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Posted: 01 Jul 2011 07:01 PM PDT

IT'S one thing to worry about all the noise over the economic developments that envelop global markets and quite another to predict how investors will react to them. But there is one overriding common theme caution.

There are many reasons for such apprehension. The year started with the Arab revolution, which led to the political upheaval in many countries in the Middle East and North Africa. Then there were the earthquake and tsunami in Japan that wreaked havoc on the northeastern coast of the country and had repercussions elsewhere given the deep linkages Japanese industries have in the global supply chain.

If they were not enough to ignite worry among investors, the ongoing debt problems in Europe seems to be frothing over as Greece was on the verge of a massive default that would have caused a severe contagion in lenders from Germany and France, two of the EU's largest economies.

In addition, the economic malaise in US persists. At best, the economic indicators are still patchy to suggest that the United States has truly broken away from the gravity of its financial crisis. To infuse more momentum into the US economy, given fears of deflation, the US Federal Reserve embarked on a second round of printing money, called Quantitative Easing 2 (QE2) to the tune of US$600bil. While the move has injected money into the system and helped lift Wall Street, it really has done little for Main Street.

As a consequence of liquidity and growth rates rebounding in emerging markets, commodity prices have surged, lifting inflation and causing another headache for central bankers, governments and consumers world over given the rising cost of living.

The pain is not spread out evenly across all markets.

The FTSE Bursa Malaysia KLCI this week hit a new record high at 1,582.94 on Friday, the third consecutive day it breach record levels. Maybe it reflected the relief over the austerity measures in Greece's bailout plan which were passed amidst tough internal resistance. This lends credence to the long-held belief that when things get tough globally, foreign investors began to appreciate Malaysia's defensive qualities.

With the close of the first half of 2011, pundits are now poring over how the markets will fare in the second half. Given the volatility of markets and the unpredictability of ensuing events, most of them are likely to adopt cautious projections.

Global Fund Manager Survey

One guide to what people who manage money are thinking about is the Bank of America Merrill Lynch fund manager global survey. The latest published survey, which was conducted from June 3-9 on 282 people who managed US$828bil of assets under management, is pointing to money managers favouring less risk.

The survey's risk and liquidity indicator fell to 38, which is below the long-run average of 40 for the first time in nine months.

"The indicator had been relatively resilient so far despite growth concerns," says the report.

"Equities and commodities weights have been cut with gains for cash and bonds with most of the asset classes very close to their long-run averages."

The survey discovered that growth and profit expectations stabilised after recent sharp falls as inflation expectations fell dramatically in June from a couple of months ago.

The fund managers felt the global macroeconomic backdrop was not weak enough to warrant more stimulus as three quarters of its panellists thought a recession was unlikely and only 13% expect a new round of QE in the second half.

Despite concerns permeating investment decisions, emerging markets remain the favoured destination among those surveyed.

Although the numbers have slipped from May where 29% of fund managers polled were overweight on emerging markets, the survey revealed that 23% were positive of the prospects of emerging markets in June.

"The cut in emerging market positions comes amid a broad-based rotation towards defensive assets: Global equity allocations are reduced and the average cash level has risen from 3.9% to 4.2%," says the report.

Investors were favouring markets with domestic demand drivers and as global economic growth is forecast to drop a tad, investors trimmed their positions in cyclical stocks.

Among the most favoured emerging markets are Russia, Indonesia and China.

One painful finding of the survey is this among the emerging markets, Malaysia was the least favoured. But not all equity research houses may concur with that. Goldman Sachs, for one, has an overweight call on Malaysia and given the relative size of the Malaysian market, a handful of such calls would be enough to provide an oomph.

Defying that painful notion further is the fact that Bursa Malaysia hit an all-time high this week. Furthermore, the trading patterns in April and May show that foreign institutional investors were net buyers of Malaysian equities, quite the reverse from their net selling position earlier in February and March. As for domestic institutional investors, the trend was the opposite they were net sellers in April and May but net buyers over the previous two months.

