Share prices to gain after 22% loss
By Teng Hong Joe
JAKARTA (JP): The performance of the Jakarta Stock Exchange (JSX), during the past year has been disappointing. From the beginning of the year through Dec. 19, the Jakarta Composite Index (JCI), lost approximately 22 percent. But it is important to note that the JCI began the year with a 68 percent increase from that in early 1993 and had recovered 104 percent from its low of 224.7 in October 1991.
Since the history for performance of emerging markets in the short term is quite volatile and that trading in this market is quite difficult, it is important to have a long term horizon.
The average annual return on the JSX index since 1992 is 28.7 percent, which compares favorably with the average return on time deposits of 16 percent during the same period.
Rising interest rates in the U.S. have been the major factor behind the poor performance of virtually all stock markets. The effect of rising interest rates is three fold.
First, investors will reconsider bonds or time deposits as a safer way to invest their money.
Second, as a consequence, there is a sell-off of equities as fund managers are raising cash in anticipation of redemptions by investors.
Third, the higher interest rates will impact economic activity and corporate earnings. Given that Indonesia enjoys free foreign currency traffic, and that the rupiah is more or less pegged to the U.S. dollar, interest rates in Indonesia have followed that of the U.S. dollar.
All markets in the region have been affected by higher interest rates. Compared to other markets in the region, the performance of the JSX has not been particularly bad.
However, from time to time during the past year, the JSX has under-performed against its regional counterparts.
There are a few domestic factors that need to be taken into consideration. Weak oil prices, higher than anticipated inflation, political and social turmoil, the problems with the state banks, slowdown in non-oil export growth and too many IPOs are factors that have had a negative impact on investor sentiment.
The weakness in oil prices negatively influenced investor sentiments during the first half of the year. The government projected an average oil price of US$16 per barrel in its current budget.
However, during the first quarter of the current fiscal year, oil prices were considerably below $16, which sparked fear among investors of a budget deficit. The oil price has recovered in the second half of 1994. At the moment, oil prices are $16.35 per barrel, while the average price during the current fiscal year reached $16.09.
The high inflation rate during the year has been a major concern for investors. Inflation in 1994 is expected to reach 9.6 percent, which is almost equal to the 9.7 percent in 1993.
Too much rain in the first half of the year, and too little rain in the second half are just partial excuses for the high inflation.
There are a number of other causes behind the persistently high inflation that requires attention.
Poor infrastructure remains to be one of the main causes of inflationary pressures. Nevertheless, compared to just four years ago, the infrastructure has greatly improved. The speed at which more roads, electricity and telephone lines are coming on line is a clear sign of the government's commitment to tackle the inflationary pressures caused by poor infrastructure.
Further improvements over the next five to ten years are necessary to attract foreign direct investments. The government's policy to build an infrastructure which is sufficient to attract more foreign direct investments, will be one of the key factors behind economic growth over the next five years.
We have no doubt that this policy will be given priority during years of slower economic growth, which makes the infrastructure resilient against a possible economic slowdown.
The wage increase this year and next year have also ignited fears of inflation because of concerns that such rises do not coincide with rises in productivity.
The sharp rise of 27 percent for the average minimum wage in 1994 and another 10 percent in 1995 seems justified and such increases are important to minimize social unrest.
However, the poor export performance of Indonesia's garment industry partly illustrates the devastating effect of wage increases without increases in productivity.
Indonesia needs to continue addressing this matter or else it will be involved in a continued wage-price spiral, which could wipe out the country's export competitiveness.
Virtually all commodity prices have gone up sharply in 1994, resulting in further inflationary pressures. Being a country with plenty of natural resources, Indonesia benefits from this strong positive leverage.
On the other hand, the manufacturing industry is faced with squeezes in margins, caused by a lack of vertical integration, or by an inadequate supply of raw material.
We are projecting inflation in 1995 at 8.5 percent. Higher average commodity prices, higher wages, stronger economic growth, further cuts in government subsidies, a 10 percent wage rise and periodical adjustments of electricity rates will contribute to next year's inflation.
The periodical unrest on the political front in 1994 had a negative impact on the stock market. An increasing number of investors are viewing such unrest as "growing pains" in the process of Indonesia's political maturing. We could not agree more.
We feel that whenever the market might react again to political unrest, investors should view these as buying opportunities.
The new cabinet with its strong presence of highly skilled Moslem technocrats has overcome initial doubts from investors regarding its ability to guide Indonesia into its next 25 years of development. It has gained strong international support for its deregulation and willingness to mention and address fundamental problems.
The Bapindo case showed a surprising level of openness, and as we will explain later, at the end of the day it did not damage investors' perception on Indonesia too badly.
The on-going deregulation, aimed at attracting more foreign direct investments, has enhanced the fact that Indonesia is one of the most attractive places in Southeast Asia for foreign direct investment, and as a result, Indonesia has achieved record foreign investment commitments in 1994.
The much discussed Bapindo case has shown us three important facts, unfortunately at considerable cost to the country.
First, the openness surrounding the Bapindo case and the firm actions taken against the individuals involved will, hopefully, have their preventive effect. This case illustrates the government's policy to be more open and to gradually fight corruption.
