DNH Financial urges investors to take advantage of ‘window’ period

DNH Financial is urging investors to take advantage of what it described as ‘window’ period midst market’s sideways movement and consolidation process.

“The market’s current sideways movement as only normal and part of its consolidation process while at the same time being highly beneficial to investors. We consequently advise investors to take advantage of this ‘window’ period to do their homework, select between the good and the bad and build a robust portfolio of stocks that will outperform during the secular bull phase. Investors are encouraged to enter the new market cycle breaking away from their traditional expectation of short term speculative gains to longer term sustainable returns,” DNH Financial said in its weekly review. Here are excerpts.

 

Sitting in the wings

The Sri Lanka bourse traded range bound during the week with the ASPI gaining just 0.7%WoW to close at 6784 while the MPI ended the week, a tad higher at 6045(+0.3%WoW). Turnover remained subdued with trading in Lanka ORIX Finance, Regnis and The Finance accounting for 17% of the day’s total. Gainers outpaced losers with Asian Alliance, Singer Industries and Industrial Asphalts rising by 77.9%, 53.0% and 52.8% offsetting losses in Alufab, Sathosa Motors and Tangerine which declined by 19.8%, 14.4% and 12.9% respectively.

Global markets meanwhile closed mixed, ending a mercurial September that witnessed some of the heaviest selloffs since the 2008 Lehman Brothers collapse amidst growing concerns over the Eurozone debt crisis and the prospect of a recession in the global economy. In commodity news, gold prices declined by 1.1%WoW to $1621 an ounce however rebounding from 7-month lows. Given the bourse’s relative inactivity, investors have been largely sitting in the wings in anticipation of a market trigger that would provide the necessary impetus for generating momentum in the immediate term. We believe that the 3Q2011 corporate results would provide the necessary catalyst to propel the market upwards from the sideways flag that we have been experiencing over the last few weeks. While on a PE valuation basis, the bourse has now fallen from 29.5X during the 1Q2011 to 17.5X in 2Q2011, we believe that valuation multiples will experience a sharp decline once the 3Q2011 corporate results are released and factored in. Given our expectation of 30%+ EPS growth for the quarter, we expect the PE multiple to consequently decline to 13.5X, which we believe will trigger a strong buy signal for the market.

 Secular bull market is just beginning

Notwithstanding the sluggish YTD performance of the Sri Lanka bourse, we firmly believe that the market is now establishing itself for a much awaited secular bull run phase which is likely to extend for several years. Having risen by 320% in 2009/10, we find the market’s current sideways movement as only normal and part of its consolidation process while at the same time being highly beneficial to investors. We consequently advise investors to take advantage of this ‘window’ period to do their homework, select between the good and the bad and build a robust portfolio of stocks that will outperform during the secular bull phase. Investors are encouraged to enter the new market cycle breaking away from their traditional expectation of short term speculative gains to longer term sustainable returns.

For global emerging market investors, with valuation multiples flashing green against a solid economic backdrop, the Sri Lanka bourse will provide a strong investment opportunity to diversify portfolios and generate alpha on a consistent basis. Market upswing may extend to several years Although the sideways market movement is vitally important in our view to provide investors an opportunity to restructure their portfolios, knock out dead wood and fly to quality, it has also the added advantage of giving the market the opportunity to allow earnings to catch up thereby compressing PE multiples. The market consolidation will consequently provide a solid foundation for the Sri Lanka bourse to enter a new secular bull phase that could extend for a number of years. As the market gains momentum propelling it to new highs, we expect corporate earnings to grow even faster with robust domestic macro-economic conditions fueling the necessary growth. The net effect would be a low PEG that would attract investment into the bourse on a continuing basis resulting in healthy turnover momentum.

 Consistently high EPS growth will keep valuations in check

Given that a secular bull market generally begins with a low PE and average economic growth, we believe that the current consolidation process will deflate the market to a more reasonable valuation (nevertheless higher than the pre-euphoric 2009/2010 bull run) at a superior economic growth rate. This we believe would provide the tailwind necessary to thrust the market into a prolonged rise resulting in a gradual increase in multiples, however not too high to cause a headwind. We believe that the PE compression consequently will emanate from consistently high EPS growth which would trim any excessive build up in valuations thus keeping valuations at reasonable levels.

Cyclical Vs Secular…which way to go?

With the stock market nearing an inflection point the question now facing many investors is whether to continue to sit in the wings or be positioned to be a part of the new market cycle that will generate supernormal returns in the longer term but in a manner different to the previous bull run phases. Given our expectation of sustained economic growth that should have a strong multiplier effect on corporate EPS in the longer term, we believe that it would be far more prudent to go secular rather than cyclical. While some bullish investors may argue that any upswing in the market could prove to be only a cyclical bull run in a secular bear market, we beg to differ and maintain our conviction that the new market cycle will indeed be a secular bull phase underpinned by strong fundamental factors but far more measured compared to the speculative and highly euphoric 2009/2010 market runs.

Taking this into consideration, it is highly necessary to seek out those sectors and stocks where the secular winds will push prices higher. Our recommendation is to consequently focus on the prime beneficiaries of the domestic economic upswing which will lead secular growth and in this respect, we remain overweight on Banking & Finance, Industrials, Healthcare and the Diversified sectors. Almost a year after the strong bull market rally when the ASPI achieved new all-time highs, investment in the Sri Lanka bourse appears radically different. Investors and speculators alike appear to have taken a back seat regardless of fundamental merit. However, we believe that the current consolidation process provides the ideal opportunity for investors to benefit fully from a prolonged market rise and to adopt a highly selective approach when re-entering the market.