Trading value which stood at RM52bil in January this year is trending downwards towards May which was the lowest for the year at RM31.2bil. Trading volume has also been falling on a monthly basis since January from 39.5 billion units to 18.4 billion units in May.

Largely, local retailers were net sellers for most of the year, only buying more shares than they sold in February.

Crystal ball gazing

What's next for Bursa Malaysia? Given that the exchange is at record levels, pessimism and optimism seem to be locked in a tug-of-war.

MIDF Amanah Investment Bank Bhd senior vice-president and head of research Zulkifli Hamzah says the first half performance was surprisingly resilient which largely bucked the regional trend.

"On closer observation, we would attribute the resilience of the market to foreign buying," he tells StarBizWeek.

"Foreign investors were net buyers on Bursa Malaysia in 10 of the 13 weeks between March 21 and June 19. We will not be surprised if foreign shareholding on Bursa Malaysia is higher than 22% now, as an estimated RM4.6bil of foreign money had been ploughed into local equity during that period."

Zulkifli opines that the foreign money flowing into Malaysia involves genuine portfolio funds instead of speculative money seeking quick returns.

"The upgrade of Malaysia's country status from Emerging to Advanced Emerging market by FTSE effective June partly explain the inflow of foreign money, but more importantly, we believe Malaysia is back on the radar screen of many global funds. This augurs well for the market in the second half," he says.

TA Securities head of research Kaladher Govindan says many of the worries investors had in the first half appear to be winding down and sentiment wise, the second half should be better.

He feels the concerted effort by the EU to tackle the debt crisis in Europe and Japan picking itself out of a recession should help improve market sentiment and anticipates the second half of the year to be a recovery period after a long consolidation period.

"Slower than expected growth in the United States and lingering sovereign debt issues in the US and Europe respectively are expected to drive back funds flow into emerging markets, which will benefit FBM KLCI," he says.

Zulkifli is maintaining his year end FBM KLCI target of 1,650 points but expects more volatility in the second half.

"The second half is generally wrought with downside surprises, and is also associated with major market corrections. We do not expect the perception to be any different this year," he says.

Earnings season will be the focus in August and he feels the numbers for the second quarter is expected to remain bad for airlines, shipping, resource-based industries such as gloves, steel and semiconductor.

"If there are any silver linings at all, we expect Malaysia and other resource-rich countries in this region such as Indonesia and Thailand to benefit from the switch out of China and the Asian tigers," he says.

"China is engineering a slowdown at a scale not seen by an economic super-power. The statutory reserve ratio for its banks is now at a disconcerting 21.5%. More banks will feel the squeeze."

Citigroup in its note on Malaysia says the upcoming earnings season in August will likely not excite the market.

"The conclusion of the latest results season confirms our view that overall business sentiment appears to have turned cautious as inflationary threat looms with economic activities on low gear," it says.

Citigroup feels inflation pressure for food and building materials, together with monetary tightening and higher inflation expectations from the electricity price hike could be negative in disposable income and business profitability. It is positive on chemical and consumer stocks and recommends investors take defensive positions in utilities and gaming.

Sectors to watch out for going forward are the oil and gas, plantation and banking, which recorded higher year-on-year earnings growth during the recent quarterly reporting season.

"We expect their positive earnings momentum to continue into the second half of this year," he says.

His choice of oil and gas stocks is due to higher oil prices which will not only benefit oil majors but also fabricators as well as support service providers as it encourages further upstream and downstream activities.

"Despite the recent sell down, we expect CPO price to remain firm as the global demand for vegetable oils is rather inelastic," he says.

He thinks earnings growth for banks will be underpinned by healthy loan growth, enhanced fee-based income, lesser provision with improved asset qualities and the rising overnight policy rate (OPR) which cushioned the pressure on margin.

Apart from these sectors, Kaladher is also overweight on construction.

