Investors ignore Fed stock warnings
HAVE warnings on rich stock valuations by US Fed officials fallen on deaf ears or is the party on only for the time being?
“The Fed officials are being heard but ignored so long as cheap borrowings enable the party to go on. As interest rates go gradually higher, the Fed message will be kept closer to heart.
“What is the rate that will tip things over? I suspect it may be around 2.5%,’’ said Pong Teng Siew, head of research, Inter-Pacific Securities.
The Fed recently raised the federal funds rate (at which banks and other depository institutions lend to each other) to 1.25% compared to 1% two months ago and 0.5% a year ago.
“If levels can hold into the middle of the month, it is possible that this party can continue, as we would be looking forward into next year’s global economic and earnings numbers, which should still show decent growth in the first half of next year,’’ said Chris Eng, head of research, Etiqa Insurance and Takaful.
“Corporate earnings have been commendable thus far but the FBMKLCI has not rallied as much as the US market following president Donald Trump’s election.
“Valuation on a price to earnings basis on Bursa Malaysia is slightly high, at 16.4 times compared to the 10-year average of 15.4 times. “A minor correction in tandem with the drop in global markets, while waiting for corporate earnings to catch up, is possible,’’ said Thomas Yong, CEO, Fortress Capital.
That the US market is not recognising the remarks made may mean two things. “It is either expecting higher earnings to catch up with valuations or it is riding on a high risk appetite for the near future,’’ said Danny Wong, CEO, Areca Capital.
“The KL market is not that expensive as our price to book value is relatively decent. And we are investing on a long term basis.
“If the US market faces a ‘payback’ time one day, we may see a knee-jerk reaction for some speculative stocks but not for strong, funda- mental companies.
“Global funds will also seek returns from this part of the world by switching from the US market, and fundamental stocks would be their choice.
“But we have to monitor our earnings growth for risk management purposes,’’ said Wong.
And despite the drop in technology stocks, Wong is still positive on those companies with capacity expansion which will drive future earnings.
“In the US equity market, signs of discomfort are already on the horizon,’’ said Nor Zahidi Alias, chief economist, Malaysian Rating Corp.
The recent comment on “rich asset valuation” by US Fed chair Janet Yellen, reminds one of former Fed chairman Alan Greenspan’s famous “irrational exuberance” rhetoric in the mid-1990s.
What can cause anxiety now is that equity investors remain bullish and continue to push up global indices to historical highs.
In the US, the S&P 500 has registered an impressive gain of 15% in the past one year; year-to-date, it is up by about 7%.
“This is rather strange, considering that US Treasury yields (returns from investments in bonds) have been trending downward since the beginning of the year. Year-to-date, the yield for 10-year US Treasuries is down by about 20 basis points.
“Such a relationship does not bring comfort to those who observe historical market movements as a healthy bull run normally reflects a general improvement in the economy.
“Under such conditions, bond yields would normally be on an uptrend. But a persistent downtrend in bond yields implies that, for some reason, there is now an increasing num- ber of investors who are seeking safe haven assets,’’ said Zahidi.
Bond prices and yields move in opposite directions; bond prices rise when yields fall.
“The US market remains hopeful of the Trump administration’s infrastructure spending, bold tax reform and repeal of the DoddFrank financial reform law to boost the economy and market. This is despite that so far, there has been hardly any significant progress seen,’’ said Lee Heng Guie, executive director, Socio Economic Research Centre.
What can trigger a correction in the stock market?
“Firstly, if the Fed plans to tighten rates more aggressively to dampen the ‘market exuberance,’ should the Trump reflation policies push inflation higher. The potential shrinking of the Fed’s US$4.3 trillion balance sheet, though likely to be in gradual and small steps, will have an impact on the financial conditions.
“Secondly, the potential disappointment in corporate earnings, should the Trump’s policies fail to deliver the much-needed impact on the economy and market.
“Indications are that the US economy is unlikely to hit Trump’s target of 3.0% Gross Domestic Product growth this year,’’ said Lee. Within the interplay of fund flows, yield plays, country-specific market catalysts and macro drivers, emerging markets, including
Malaysia, have generally performed well in the first half-year.
“But they remain vulnerable to higher US rates, tighter financial conditions, a stronger US dollar and weaker commodity prices, including that of oil,’’ said Lee.