Rough Seas Ahead

Decreased global economic activities caused by the trade tariffs’ tension; increasing interest rates; the end of the US Federal Reserves’ monetary easing policies and the beginning of the monetary tightening cycle; combined with a reduced tax rate in the US; as well as the highly dramatic flip-flopping US-North Korea “relationship”; all these are causing institutional investors to shift their focus away from Asia Pacific and towards the US.

Around us, our neighbouring countries, particularly Taiwan and Malaysia, witnessed significant outflow of foreign investments in previous months. Meanwhile, valuations of listed companies in the region maintains at their highest ever levels; Nestle (Malaysia) Bhd, whose products Milo, KitKat and Maggi (amongst many others) we grew up drinking and eating, currently trades at a whopping 54x P/E or 41x EV/EBIT. If you are a RM40billion billionaire, will you throw your entire networth into and privatise Nestle (Malaysia) Bhd at these valuations?

Here at home, the once invincible oligopoly in Singtel, Starhub and M1 faces a critical historical point as they struggle to evoke relevance and remind consumers why they exist, as the Singapore government issued a 4th telecommunications license to TPG which grew against the likes of Australian giants Telstra, Optus (Singtel) and Vodafone (i.e. TPG is a notable founder-led [白手企业家] contender), and as Mobile Virtual Network Operators (MVNOs) like Circles Life and MyRepublic hop onto the bandwagon of an increasingly liberalised telecommunications market. Already we see TPG flashing a $0 data-enabled plan for senior citizens, Circles Life issuing a fully customisable $0, 1GB data plan, and MyRepublic introducing a $8, 1GB, 1,000 minutes plan for its loyal fibre subscribers; while the 3 telcos still believe in charging their decades-long loyal customers $5 for CallerID services.

The Singapore giants Singtel, Starhub and M1 have fallen by 13%, 40% and 18% respectively from their prices on 16 December 2016, just after the Singapore government awarded the 4th telco license to TPG. Have they reached the point of maximum pessimism? We may not know, but we can glimpse over the Java Sea and observe that the largest telco TPG has taken head on so far, namely Telstra, has fallen 57% from their high in February 2015. It seems that with every market downturn, low cost providers with lower cost base (more efficient) win more consumers’ hearts and market share.

All these seem to point to a reality of the current market conditions – too much money chasing too little good companies; high premiums are paid for any company with any chance of earnings growth or even no “negative growth” while companies who face earnings risks or increased political risks gets the cold axe.

How should investors allocate their monies given the assumed foundation of the capital markets is being shaken and even long-time blue-chip high-yield companies get shaken to their core, while on the other extreme highly valued companies like Nestle (Malaysia) Bhd gets priced up to equivalent earnings yield of 1.85% (100%/ 54x P/E)?

Given that interest rates will increase in the short and mid-term, will investors continue to invest in companies at 1.85% earnings yield or would they rather invest in risk-free long-term US treasuries with closer to 2.8% and 3% coupon rates?

Might we expect significant decreases similar to those experienced by Telstra and Starhub or companies on the other extreme end like Nestle (Malaysia) Bhd? And might we take the opportunity to research further on high quality companies that have been shunned and beaten to a pulp by institutional investors?

Sure, no one can foresee the future and theoretically there are no upper limits on stock prices, but we can be quite certain that a drop from any high places will cause pain.  Thus, it is of utmost importance that we investors continue to be vigilant; avoid highly priced investments and focus on reasonably priced companies with strong potential to double earnings in 3 to 5 years, thereby lowering our assumed risks and positioning ourselves for a sustainable return on our investments.