NOT THE TIME TO SELL
The SET index touched an all-time-high intraday peak of 1,852 points at the end of February this year. By the end of June, it was 14% off that peak, falling to around 1,600. One of the chief culprits was extreme foreign fund outflows.
Even though SET movements over time have shown ever greater correlation with net inflows from local funds and retail investors, especially since the financial crisis in 2008, foreign outflows have still managed to drive the index down over the past few months.
In the second quarter of this year, net foreign outflows reached 122 billion baht — with 100 billion of that exiting in May and June. This was the most acute outflow concentration ever for the Thai market.
There are three main factors behind this phenomenon:
1. A stretched market valuation: The 12-month forward PE ratio (price divided by consensus-estimated earnings for the next 12 months) has reached a post-financial crisis high of 16.6 times or around 2.7 times standard deviation above the three-year moving average.
This occurred once before — in May 2013 when the SET crashed from 1,640 to around 1,400 (15%) after then-Federal Reserve chairman Ben Bernanke signalled “tapering” of quantitative easing. The index dropped further to around 1,200 by the end of that year, but for a different reason: the intensifying of political unrest that ultimately led to the coup in May 2014.
2. China and the MSCI: Yuan-denominated Chinese stocks, or A-shares, are now in the MSCI Emerging Market index. In the first phase, which took effect on June 1, the MSCI EM Index raised the weighting for China A-shares from zero to 0.39%. Some analysts estimate initial inflows into Chinese stocks at around US$20 billion.
This meant that global MSCI EM index tracking funds (with assets under management of nearly US$2 trillion) needed to reduce the level of investment in other EM countries, including Thailand.
We note that the second phase, which will raise the Chinese stock weighting to 0.78%, will take effect in September.
3. Trade war fears: The recent war of words between China and the US about taxing more of each other’s imports has spooked markets, sparking a flashback to the US Smoot-Hawley Act of 1930, which triggered a global trade war.
However, we believe the recent market correction is overdone.
Between February and June, the SET index had dropped by 14% from its all-time-high, while the 12-month forward earnings per share continued to rise (4%) towards an alltime high. This drove market valuations, specifically the 12-month forward PE ratio, down from the extremely stretched level of 16.6 times (+2.7 from standard deviation or SD) to just 14 times (-0.8SD), a magnitude seen only during the great flood (2011), QE tapering (2013) and the oil price collapse (2015).
Each of the market corrections above was followed by a protracted rebound back to (and exceeding) the respective pre-correction peaks.
The foreign outflows should moderate soon. The 122 billion baht that left the SET in the second quarter represents an all-time high in terms of value. Even adjusting for market prices (normalised by SET index level), this outflow is still among the most extreme, second only to that seen in the second half of 2008.
Based on a Bloomberg survey of 20 investors, traders and strategists, more than half expect the sell-off in developing nation stocks and currencies to continue. The pessimism towards shares in developing nations is close to a 23-year high.
Given that we do not expect to see an economic or financial crisis over the next one or two years, I believe that when the market is abnormally pessimistic, it is the time to increase investment, not reduce it.
In the near term, the market will watch closely the July 25 meeting in Washington between European Commission President Jean-Claude Juncker and his US counterpart Donald Trump. They are scheduled to discuss security and economic matters. Since the market does not expect much from this meeting, any good news on easing trade tension between the US and the EU will be a plus.
Our recent investment strategy recommendation is to avoid stocks with an extremely high PE ratio. We focus on laggard stocks with strong fundamentals. US dollar appreciation will lead to a weakening of the baht, supporting exporters.
Based on this theme, we like CPF for its improving swine business and TU as a laggard with lower raw material cost. We also like the Electronics sector, but since our selection of this sector in mid-June, top picks KCE and HANA have been strongly outperforming (up 20% and 10% respectively). Thus we have turned our attention to DELTA and SVI which remain laggards while benefiting from the weaker baht in the same way as outperformers.
We also recommend refineries (top picks are SPRC and IRPC) based on our view that refinery margins have bottomed out and will pick up in the third quarter, which is the high season for the sector.