"Players in the domestic-oriented sectors will do well on the back a stronger ringgit and weaker dollar," he says.

Inflationary environment bodes well for property sector as well as investors switch from holding cash to real estates."

Exporters that rely heavily on dollar based sales like those in the electrical and electronics segment will be hit and Kaladher says it will be a double whammy for manufacturers, for instance glove producers, who do not have a natural hedge due to high local cost content.

Economic Transformation Programme

Analysts have said the economy will also be a key determinant on how stocks will react in the second half of the year.

ECM Libra Investment Bank Bhd research head Bernard Ching says that with stock valuations for Malaysian equities more expensive than regional peers, analysts will be keeping an eye out on how the economy performs not only for the next six months.

"We are really looking at 2012," he says.

Economists have in recent weeks downgraded growth projections for Malaysia for 2011 as some have cut their estimates to the lower end of the Government's growth projection of 5% to 6%.

Merrill Lynch (Singapore) Pte Ltd economist Chua Hak Bin feels with the second quarter probably growing by between 4% and 4.5% as global growth slows, the external environment and the sluggish performance of Malaysia's exports would make things tough for the country.

"Achieving 5% is a stretch given the global soft patch. Exports are not going to help," he says.

One area that might, and the Government and analysts are looking at, compensate for the slower external growth is the economic transformation programme (ETP).

Credit Suisse analyst Stephen Hagger feels the ETP will succeed where others have failed due to its structure, which is private sector driven.

"We believe Malaysia is entering a super cycle' of investment and growth that could result in 6% to 7% per annum. GDP growth for three years, due to the ETP, investment from Singapore, looming general election and cash flow from commodities notably palm oil and rubber," he says in a note.

Kaladher says the ETP and other transformational programmes undertaken by the Government would offer protection for the stock market in the second half.

"In a way the market has shown resilience in the last six months when most regional indices tumbled towards their March low," he says.

"The Government's ETP commitment provides some sort of visibility for domestic projects that are expected to cushion the external slowdown."

In a report on June 13, Credit Suisse says 50% of the ETP projects have taken off. The cumulative ETP-related investments total RM170.3bil.

Zulkifli too agrees on the influence of the ETP and the Government Transformation Programme (GTP), saying those programmes were already in the process of taking the country to the next level.

"Despite all the challenges, the government has managed to institute pro-active programmes to move the country forward, and it is now a matter of execution," he says.

Apart from the ETP acting as a buffer for sentiment, there are other factors that can act as stabilisers for the stock market in the second half.

"The weightage of banking stocks on the KLCI alone is about 34%, and Malaysian banks are among the best capitalised in the region. Add that by another 16% weightage on plantation stocks and 7% on power stocks, one will get a better appreciation of the defensive nature of the FBM KLCI," says Zulkifli.

"But from a global perspective, the strongest protection accorded to the FBM KLCI is probably the strength of the ringgit, which we expect to hit RM2.95 to US$1 sometime in the second half. The fundamentals of the ringgit are stronger than that for the US dollar, and that is important for the dollar carry trade."

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A highly improbable deal

Posted: 01 Jul 2011 06:41 PM PDT

IT'S all about price really. If indeed there is a proposal to buy CIMB Group Holdings Bhd by RHB Capital Bhd RHB Cap has just about denied that it has any such intentions then it has to pay the right price to get enough acceptances.

But at that kind of right price, it may take a while before additional value can be created over and above RHB Cap and CIMB on a standalone basis, if it is likely that can be done in the first place at all.

Also, give a thought to what will happen to RHB Cap's share price if it undertakes gobbling up a banking group three times its size at a much higher relative valuation compared to its own valuation, both in terms of price-to-book value and price to net earnings.

Without a doubt, RHB Cap's earnings on a per share basis will take a tumble for the worse while its price-to-book value will rise making it less attractive to potential investors.

Add in a price discount for uncertainty over whether the acquisition will work, and you have a recipe for disaster, at least as far as short-term price is concerned. That throws a massive spanner into the works because shareholders won't be very interested in subscribing for new shares when the price outlook is poor.

