(Jan 31): It has been an eventful start to 2020. In the very first few trading days of the new year, global stock markets were roiled by the sharp spike in tension between Iran and the US. Fortunately, cooler heads prevailed and the two countries appear to have settled into an uneasy ceasefire.
This was followed by a string of positive developments on the trade front that lifted investor sentiment and sent stocks rallying higher. The Standard & Poor’s 500 index reached new all-time highs, building on last year’s strong gains.
The US and China signed a phase one trade deal that includes a commitment by the latter to substantially increase purchases of US goods and services, including farm products such as soybean. This would play well for President Donald Trump in his re-election bid.
The deal will alleviate some of the pressures on China, raising hopes that the slowdown in the world’s second-largest economy is stabilising. The country’s industrial production ended 2019 on a stronger note, beating market expectations, while the government has signalled continued accommodative monetary policy and more fiscal stimulus this year.
Meanwhile, the US Senate approved the United States-Mexico-Canada Agreement (USMCA), which is the revised North American Free Trade Agreement (Nafta).
Trump and French President Emmanuel Macron then called a temporary truce in their dispute over France’s plans to impose a digital tax that will hit US tech companies such as Amazon.com and Alphabet.
The dispute had earlier threatened to erupt into another tit-for-tat tariff escalation that would also pull in other European Union countries.
These events underscore our belief that Trump will do everything possible to keep the US economy — and stock-market rally — on track. As we have written previously, he watches the stock-market movements closely and credits himself for its success.
Towards the end of the month, markets were once again buffetted by bad news.
This time, it was fears that the coronavirus outbreak in Wuhan, China, could turn into a global pandemic.
Despite the Chinese government’s massive efforts to lockdown the worst-affected cities, the outbreak spread rapidly.
Thousands of cases have been confirmed worldwide, mostly in China, but also in the region, Taiwan, South Korea, Thailand, Japan, Hong Kong, Singapore, Malaysia, Australia as well as the US, France and Germany.
The coronavirus is a cousin of the virus that caused the severe acute respiratory syndrome (SARS) outbreak in 2003. Its devastating impact on economies in this region is still fresh in many people’s memories.
The economic impact of this current outbreak could similarly be quite serious. Those worst affected would be the tourism industry (hotels and airlines), retail, entertainment and F&B businesses. On the local bourse, glove maker stocks such as Top Glove and Hartalega surged in anticipation of higher demand. Healthcare stocks also performed well.
Positively, based on past experience, including the SARS outbreak, markets have bounced back fairly quickly. We believe that global excess liquidity will limit the downside. Most investors are not leveraged and markets remain on a “buy on dip” mode.
Events over the past month showed how impossible it is to time the market. Taking a longer one-year view, we remain fairly upbeat. The underlying data continues to support our expectations for a stronger global economy in 2020. The International Monetary Fund forecasts GDP growth of 3.3%, up from 2.9% in 2019.
The de-escalation of trade conflicts and expected recovery in global manufacturing, investments, trade volumes and economic growth all bode well for Malaysia, as a small and open economy.
In addition, we expect our government to loosen its purse strings and increase fiscal spending to stimulate domestic growth. That includes the resumption of major infrastructure projects that had been on hold since May 2018.
We also believe Bank Negara has room to ease monetary policy further, after the 25 basis point interest rate cut on Jan 22.
Based on historical real lending rates, there is room for rates to fall another 75bps, at least.
Globally, central banks remain in easing mode and interest rates are near historic lows. Bank Negara can even take on a more proactive role in stimulating the economy — for example, by expanding its balance sheet through quantitative easing, mirroring the US Federal Reserve, European Central Bank and Bank of Japan.
Simultaneous expansionary fiscal and monetary policies, coupled with stronger manufacturing and exports, will reinvigorate domestic investments, and boost investor confidence and growth prospects.
These should, in turn, stabilise the ringgit — making Malaysia more attractive to foreign capital flows.
The ringgit strengthened slightly in January, averaging at 4.08 to the US dollar, from 4.093 at end-2019. The local bourse recorded net inflows from foreign funds totalling some RM521 million for the year-to-date till Jan 24. Fund flows could rise over the course of the year, on the back of a corporate earnings turnaround and stable ringgit.
We see signs of a nascent corporate earnings recovery in the last two quarters.
Improving the external and domestic economic outlook can sustain this earnings turnaround. This is in line with what we have been saying in recent weeks.
