Performances of most equity markets started out strong in the first two months of 2007. However, at the end of February and in the middle of March, many equity markets suffered quite a bit of volatility.

After computing the net returns of the equity markets in the first three months of 2007, we found that returns of most bourses stayed relatively flat. Out of the 16 market indices we studied, only 6 achieved positive returns (index returns are in SGD terms). The flat performance of world equities showed as the MSCI World Index rose only 0.9% in the first quarter of 2007 (as at end March 2007). The good news is that we saw far stronger returns from the region that most of our investors live in - which is South East Asia. The Malaysia KL Composite Index was up a stunning 14.7% in just a single quarter. In addition, the Singapore Straits Times Index (STI) rose 8.2% during the same period. Table 1 shows the market performance scoreboard for the first quarter of 2007. As exciting as this might be for investors overweight in Singapore or Malaysian equities, the situation is quite different for those who held on to Chinese and Indian equity funds. There were some corrections in the month of February and March in these two bourses that led them to lag behind the performance of their Asian peers.

In the past two weeks, there was a turn of sentiment and many markets showed strong improvement in performances of some Asian market indices. For example, if we extend the period of study to 4 April 2007, the return for the Korean market, represented by the KOSPI is +1.6%. The Indonesian market, represented by the JCI, returned 4.4% in the same time period, a marked reversal from the lackluster return of -0.7% in the first quarter.

Nonetheless for this report, we would be mainly going through performances of the markets in the first quarter and also our views on these best performing markets.

Table 1: Market Performance Scoreboard

Source: Bloomberg. All returns are expressed in SGD terms without dividends reinvested, SET returns are reflected in terms of onshore THB/SGD exchange rates.

Malaysia, as represented by the Kuala Lumpur Composite Index (KLCI) was the best performing market in the first quarter of 2007. The Malaysian bourse returned 14.7% in the first quarter of the year. The second best performing market is the STI, which delivered a return of 8.2%. In this update, we will examine the reasons behind the strong performance of the top three best performing markets. Adding to that, we are also highlighting our outlook for these markets and some of the reasons why we are positive towards Malaysia and our very own Singapore bourse.

Malaysia (KLCI up 14.7%)

Investors took well to the slew of positive news that was announced in Malaysia and the bourse was the only one that spotted a double-digit return in the first quarter of 2007. One of the positive news came in when the Ninth Malaysian Plan (9MP) was released in March 2006. The gist of the 9MP is that it is a five-year blueprint outlining the policies and key measures aimed at fulfilling Malaysia's aspiration of becoming a developed nation by 2020. This blueprint is slated to help improve Malaysia?s economy through certain objectives such as improving corporate governance, moving the economy up the value chain and improving the business environment. Over the lifetime of the Plan, proposed to last from 2006 to 2010, the Federal Government has targeted a 17.6% increase in spending on development and infrastructure projects. Given that there would be higher levels of investments upon the commencement of several 9MP projects, this is likely to lead to a recovery in the engineering segment of Malaysia's economy, and is likely to benefit the civil engineering segment, which includes engineering and construction companies. Companies in this sector such as UEM World Bhd, Dialog Group Bhd and Gamuda Bhd delivered 156%, 74.2% and 56.9% respectively in this period (in Ringgit terms).

The second piece of good news comes from Malaysia's Prime Minister Abdullah Ahmad Badawi's announcement on the scrapping of capital tax on property sales on 22 March 2007. Previously, foreigners could only take on up to three loans for the purchase of commercial and residential properties. However, the central bank has abolished this ruling and that means it allows foreigners to take up more than three loans to pay for their purchases of Malaysian properties. We think that the implication of liberalizing the property sector means potentially higher demand for premium properties. In addition, it is likely that real estate companies specializing in premium housing developments will benefit. As such, five out of the top 10 performers in the KLCI are involved in the real estate business. These companies including Selangor Properties, Guocoland and SP Setia Bhd have turned in strong performances in this quarter of more than 50% (in Ringgit terms).

In the financial sector, Malaysia's exchange has introduced a new Islamic index together with the FTSE Group. Foreigners investing in the Islamic financial sector are allowed 100% equity ownership, up from a previous ownership limit of 49%. Adding on to that, incentives and tax breaks are given to Islamic financial products. Foreign Exchange Administration Policies have also been relaxed to promote greater flexibility for business to manage and finance investment opportunities. As such, onshore banks now have greater flexibility to undertake foreign currency businesses. Also, to widen the investor base for Ringgit assets and financial products, non-resident stock broking companies and custodian banks have the added flexibility to obtain Ringgit overdraft facilities. With these positive moves made to enhance the level of flexibility in Malaysia's financial sector, banks like Bumiputra-Commerce Holdings Bhd, AMMB Holdings Bhd have enjoyed strong returns of 28% and 21% respectively in the past quarter (in Ringgit terms).

