(May 6): We know that the world’s stock markets are correlated and move in lockstep, especially during periods of heightened volatility and uncertainties. For instance, if the US market suffers a massive selloff overnight, you can almost be certain that Asian markets will open sharply lower and vice versa.
This positive correlation has only strengthened with globalisation and technological advancement, with information being disseminated widely and instantaneously. Financial markets are more closely integrated than ever before in history.
Chart 1 tracks the historical movements of the FBM KLCI, Straits Times Index and Standard & Poor’s 500, which highlight their increasingly positive correlations.
That said, we do see periods in which one market outperforms another — even when they move in a similar direction (see Charts 2 and 3). For some periods, there could be specific reasons that hurt one market more than the rest, such as the subprime mortgage crisis in the US from 2008 to 2010. In the immediate aftermath, US stocks underperformed both the Singapore and Malaysia markets.
However, as economic recovery in the US gained traction, its market has gradually outperformed the FBM KLCI and STI (see Chart 4). And that gap has been widening, owing to a combination of factors.
For starters, the US Federal Reserve reduced short-term rates to near zero and undertook three rounds of massive quantitative easing programmes, which flooded the stock market with liquidity. Investors took on more risks in equities in order to earn higher yields.
Also, the US economy recovered at a steady, if not exciting, pace even as other regions, notably Europe and, more recently, China and Asia struggled to maintain momentum.
But the overriding reason is more fundamental: earnings growth. Charts 5 to 7 show the close correlations between earnings and stock prices over time for the US, Malaysia and Singapore.
Corporate earnings for companies listed on Bursa Malaysia peaked around 2012 and have since been on a broad downtrend. In fact, earnings contraction accelerated in the past year. Against this backdrop, Malaysian stock prices are actually holding up surprisingly well — as reflected in the current big gap between the two lines in Chart 6.
Similarly, earnings in Singapore too have not improved since 2010 — which is reflected in the flattish performance for the benchmark market index (note that the dataset is relatively limited for Singapore).
Clearly, Malaysia and Singapore companies are facing difficulty in growing earnings in recent years, despite both countries reporting steady GDP growth. Why? I will elaborate further on this next week.
By contrast, US stocks are outperforming for a very good reason — earnings have been rising steadily and are now far above pre-financial crisis levels. In other words, the widening performance gap between the three markets (in Chart 4) is well justified by their differential earnings growth.
All of the above underscore the hypothesis that markets are generally efficient. And that share prices roughly reflect the underlying fundamentals (earnings) of companies over the long term.
That said, market valuations (price-to-earnings ratio, PER) do trade in bands — higher or lower — at different periods of time (see Chart 8).
Why is this so? Because the stock market is ultimately a market for stocks. What I mean to say is that stock prices are driven by the dynamics of demand and supply — just like any other market for oil, fish, houses and other goods and services.
Stocks are but one of many investment products available to investors that include bonds, gold, commodities and property. Money flows into the investment product with the most attractive returns after taking into account the difference in risks among asset classes.
For example, when earnings yield is significantly higher than the risk-free return, there will naturally be more demand for stocks, which is, in turn, supportive of higher PER valuations.
The opposite happens when earnings yield drops relative to the risk-free rate, thereby making bonds more attractive. Less demand for stocks translates into lower PER. Between stock markets — and individual stocks — there are differential earnings yields that will drive relative under/outperformance (see Chart 9).
There are many factors that affect demand and supply. Suppose the number of listed stocks on an exchange falls by half tomorrow. I would bet that PER multiples would surge — simply because the same amount of money (demand) will now be invested in a smaller pool of companies (supply), all else being equal.
The Global Portfolio continued to do well in the week ended May 2, gaining another 3.3%. Notably, shares for Ausnutria Dairy performed strongly, up 15.3% for the week and 57.9% from my average acquisition cost.
Last week’s gains lifted total portfolio returns to 5.4% since inception. We are only slightly underperforming the benchmark MSCI World Net Return Index, which is up 5.9% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
This story appears in The Edge Singapore (Issue 880, week of May 6) which is on sale now. Subscribe here
