 fund managers. Managers were most bullish on China, followed by Korea. Inflation topped the list of risks.

On valuations, 43 per cent felt that Asian markets were fairly valued, with 30 per cent saying that they were undervalued. 'This perspective is shared by Russell, as we generally view the equity market valuation as neutral for Asia ex Japan. We also agree that equity markets have upside, but we're wary of some of the more bullish forecasts,' said Sarah Lien, Russell Investments senior research analyst. Future market corrections were seen as buying opportunities.

Albert Lam, IPP Financial Advisers investment director, believes that there is still room for markets to run, based on the firm's models which show that based on a number of metrics such as PE and price to book multiples, Asian markets range between attractive and reasonable. He expects emerging markets and Asia to underperform developed markets such as the US, however.

'This is not the time to be cautious. There is still a lot of money to be made. Rates will continue to be low for some time. Even if rates rise, they are normalising, and that is a good word.'
gen@sph.com.sg

The Strategy Going Forward

I've seen many types of people in an organisation. Some people talk non stop. Some people keep very quiet, crack a few jokes occasionally. Some people just work and work without expressing themselves. Some people are very argumentative, totally uncooperative.

I've also learned to let go. To give people room to grow, allowance to make their mistakes, to find their own way. Sometimes, I'll nag very often in order to achieve an objective. From now on, I'll be more measured, more thoughtful, more observant of people's agenda. I will emphathise more, because by understanding their points of view, I'm able to make different decisions to achieve the same outcome.

I can be a bully and threaten. I can be a nice person and counsel. I can be patient and listen. I know the first option is not possible all the time because I have to win hearts and minds. But I must also be careful not to appear weak and floundering. I must be firm, fair, and driven, yet be patient and understanding.

I guess it takes a Superman to achieve somethings sometimes. But if I don't try, I'll never know, will I?