As at end March 2007, the PE for the KLCI was 16.4X for 2007 and 14.4X for 2008, which is slightly more expensive relative to the past 5 years' average of 15.7X. We think that the Malaysian equities market is attractive with earnings growth at 13.7% and 13.2% for 2007 and 2008. In our latest Star Ratings, we have upgraded the Malaysian equities market from 3.0 stars to a 3.5 stars rating.

Malaysia is not the only country that took up policies to improve the business environment. The Singapore government also took up some measures to attract foreign businesses to set up shop in the nation.

Singapore (STI up 8.2%)

In the budget released in February this year, the government cut the corporate tax to 18% from 20%, increased employer's contributions to CPF by 1.5% to 14.5%, and hiked GST by 2%. With lesser corporate taxes to be paid, corporate earnings are expected to increase, with companies deriving most of their business in Singapore benefiting the most. The Ministry of Trade and Industry (MTI) has revised the projected economic growth rate in 2007 by 0.5 percentage points, to between 4.5% and 6.5%. Real estates companies have turned in strong returns this quarter, continuing their strong run since June 2006. As premium housing prices continued to climb, stock prices of developers also rose in tandem. Real estate companies like Wing Tai Holdings, Keppel Land Ltd, Allgreen Properties Ltd and CapitaLand Ltd can be found on the list of the top 10 performers in this quarter, returning more than 30% respectively

Monetary Authority of Singapore (MAS) reduced banks' tier 1 capital to 6% from 7%, effective from March 1. This change allows banks to free up more funds from new loans. On expectation that loans growth would be strong on both the corporate and consumer sides, as well as increase in fees income from wealth management and corporate advisory services etc, OCBC and UOB registered returns of 17% and 8% respectively for this quarter, while DBS dipped 5%.

As at end March 2007, the PE for the STI was 17.3X for 2007 and 15.6X for 2008, which is more expensive relative to the past 5 years' average of 15.9X. We think that the Singapore equities market remains attractive with earnings growth at 6.9% and 10.6% for 2007 and 2008.

Other equity markets that delivered positive returns on a year-to-date include Europe, Emerging Markets and Japan. These markets were up marginally at 1.7%, 0.6%, 0.4% respectively. Instead of focusing on these markets which showed relatively flat performances, given that some of the best performing equity markets including India and China turned out to be the worst performers in the first quarter, let's look at some of the reasons for the underperformance of these markets.

Worst Performing Markets

The three worst performing bourses year-to-date on our scoreboard were India, China and Hong Kong. The India market, represented by the Mumbai Sensitive Index or SENSEX, was down 4.6%. The China bourse, represented by the HSMLCI and the Hong Kong market, represented by the HSI, lost 3.5% and 2.4% respectively. Incidentally, China was one of the markets that we found attractive. On the other hand, we were quite negative over India as we think that valuations are now at a premium to historical levels. What were the reasons behind the lackluster performance and what are our views on these markets going forward?

India (SENSEX down 4.6%)

Indian equities turned out to be the worst performing market in the first quarter of 2007. We were not fond of the market in the beginning of the year as valuations for the market are on the high side and the government is likely to take up contractionary monetary policies to curb inflation in the economy. Inflation has stayed close to 2-year high levels, ranging from 6.5% to 6.8% in the past two months. India's inflation was 6.5% in the week ended 23 March and stayed above the Reserve Bank of India's (RBI) tolerance level of 5% since September 2006. Since March 2006, the RBI has raised its benchmark repurchase rate six times, including the latest rate hike on 2nd April 2007. Rates are at a four-and-a-half year high of 7.75% as at 2nd April 2007. Large banks in India such as ICICI Bank, which commands a 30% share of retail lending in India, raised benchmark interest rate on all floating-rate loans, including mortgages, by 1% to 12.75%.

Hikes in interest rates generally do not bode well for businesses thinking of borrowing monies to expand their businesses, or individuals who are thinking of purchasing real estate. In line with the hike in interest rates, banks were the worst hit in the first quarter of 2007. Two out of the ten worst performing members included in the SENSEX were banks. HDFC Bank Ltd and State Bank of India lost 11.3% and 20.3% respectively (in INR terms). One of the biggest banks in India, ICICI Bank shaved 4.2% off its market price (in INR terms) in the first quarter. This shows that investors were quite affected by the continued efforts to cool the Indian economy down through the hiking of rates.

Rising inflation rates is not the only problem that India is facing. According to a report from Bloomberg, the International Monetary Fund (IMF) commented that factories and power plants in India are running at close to their limits, as unprecedented bank lending and higher salaries fuel rising consumer spending. The SENSEX fell 4.6% in SGD terms in the first quarter. As at end March 2007, the PE for the Indian bourse was 21.9X for 2007 and 19.6X for 2008, which is more expensive relative to the range of 10.6X to 23.6X in the past 4 years. We think that the Indian bourse continues to trade at a premium. Earnings growth is at 14% and 11.5% for 2007 and 2008. The bourse has been going through some form of correction since the middle of February. We think that the market will continue to adjust itself until it reaches a fairer level of valuation.

