Published October 19, 2009

Fastest recovery on record is cause for concern

Sentiment index reaches heady, pre-crisis levels of Q3 2007

By TEH HOOI LING

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(SINGAPORE) While the jury is still out on whether the recovery we are seeing today will be 'V' or a 'W' shaped, investors are becoming as euphoric as they were during the height of the stock market boom in the third quarter of 2007 - which is worrying some market observers.

Last week, International Netherlands Group (ING), a global financial institution based in Netherlands, released its ING Investor Dashboard Sentiment Index for 13 markets in the Asia Pacific.

Almost all Asian countries reported consecutive improvements in investor sentiment during the second and third quarters. But a fact that escaped most write-ups of the ING investor sentiment index was that the index has reached the heady, pre-crisis levels of the third quarter 2007.

That was when the outlook was considered ultra-rosy and the Dow Jones Industrial Index was at 13,895 points, en-route to hit 14,164 points just 10 days later. In Singapore, the Straits Times Index ended at 3,645.41 on Sept 28, 2007, and climbed to a record high of 3,831.19 on Oct 11, 2007.

So has investor sentiment run ahead of fundamentals? Noted a savvy private investor: 'The numbers suggest strongly we are at, or close to, a short-term top.'

Indeed, according to Citigroup's Asian equities strategiest Markus Rosgen, the market recovery we've seen this year has been the fastest in percentage terms since the inception of Citi's database in the mid-1970s.

In valuation terms, this has also been the fastest recovery on record, and the one which has discounted the furthest out. 'The price-to-book value today of 2x finds itself at the same level as year three or four of the last six recoveries since 1970s,' observed Mr Rosgen in a recent report.

On the earnings front, it was a similar story. Earnings did not decline as much during this cycle as they did during the 2001 cycle, the 1997/98 cycle or the 1980's recession. 'So, with markets anticipating a vigorous recovery in the real economy, it is no surprise that earnings revisions have shown the strongest recovery since data began in 1990.'

Earnings revisions, he noted, have moved beyond those that followed the 1990 recession, the 1997/8 crisis, the 2001 recession, and are above both the 2000 and 2007 market peaks.

'It is hard to see how it is going to get better for earnings revisions from here. In fact, we are starting to see the first signs of downward revisions to earnings,' said Mr Rosgen.

But the good news is we are entering a favourable period in terms of year-on-year comparisons. This time last year, a lot of economic activities had almost ground to a halt. So it is nearly impossible for year-on-year numbers to get worse in the next few months. Export growth and export prices should be positive from now till early second quarter 2010.

'But the snag is, at 2.1 times book and 16.9 times mid-cycle earnings, much of that expected improvement is already in the price of Asian equities. Market would need to give some performance back in order to move higher. Negative earnings revisions make it hard to see further near-term upside,' he concluded.

Daiwa Securities SMBC analyst Tham Mun Hon also noted that the Asia Pacific region ex-Japan has been the first to emerge from the global slowdown. 'But we believe most of the good news has been priced in and that funds inflow is likely to remain quite weak unless we see a further upgrade of the region's economic growth outlook.'

Gabriel Yap, senior dealing director at DMG & Partners Securities, however, takes a different view. He believes Asian market valuations are still not over-stretched. The quality of the earnings of big cap stocks is good. Meanwhile, small cap stocks still lag the general market in terms of valuation, he added.

But purely from stand point of market prices, where do we stand today? The Dow Jones Industrial Index crossed the psychologically important 10,000 level last week for the first time in more than a year. Still, it is 30 per cent off its October 2007 peak. Singapore and Hong Kong are about 20 to 25 per cent off their 2007 peaks, while China is still down by a whopping 45 per cent.

But given that we are supposed to have just gone through the worst crisis since the Great Depression, perhaps this is as good as it gets, or can get, one year on.