Equity markets are driven by not only underlying earnings but also the momentum generated from storytelling. We know that the intrinsic value of stocks — and, accordingly, valuations for the broader market — is determined by its discounted future cash flows. This is what we are taught in school. Yet, observations of the real world also tell us that some markets (and stocks) always trade at higher relative valuations while others can stay cheap for a very long time. We are fundamentally driven analysts, but we cannot deny that markets need good stories to thrive.
Last week, we wrote about how very good storytelling successfully attracted massive investor — and speculator — interest in Nvidia Corp and Tesla, lifting their valuations far higher and for far longer than underlying earnings could rationalise or justify (see “Nvidia and Tesla — the gods of storytelling — and speculative gambling”, The Edge, Sept 23). Liquidity and momentum matter because the equity market is a market for stocks — prices and valuations are driven by demand and supply. In short, markets with higher liquidity tend to trade at higher relative valuations.
And higher relative valuations are critical, not just for the listed companies and stock investors but also for the nation as a whole. High-quality companies — with the best stories and growth prospects — can and will choose to list in the market that gives them the highest valuations. This perpetuates a virtuous cycle — good stories attract investors and improve liquidity, generate momentum and raise valuations that in turn attract more companies with good stories. An efficient and robust equity market has the ability to attract and retain capital — foreign and domestic — that goes to fund investments, create jobs and drive economic growth, innovation and prosperity. There is no better example than the US stock market.
The US equity market has the breadth and depth to attract larger and larger amounts of capital from investors, domestic and foreign. Fund inflows enhance liquidity and boost stock valuations — companies can raise monies “cheaper” to spend on capital expenditure (capex), which fosters innovation and growth. (Similarly, robust capital inflows into its bond market — corporate and sovereign — keep borrowings costs lower relatively, to finance capex, development and social programmes. Government deficit spending injects cash into the circular flow of the economy and into the business sector.)
Of course, it is enabled by the US socio-political and economic structure that allows capitalism to be resilient and adaptive, free market competition, strong protection of private property rights, entrepreneurship, skilled labour force, rule of law and so on.
Chart 1 shows some key valuation metrics for the major global stock markets. Over the past 15 years (2010-2024), the Standard & Poor’s 500 index has traded at a higher price-earnings ratio (PER) and price-to-book (P/B), on average, compared to the bellwether indices in China, Germany, Malaysia and Singapore, though slightly lower than India. Why?
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To be sure, earnings growth for US stocks has been strong over the period, averaging 7.4% annually. No surprise, then, that the market has done well — stock prices and valuations must be supported by underlying earnings and growth.
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Here’s the thing, though: German corporate earnings have expanded at a more or less similar pace to the US, at 6.5% annually on average, plus higher dividend yields. And, yet, valuations are significantly lower. The DAX traded at a PER of only 14.4 times and P/B of 1.6 times compared to the 19.4 times and 3.2 times respectively for the S&P 500 (see Table titled “The US stock market is better at storytelling”).
Why the huge disparity? The US stock market is simply better at storytelling! Remember Nvidia and Tesla? As we said last week, good stories attract investors, improve liquidity and generate momentum that boost valuations. The US market — with high liquidity and market depth — attracts a wider range of investors with differing strategies and, yes, that includes speculators. We would go so far as to say that a degree of volatility and speculators are integral to a vibrant equity market. Fear and greed drive markets.
Without a compelling story, cheap markets can stay cheap for a long time. Absolute low valuations on its own — whether in terms of PER, P/B or other metrics — cannot drive markets. There are simply too few Warren Buffetts in this world, the investors who have the discipline to buy for value and are prepared to sit and wait for years, even decades, for that value to crystallise. And when valuations stay persistently low, these markets lose out when it comes to attracting high-quality listings, especially those with good, exciting stories. Low liquidity is unattractive to investors — illiquid stocks tend to trade at a discount, to compensate for the risks that investors cannot exit easily and quickly when they wish to.