Second, by backing the Bapindo's deficits, the Indonesian government has shown its commitment to honor the liabilities of state-owned companies. This is important because it contributes to Indonesia's reputation as a borrower in international capital markets. As a result, even with all the negative publicity that Indonesia underwent, interest rates for Indonesia and for Indonesian private companies have not risen dramatically.
Thirdly, it has now become clear that the state banks need to improve their managements and balance sheets to meet international banking standards and thus prevent them from further deterioration.
It is interesting to note that the private banks have seen their market share rise from roughly 20 percent in 1988 to 50 percent in 1994. As the more efficient and professional private banks increase their market share over state banks, the quality of Indonesia's financial system as a whole will improve, which in the long term will ease domestic interest rates.
Non-oil exports have been a major contributor to growth in 1993 and 1992. Unfortunately, loss of competitiveness and weakness in prices of major export products have caused non-oil export growth in 1994 to decline further to roughly 10 percent, compared to 15 percent in 1993 and 28 percent in 1992.
A combination of factors, several of which have been mentioned above, are responsible for the lackluster export performances in 1994. The disappointing performances of plywood, textile and garment exports are generally seen as the main cause of decreasing non-oil export growth.
Also the absence of significant productivity improvements, high, hidden costs and lack of vertical integration have caused Indonesia to lose its competitiveness to other Asian countries.
Given the recent establishment of more upstream industries, we think Indonesia will regain part of its export share over the next two to three years.
Going into 1995, the outlook for the JSX is favorable. We expect the gross domestic products (GDP) to grow by seven percent, compared to 6.8 percent in 1994. The huge investments in the infrastructure, the realization of record foreign direct investment commitments of $32 billion in 1994 and the effect of tax reforms are main contributors to a higher GDP growth.
Corporate earnings growth will maintain momentum. In 1994, the earnings of the 50 companies that make up the GT-DBS 50 index are estimated to increase by roughly 36 percent and earnings per share (EPS) by 24 percent. For 1995 we are projecting corporate earnings to grow by 26 percent and EPS by 25 percent.
On the negative side, further rises in interest rates will be the major threat for a recovery of the stock market in 1995. However, we expect interest rates to ease slightly in the second half of next year.
Although the huge flow of new issues has been and will be soaking up a large amount of funds, we consider this factor to be positive for the Indonesian capital market. The flow of new issues increases liquidity in the market, while at the same time the market is gaining depth.
With additional companies representing more sectors coming to the market, the stock market will better represent the Indonesia economy, and offer investors better exposure to the Indonesian economy.
Given the strong spending in infrastructure developments by the government and private sectors, companies with an exposure to infrastructure will offer interesting investment opportunities. Demand for infrastructure-related products and services will remain strong over the next five to ten years. While in times of economic downturn, such demand will be relatively resilient.
The acceleration in GDP growth, the effect of the implementation of new investments, tax reforms which have lowered the effective tax rate, 10 percent wage rises for minimum wage levels and strong consumer confidence will continue to benefit companies with exposures to the consumer sector in 1995.
In emerging countries like Indonesia, consumer companies can post growth figures of between at least 10 to 20 percent per annum. With such bright prospects, investors are willing to pay premium multiples for consumer stocks. Now that a number of consumer stocks are trading 10 to 20 percent below their recent highs, investors should increase their exposure to consumer stocks of which some are attractively priced in relation to the their projected EPS growth for 1995 and 1996.
During 1994, foreign investors continued to dominate the trading on the JSX. It should be mentioned that in the past year, activities from local institutional and private investors have increased significantly.
After the implementation of rules for pension fund investments, that were released in April 1993, a number of local pension funds have started to invest in the stock market. At the moment, we estimate the total funds under management by local pension funds at Rp 8 trillion.
We expect that over the next few years, local pension funds will become more accustomed to investing in the capital market, and hence increase their exposure. Potentially, the Indonesian pension funds could become a major market force in the next five to eight years. The trend is very positive because pension funds with long-term objectives are usually the type of investor that can benefit from short term technical corrections like the ones that we have seen in the past few weeks.
Local private investors seem to have returned to the market, although it should be mentioned that their investment strategy remains highly speculative and their time horizon very limited. Once open-end investment funds become available in 1995, private investors should seriously consider investing in the stock market through such funds, and enjoy the benefits of professional fund management.
In conclusion, we believe that the JSX will perform well in 1995, and investors should be buying now. Supported by a strong momentum in economic growth and corporate earnings, we believe that both local and foreign investors will be attracted by Indonesia's strong growth momentum and promising long term prospects.
After the recent weaknesses, valuations are now highly attractive. The GT-DBS 50 index is currently trading at 15 times its prospective earnings, compared to roughly 18 times at the beginning of the year, leaving ample room for attractive capital gains that could easily surpass 20 percent.
Teng Hong Joe is the General Manager of Business Development of PT Gadjah Tunggal DBS Securities in Jakarta.
Windows A: In trading in such emerging markets as the Jakarta Stock Exchange it is important to have a long time horizon.
Window B: Although the huge flow of new issues has been and will be soaking up a huge amount of funds, we consider this factor to be positive for the capital market.
Window C: Demand for infrastructure-related products and services will remain strong over the next five to 10 years. While in times of economic downturn such demand will be relatively resilient.