Tong Kooi Ong
The stock market is a market for stocks
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, where now information is disseminated widely and instantly. Financial markets are more closely integrated than ever before in history.
Chart 1 tracks the historical movements for the FBM KLCI, ST Index and S&P 500 Index, which highlight their increasingly positive correlations.
Chart 1: Stock markets have history of positive correlation
Chart 2: Tracking the FBM KLCI and S&P 500 Index
Chart 3: Tracking the ST Index and S&P 500 Index
Chart 4: US market outperforming as economic recovery gains traction
That said, we do see periods where 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 in 2008-2010. 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. I believe this is due to a combination of factors.
For starters, the 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 5-7 show the close correlations between earnings and stock prices over time for the US, Malaysia and Singapore.
Chart 5: S&P 500 index vs. earnings
Chart 6: FBM KLCI vs. earnings
Chart 7: STI vs. earnings
Corporate earnings for companies listed on the 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 as well as Singapore companies are having 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)
Chart 8: PER for the US, Malaysia and Singapore markets
Chart 9: Difference in earnings yields and risk-free rates
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 all other goods and services.
Stocks are but one of many investment products available to investors, that include bonds, gold, commodities, property, etc. Money flows into the investment product with the most attractive returns after taking into account the difference in risks amongst 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. Lesser demand for stocks translates to lower PER. Between stock markets – and individual stocks – there are differential earnings yields that will drive relative under/over-performance. (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 Thursday, 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 under-performing the benchmark MSCI World Net Return Index, which is up 5.9%, over the same period
Sentiment on the Bursa Malaysia was somewhat ambivalent in the absence of fresh leads. Stocks mostly drifted sideways. Both the Malaysian Portfolio and the benchmark index ended the week flattish.
Total portfolio returns now stand at 49.9% since inception. This portfolio continues to outperform the benchmark index, FBM KLCI, which is still down 11.3% over the same period, by a long way.
A Note to Readers
It is my pleasure to share with you my Value Investing Portfolio. However, I must emphasize that it is by no means a recommendation or a solicitation or expression of views to influence you to buy or sell any stocks. I am just sharing openly on what I am doing with my stock portfolio.
Further, I like to remind all investors that investing is not just about the profits or returns. You will inevitably suffer stock losses too. You need to understand your own investment objective, risk appetite and the amount of loss you can afford to bear. So, while many investors talk only about absolute returns, I am also sharing the computed risk-weighted returns of my portfolio.
Tong Kooi Ong