The Employees Provident Fund or EPF, the largest single shareholder of RHB Cap with a 45% stake will not be able to explain to its millions of members why it chose to subscribe to a rights issue or agreed to take up the rights shares that other shareholders did not want.

At this stage, it is most probable that there is a merger proposal out there which calls for RHB Cap to make a bid for all of CIMB via a cash offer or a combination of cash and shares at 2.65 times its book value. Strangely RHB Cap itself appears unaware of the deal.

Nevertheless it is speculated that such a proposal has been floated to effect a merger between RHB Cap and CIMB. CIMB and Malayan Banking had earlier announced that they are not proceeding with a takeover of RHB Cap because the benchmark price had got too expensive.

As the two banks were contemplating a possible takeover, RHB Cap's other major shareholder Abu Dhabi Commercial Bank (ADCB) announced last month that it was selling its stake to sister company Aabar Investments PJS for RM10.80 per share or RM5.9bil. That works out to 2.25 times book value, a figure neither CIMB nor Malayan Banking were willing to pay for RHB Cap.

RHB Cap's share price fell below RM9 after the two banks walked away from any potential takeover of the banking group when they considered the reference price of RM10.80 per share, which valued the whole of RHB Cap at RM23.6bil, too rich.

Now the latest proposal, intentionally or otherwise, has created another merger buzz but try as you might, it is difficult to see how the deal can be done. CIMB's market value now is around RM66bil. A deal to have a good chance for CIMB's demanding shareholders to accept will have to give a good premium over market value.

Put that premium at 20%, and you will have a takeover value of almost RM80bil for CIMB and an acquisition price-to-book value of three times. With that kind of figures, the new RHB Cap's earnings per share is likely to be significantly diluted.

RHB Cap, under that elusive proposal, is likely to depend on its major shareholders EPF and Aabar to raise the cash in exchange for additional shares in RHB Cap but for both of them, it is unlikely that such a situation is tenable when the market is likely to downgrade RHB Cap and for the share price to fall.

EPF will be hard put to explain to its nearly 13 million members, who include most of Malaysia's workforce, why there is a need to spend so much money and incur extra risk to enable RHB Cap to buy CIMB. If EPF wanted CIMB that badly, all it has to do is to simply buy more shares on the market.

Indeed EPF is the second largest shareholder of CIMB with an 11.6% stake while Khazanah Nasional Bhd is the largest with 28.6%.

The best thing for RHB Cap to do under the circumstances is to improve its operations further and make itself even more attractive as a merger and takeover target. Taking on too much can cause severe indigestion or worse pythons have been known to die when they swallowed a prey that was too big for them.

For EPF, an accident of fate and the need to protect their investment value, brought them a majority stake of 82% in RHB Capital which they whittled down by a sale of a 25% stake to the Abu Dhabi investors and other disposals.

They have made good profits on their RHB Cap stake but it is best not to tempt fate. It is time for them to cut their stakes in RHB Cap, and for that matter any other major stakes they have in other companies, even further.

That will stop their involvement in the management of these companies altogether, leaving this to professional managers instead. That ensures that EPF is singularly focused on managing the money of its nearly 13 million investors prudently and with a proper balance between risk and return considering that these are retirement funds that are being invested.

As it is, market players accuse EPF of channelling unfairly to RHB Cap a huge chunk of its own business such as trading in shares and bonds, fund management and corporate banking. Divesting its stake in RHB Cap further and withdrawing from any kind of management participation will enable EPF to keep all choices open when deciding on services.

What then does this proposal mean? Is it trial balloon to float an idea? Or is it bait on a hook to see if someone will bite? But for now it looks like in its current form it has little chance of success.

Managing editor P Gunasegaram is finding it increasingly difficult to decide whom to listen to these days.

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What’s next for the market?

Posted: 01 Jul 2011 05:54 PM PDT