SENTIMENT VS FUNDAMENTALS

At the beginning of the year, mainstream research houses were targeting a 2018 year-end SET index in the range of 1,750 to 1,900 points. Given that the index finished 2017 at 1,750, the expected index return of up to 9% was not a stretch.

The forecast was mainly driven by fundamental factors: accelerating GDP growth, rising oil prices, an improving earnings outlook. Consensus expected aggregate earnings growth of 8-9% implies that forecasters factored in a buffer for a decline in price/earnings (PE) multiple (of around -1% to -9%) to reflect the risk of tightening financial conditions.

With the SET now moving between 1,600 and 1,650, the implied return year-to-date is -8%. The key question is, what went wrong?

While we got the fundamentals right, we were admittedly spectacularly wrong in our assumptions of market sentiment, especially for foreign investors.

From a fundamental perspective, GDP growth registered an impressive 4.8% yearon-year in the first half of 2018, the highest in many years. Even after the weak third-quarter growth of 3.3%, full-year GDP is likely to end up above 4%, beating the historical average of 3.0% to 3.5%.

Listed companies reported earnings growth of around 12% year-on-year in the first nine months of 2018. Even if fourth-quarter earnings decelerate to the low single digits, fullyear earnings growth will still be around 10%, not bad compared with the forecast of 8-9% at the beginning of the year.

We did, however, miss market sentiment by a mile, especially in terms of the view of foreign investors towards emerging markets (EM). The main trigger has been the trade dispute between the US and China.

However, despite all the rhetoric from the US administration, the effective additional tax collection is likely to be about 0.3% and 0.5% of US and Chinese GDP combined (at worst), and there is a good chance that the actual impact will be less than that. Commodities will be rerouted, while production bases and supply chain networks for manufactured products will be re-optimised to minimise the tariff impact.

RISK-OFF MOOD

Unfortunately, the trade dispute news itself has pushed markets into a risk-off environment, especially in emerging economies. As global investors redeem their EM-focused mutual fund units, the fund managers must liquidate their portfolio holdings in various EM countries at any price (mutual fund unit redemption acts like a forced-sale order to fund managers).

Thailand has likewise been hit by outflows, regardless of whether individual investors specifically like or dislike Thai equities.

Based on data from SETSmart, foreign investors have been net sellers of Thai equities for 14 months for a total of more than 315 billion baht since October 2017. This year alone, foreign net selling value has reached 280 billion baht, well above the 160-billion-baht sell-off in 2008, the year of the global financial crisis.

Thailand has strong domestic savings, as reflected in the current account surplus of about 11% of GDP in 2017 and 6% of GDP in 2018 (SCBS estimates), putting it among the top 10 of the roughly 190 countries followed by the International Monetary Fund.

Since local banks have not been fighting for deposits (yet), the excess savings have been channelled into mutual funds, which invest chiefly in local bonds and equities. Unsurprisingly, nearly 60% of foreign net selling has been absorbed by net buying by local funds of about 165 billion baht so far this year.

In addition, the current account surplus also shields Thailand from the recent EM currency crisis (September 2018) that spread from Turkey and Argentina to South Africa, Indonesia and India. Over the past two months, the US dollar appreciated by nearly 3% against a basket of US trade-weighted global currencies, while the baht weakened just 2% against the dollar, outperforming peers. Bloomberg on Sept 5 declared Thailand a safe haven in an article headlined “Birthplace of Asian crisis becomes haven in emerging-market rout”.

EARNINGS STILL HEALTHY

I believe that the Thai equity market sell-off is overdone and will reverse (or at least stop) soon. While the SET has fallen by 8% so far this year, aggregate nine-month earnings have grown by 12%.

This has brought the forward PE ratio (a matrix that measures the expensiveness of equity prices against ability to generate earnings over the next 12 months) down by 16% from its peak in January 2018. We are no longer expensive. And more positive factors are on the horizon: The US Federal Reserve may not raise interest rates as much as the market fears next year (the tone is changing from the recent three-step projection in 2019). Thailand’s domestic consumption stimulus measures are lining up as the country prepares for an election, with an election rally likely in the first quarter of 2019.

The consensus is for SET earnings per share to rise by 7-8% on the back of 5% nominal GDP growth in 2019.

The Brexit risk factor will end (one way or another) by the fourth quarter of this year or the first quarter of next year at the latest. While the US-China trade dispute could lead to an economic slowdown in China, we could see investment flow out towards Asean (including Thailand) as part of China’s supply chain re-optimisation. Negative sentiment could outweigh positive fundamental factors in the short run. But over the longer period, fundamental factors will always win. Pornthep Jubandhu is senior vice-president for the investment strategy department at SCB Securities Co Ltd.