Malaysian stock market: PULL BACK VERY SOON?

Ever since the last time we recommended a ‘buy’ on the FBMKLCI in the week ending November 2012, there had been much changes in the market both fundamentally and technically. On the fundamental side the P/E ratio for FBMKLCI as of December 2012 stands at 15.8 which is a tad away from the historical mean of 16. That means we are at the high end of the reading meaning there should be limited upside for the FBM KLCI in the short term.

Anyway this is a quick analysis and market update as I was only able to assemble the data hastily plus I have had to do a bit of travelling especially to Indonesia. Things are really moving in Indonesia where the market is sizzling. They have record new listings, M&A activities and also their average daily volume traded in BEI is more than double our local market.

Over the Cliff?

On our local front the technical side point towards an extremely overbought situation and it seems like our market is about to ‘go over the cliff soon’. As we have alerted during the last correction in November 2012, the market had been dropping continuously for 18 days and we also pointed out that such stuff don’t happen every day. Anyway to cut the story short, in the immediate term our market is dangerously overbought and seems like it had peaked for this run. It moved up from the low of 1590.67 points in November 28th last year and managed to ram up about 100 points to close at 1692.65 today (03/03/2013).

P/E Bench Marking

We again caution those amateur investors who are now feeling the ‘top of the world’ or ‘invincible’ as the index is making another new high. But if you look at the prices of most stocks they are not only trading below their previous high but also below the prices at the beginning of the year. This represents a weakness in the market and a divergence in performance between the stocks and the market index.

What can cause this? One explanation will be the ‘exit of smart money’ from the market. Institutional and mutual fund investors normally employ what they called the ‘P/E Benchmarking’ strategy in their day to day stocks trading. P/E benchmark trading refers to a trading strategy used by large institutional investors to compare their stocks to the industries and market. They will use the P/E ratio as benchmark to evaluate how ‘expensive or cheap’ their stocks as compared to the industry and the market. When the P/E of a particular stock is trading at a premium to other stocks in the same industry and also the market then it’s time to get rid of the stock and vice versa.

As we have mentioned above the current market P/E is about 15.8 which is very close to the historical mean of 16. This represents less than a 1% discount (15.8/16 = 0.98%) and certainly will pose a limited potential on the upside. Contrary to popular belief that institutional investors tend to hang on to their portfolio for long periods so as to maximize their return. In reality they tend to trade the markets as frequently as they can. Large investors especially the mutual funds have their costs to cover monthly such as salaries, rental, bonus, operating expenses and etc.

Income & Growth Models

There are two investment models available to them and there are the income and growth models. In an income model most of their funds are invested in fixed income assets and their return will not able to achieve their profit target after deducting their ‘expense ratio’. The expense ratio refers to the percentage of the fund’s assets they will charge for managing a fund which average between 1% to 3% a year. This will definitely affect an investor’s rate of return because the fund manager will deduct the expense ratio regardless whether the fund lose or make money on that year. Hence in order to beat the market they tend to take on higher risk and return by adopting the growth model. This will mean that they will be more aggressive in their investment approach and will always keep their‘portfolio fresh’. By this it means that those folks will be trading more aggressively and normally will have an annual turnover of more than 100% of their portfolio.

On the technical perspective the FBMKLCI, as we already mentioned earlier it is on the verge of going over the cliff. We present below the daily one year FBMKLCI chart.

From the above chart you notice that there are 3 divergences occurring at the same time which is represented by the green arrows. At the top section which is the price chart the FBMKLCI index seems to be on the uptrend while both the MACD and RSI indicators are showing opposite trends. This shows weakness in the FBMKLCI index and we believe the trend will reverse as soon as next week. This phenomenal is also known as structural weakness and whether it is going to be a market top or normal correction will depend on how it will perform in the coming week. From what we see from the above the target for the next down move will be,

1692.65 - 1590.67 = 101.98

50% retracement = 101.98/2 = 50.99 or 51 points (rounded)

The next FBMKLCI target should be 1590.67 + 51 = 1641.47 points

If the market cannot hold at 1641.47 points, we suggest you should take some action to rebalance your portfolio.

Disclaimer On : The above represents our view on the market based on our analysis and is only a guide on the movement of the market index. You should not solely use it to time your stock market trading.

http://samcheekong.blogspot.com/