Malaysia had a good story in the early 1990s, prior to the Asian financial crisis (AFC). It was a story of industrialisation, rapid economic growth driven by strong investments, market liberalisation and privatisation of large state-owned corporations. Also, there was a massive dose of speculation. People were talking about stocks at the water coolers, coffee shops and even fish markets. It is not so different from meme stock traders discussing strategies in online forums such as Reddit today (remember, technology is just the enabler). Bursa Malaysia (then known as the Kuala Lumpur Stock Exchange) was among the most exciting stock markets in the world. Trading volume and liquidity was huge and, in some days, even exceeded that of the New York Stock Exchange. The Malaysian stock market story ended with the AFC and has yet to regain its lustre in the 25 years since.
Investor confidence was severely damaged with the imposition of capital controls. In addition, we have previously written about the shift in valuation methodology for IPOs on Bursa, which now favours the founders and promoters — in the heydays of the early 1990s, being allotted shares in an IPO was almost akin to striking the lottery. Today, little money is left on the table for the retail investors post-listing. No profit, no excitement, no story.
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To make matters worse, earnings growth for Bursa-listed companies post-AFC was clearly inferior. This is also a reason that the Singapore Exchange S68 (SGX) has underperformed — relatively slow earnings growth. Even though dividend yields are comparatively higher, stock investors typically value growth over yields. Investors who invest for yields would most likely buy bonds, which offer similar returns with much lower risks.
Reforms, reforms and reforms
The reality is that large markets such as the US will keep attracting more funds, which underpins its economic dynamism and growth. More liquidity leads to bigger premium valuations. They will attract more and better quality company listings, giving investors ever more choices — and ultimately squeezing out smaller markets. This is why stock market operators and regulators in the rest of the world are growing increasingly concerned that their capital markets are being marginalised, and why they are undertaking reforms to attract global investors and improve market valuations.
The Japanese stock market is one such success story. We first highlighted this in December 2023 and, again, in our column on Jan 29, 2024 (see flashback and scan the QR code for the full article titled “Japan finally got it right ... better late than never”). In early 2023, the Tokyo Stock Exchange (TSE) issued a directive to all listed companies, especially those whose shares are trading well below book value, to enhance corporate governance and transparency, and boost shareholder value and returns. Companies are required to “comply or explain” and disclose action plans on how they intend to improve capital efficiency — or face the prospect of being placed under supervision or even delisting. The objective was to make the bourse more attractive to global investors.
Since then, a growing list of companies have initiated plans to do exactly that — including implementing share buyback programmes, distributing more dividends, selling non-core assets (such as real estate investments unrelated to the core business) and low-margin businesses to improve capital allocation, unwinding cross holdings, improving corporate governance and being more open to ideas from activist shareholders. Proceeds from the sale of idle real estate, for instance, can be channelled into new investments/businesses, digital infrastructure and/or growing core businesses. The result — Japanese stocks saw a surge in interest from global investors, including investments from Warren Buffett’s Berkshire Hathaway. Valuations improved and the Nikkei 225 index surged to fresh all-time record highs for the first time since the asset bubble burst in the early 1990s (see Chart 2).
South Korea launched its equivalent initiative, the “Corporate Value Up” programme, to address the persistent “Korea discount” on its stocks, which was due primarily to perceived corporate governance weakness, especially among the chaebols. The push to enhance corporate governance, improve disclosures and communications with investors and boost shareholder value is part of broader efforts to narrow the gap between the market value and intrinsic value of listed companies.
In a just-released report on European competitiveness, former European Central Bank president Mario Draghi stresses the need for a unified capital market across the European Union. The goal is to deepen and integrate currently fragmented capital markets in Europe, making it easier for companies (including small and medium enterprises) to raise funds and for investors to invest across borders. Part of the report focuses on the need to boost retail investor participation by improving financial literacy and greater transparency on investment products, among others. Europe’s economic growth and capital market gains have significantly lagged those of the US market in the past two decades.
Conclusion
Frankly, it would be difficult to emulate the US stock market’s attractiveness, which is aided by the US dollar hegemony. Equally, there are significant differences in the structure of the economies — and hence, the types of companies. For example, the US economy is driven largely by the services sector and consumer spending, underpinned by high per-capita income. The largest listed US stocks are tech and software companies with high growth potential, and strong “innovation for the future” stories. The Malaysian economy, by comparison, is still heavily dependent on low value-added manufacturing and commodity exports. And the largest companies on Bursa and SGX hail from the “old economy” — banks, telcos, property developers and real estate investment trusts, construction and building materials and plantation companies — stocks that are unlikely to generate strong investor excitement.