China (HSMLCI down 3.7% and HSI down 2.4%)

The China and Hong Kong markets had suffered a 3.5% and 2.4% loss respectively (in SGD terms) for the first quarter of 2007. Since early 2007, we did expect that the Chinese and Hong Kong indices market would experience greater volatility, especially the banking sector. In a report named Greater China Markets - What?s Next?, we noted that the China market was valued more expensively than a year before and we did expect volatility to be rife. Other than market weakness, losses can also be attributed to the weakness of HKD with respect to SGD. The HKD appreciated by 1.6% against the SGD during the period. On the economic front, China still appears to be one of the fastest growing emerging nations.

The China economy has been growing at the fastest pace in the last 10 years posting an annual GDP growth of 10.7% in 2006. Asia Development Bank (ADB) forecasts that China?s economy will grow 10% in 2007 and an average of about 9% for the next 5 years. Inflation is forecasted to stay below 2% in 2007. In fact, there were still some stocks in China that did well during the first quarter.

An example would be China Mobile, which is the largest weighted stock in the HSMLCI. China Mobile was still up 5.7% (in HKD terms) during the period. However, the banking sector, which we spotted expensive valuations, did not perform well in the first quarter of 2007. The worst performer within this sector was China Construction Bank, which retreated by 9.7% (in HKD terms). The Bank of Communications also dropped by 14.9% (in HKD terms) during the same period.

Another piece of news would be the unification of tax rates for both foreign and domestic companies in Mainland China. We think that it would likely benefit domestic companies such as domestic banks as they would be paying lower taxes from 2008 onwards. It could also spur the growth of private enterprises, which has been at a disadvantage in comparison to foreign enterprises (which had preferential tax treatments beforehand). Despite the weak performance of the China market in the first quarter of 2007, the estimated earning growth for the market is very positive. For 2007, earnings are estimated to grow by 29.3% and 17.3% for 2008. Our outlook on the China market remains positive, moving forward.

For the Hong Kong market, HSBC suffered the largest index point drop in the period, and retreated by 4.8% in HKD terms. Poor stock returns from HSBC are likely to be more related to the writing off of sub-prime loans reserves in the US. However, the Hong Kong economy still showed strong growth of 6.8% in 2006. The Hong Kong economy has still benefited from the spill-over effects of the Mainland China, especially in terms of the stock market, as well as retail sales. Some property stocks such as Hang Lung Properties, however, were supportive to the HSI in the first quarter. Hang Lung Properties was up 12.1% and Cheung Kong Holdings was up 3.3% (both in HKD terms). Nevertheless, as compared with China based companies, Hong Kong companies are having weaker earnings growth and the property sectors are less promising than those stocks with operation in mainland China. Thus, we maintain a neutral or 2.5 stars rating on China.

Conclusion

Equity markets delivered pretty strong returns in the beginning of 2007. However, in the months of February and March, equities experienced quite a bit of volatility, with some corrections happening at the end February and the middle of March. Despite the volatility experienced in the first quarter this year, the Malaysian and Singapore indices stood out as the best performing markets in the first quarter of 2007. These top performers delivered returns of 14.7% and 8.2% respectively in a short span of three months. We think that both the Malaysian and Singapore markets remain attractive based on the reasons that we have given in the first part of the article. Valuations for these markets are at reasonable rather than very attractive levels. However, we think that given reasonably good earnings growth propelled by pro-business policies taken up by both governments, we think that both markets show good investment prospects for the rest of the year.

At the bottom of the list are India, China and Hong Kong. While China is still one of our favorite Asian single country markets for the next three years, we think that the market will experience strong levels of volatility. Based on our assessment, despite the lagging performances from the China market, we still see strong potential from the strong estimated earning growth. We continue to think the China market is attractive.

There was a marked rise in volatility for a number of the Asian markets, but we still think the region is very attractive. We expect that for the rest of the year, equities will outperform bonds, and have positioned our Fundsupermart recommended portfolios to reflect this view on asset allocation. As at end March 2007, estimated PE for the Asia ex-Japan market appears to be reasonable at 15.2X and 14.5X for 2007 and 2008. In addition, earnings growth is at healthy levels of 15.7% for 2007 and 11.4% for 2008. Given that fundamentals in this region remain sound, we continue to be bullish on Asia ex-Japan equities.

Fundsupermart.com is Singapore's largest online distributor of unit trusts, and is the online distribution arm of iFAST Financial Pte Ltd. iFAST Financial is a holder of the Capital Markets Services License and Financial Adviser's license by the Monetary Authority of Singapore and is a CPFIS Registered Investment Administrator (IA).

No investment decision should be taken without first viewing a fund's prospectus. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice.

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