As previously articulated, the Malaysian Portfolio performed strongly in 4Q2019, ending the year up 5.5% compared with the 6% decline for the FBM KLCI and 1.8% drop for the FBM Emas Index.
Our switch to a more aggressive basket of stocks — and paring cash holding to just 8% — continues to pay off in early 2020.
The portfolio is up a further 2.2% for the year-to-date, despite the global selloff and weakness in the broader market. The FBM KLCI and FBM Emas index are down 2.7% and 2.6%, respectively, so far this year.
KESM, Frontken and Inari were our top performers in January, gaining between 6% and 21%. Total portfolio returns now stand at 60.4% since inception. By comparison, the FBM KLCI and FBM Emas index are down 15.5% and 13.2%, respectively, over the same period.
Frontken is riding the wave of returning confidence in the global semiconductor industry and expectations for rising demand, especially on 5G build-up. The company is a leading service provider of advanced precision cleaning and surface treatment for foundries, including Taiwan Semiconductor Manufacturing Co.
Its cleaning and coating services increase and prolong the lifespan of machinery and equipment, which would improve the customer’s operating and maintenance costs.
As wafer fabrication transitions to ever-smaller process nodes, in order to make smaller devices with more demanding power usage, equipment handling and cleaning criteria become increasingly stringent, with lower tolerance for leftover particles. Frontken continuously adapts its cleaning processes and has an excellent track record in terms of reliability, competency and efficiency of services.
Frontken also expects to benefit from a recovery in capex in the oil and gas industry. Its services include thermal spray coating, plating and conversion coatings to prevent wear and tear and corrosion on pumps, valves and other mechanical components.
KESM’s share price has rebounded strongly since last October. The company is the largest independent provider of burn-in and test services in Malaysia. All mission-critical chips such as those used in the automotive, aeronautic and space industries are required to undergo burn-in tests. KESM derives 80% of its revenue from the automotive industry.
We believe that the worst is over for the company, which saw profits drop sharply in FY ended July 2019. Earnings in the last two quarters showed sequential improvements.
While global vehicle sales may be flattish in 2020, demand for automotive chips is supported by the rising chip content per vehicle — underpinned by wider adoption of electric vehicles, enhanced safety features and, going forward, increasing vehicle connectivity and autonomous driving.
Despite the steep fall in profits in FY2019, KESM’s balance sheet strengthened. Net cash rose to RM161 million currently, from RM99 million at end-FY2018.
We believe Pantech is another company that is poised for an earnings rebound. Profits expanded strongly in FY ended February 2018 — to RM47 million from RM30 million in FY2017 — but stalled in FY2019. Shipment of carbon fittings to the US was suspended in June 2018, pending a US investigation for circumvention of anti-dumping duties imposed on products with Chinese origin.
Pantech successfully defended against the allegations and shipments resumed in 2H2019. Utilisation at its carbon steel manufacturing plant has returned to full capacity, from as low as 30% during the suspension.
Earnings in FY2020 will be affected by lower average utilisation as well as higher production costs upon resumption of exports to the US, but we expect margins to improve in FY2021. Valuations are attractive at less than nine times estimated earnings and only 0.6 times book value.
(For more information and updates on these companies, and more, visit www.absolutelystocks.com.)
Meanwhile, the Global Portfolio fell 1.4% for the week ended Jan 30, in line with the selloff in global markets as concerns grew over the viral outbreak. Shares in Chinese e-commerce giant Alibaba Group Holding fell 4.7%. Shares in The Walt Disney Co were down 5.5% after the company temporarily closed the Shanghai Disney Resort and Hong Kong Disneyland Park.
On the other hand, interest in homebuilder Lennar remained robust. The stock gained a further 3.1% for the week and is now up 16.5% from our cost.
The Boeing Co recouped some lost ground, closing 4.2% higher last week, despite reporting its biggest-ever full-year loss as costs related to the 737 MAX planes mounted. There was relief that losses were not higher, raising hopes that the worst may be over. We are confident that the issue will be resolved, though there is no concrete timeframe. Management has officially pushed back the return of the 737 MAX to mid-2020.
Last week’s losses pared total returns for the Global Portfolio to 22% since inception. Nevertheless, this portfolio is still outperforming the MSCI World Net Return Index, which is up 17.4% over the same period.
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. 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.