Some have lamented the number of delistings and lack of new IPOs on the SGX. But it is not simply about the number of listed stocks; rather, it is their quality and growth prospects. As we have noted before, the majority of large IPOs on Bursa in recent years have really been exit strategies for near-mature businesses (near or at the top of their S-curves). In other words, it is a weak earnings growth outlook. Furthermore, a substantial percentage of the monies raised went to their founders and promoters, not the company. In the US, companies typically go for listing at a much earlier stage, where the primary objective is to raise capital for growth.
Having said that, many of the reform measures such as those undertaken by TSE, while not comprehensive, are probably realistic goals for Bursa and SGX. Corporate governance reforms to boost shareholder values are good stories, which have been proven to be effective in attracting global investors and improving valuations.
We have written many articles on this subject over the past few years. The stock exchanges and regulators should encourage more share buyback programmes (with appropriate guardrails against share price manipulation to reduce public distrust) and shareholder activism. Companies in the US spend far more on share buybacks than on dividend payouts annually, and the share prices of companies with large buyback programmes have tended to see stronger gains.
Surely more could be done to more forcefully address companies trading persistently below book value, including holding companies and those with lazy balance sheets. Companies with negative enterprise values, trading below even their net cash, would be an excellent starting point. Often, we see controlling shareholders content to earn too-low yields on their cash pile while paying themselves fat salaries.
In the US, corporate governance and activist shareholders are much more robust in calling out companies with poor shareholder returns. Top managements are typically paid mostly in share options, which aligns their interests with those of minority shareholders.
The relative lack of liquidity, we think, is another key reason that Bursa and SGX have underperformed over the years. And part of this is due to our own doing. Since the AFC, the presence of local institutions such as the Employees Provident Fund (EPF) and government-linked companies/government-linked investment companies (GLCs/GLICs) has been increasingly dominant on Bursa. For instance, EPF’s shareholdings as a percentage of total Bursa market cap has grown about 50% over the period. This had the effect of lowering free float (liquidity) and stamping out much of the price volatility — these local institutions are ready buyers in the market. Case in point: The free float for the FBM KLCI is currently less than 30%, with more than 70% of issued shares owned by GLCs/GLICs and company owners/insiders. The comparative free float for the STI is better, about 65%, and for the S&P 500 index, a high 95%.
These domestic institutions are crowding out retail investors. And, quite frankly, nothing kills speculative activities faster than low price volatility. An active and vibrant equity market needs all types of investors, including speculators. We should not fear price volatility. The Magnificent 7, the leaders in the US equity market rally, as a group has higher price volatility than the overall market (beta >1). Microsoft Corp has the lowest beta, at 1.07; and Nvidia, unsurprisingly, has the highest, at 1.74.
Higher price volatility encourages speculative trading — not only in the stocks but also fosters the development of the derivatives market. Yes, Bursa has many listed structured warrants but, with limited price volatility in the underlying stocks, there is minimal investor interest. In fact, most go through the day with zero volume traded. More actively traded derivative products will surely improve the market’s breadth and depth, all of which generate liquidity. Higher liquidity generally leads to higher valuations. And better valuations are critical for the continued development of the country’s capital markets and bolster economic growth.
The Malaysian Portfolio gained 0.5% for the week ended Sept 25, underperforming the benchmark FBM KLCI, which gained 0.8%. KSL Holdings (5.1%), Gamuda (3.6%) and LPI Capital (1.5%) were the top gainers while Insas Bhd – Warrants C ended 4.8% lower. Total portfolio returns now stand at 197.9% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 8.5% over the same period, by a long, long way.
The Absolute Returns Portfolio continues to perform well, gaining 2.1%. Total portfolio returns since inception now stands at 12.4%. The top gainers were CrowdStrike (+7.2%), Tencent Holdings (+6.8%) and Swire Properties (+4.4%); and the top losers were DR Horton (-3.6%), Berkshire Hathaway (-0.9%) and OCBC (-0.1%).
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
