Let's get the facts straight: we are definitely no longer in the early stage of the current stock market cycle. However, I don't think we are anywhere near the end of a late cycle either.
From a macroeconomic perspective, a late-cycle economy has normally been associated with overheating economic growth, high and rising inflation, rising policy interest rates to curb inflation, and price bubbles forming in some assets.
This late cycle will come close to an end when the interest rate is so high that it starts to slow down growth, bringing down the long end of the yield curve. This will lead to a flat (or even inverted) yield curve, a sign normally associated with a coming economic downturn.
From a market perspective, the late cycle is normally characterised by stock prices rallying well beyond levels that earnings can support, and price-to-earnings ratios rising far above the historical average, pushing down earnings yields. The cycle comes to an end when rising interest rates start to hurt growth expectations, which leads to prices collapsing.
So, are we in the late cycle? We probably are at the beginning of it. However, the late cycle can last for several quarters or even years.
In the global scheme of things, US economic and market conditions are probably leading the pack. Thailand is still far behind. The US has already raised its policy rate seven times since the end of 2015. Some emerging markets have started to follow suit. But Thailand hasn't even made its first rate move.
NO OVERHEATING
Our GDP growth is nowhere near overheating. In fact, it only breached 4% year-on-year (considered the new normal for Thailand) in the second half of last year, driven mainly by exports, while domestic demand was persistently sluggish. Private consumption growth just broke above 4% in the second quarter of 2018 for the first time in five years.
Headline inflation only climbed above 1% in April 2018 and has stayed in the range of 1% to 1.5% for the past few months. This is still at the low end of the Bank of Thailand's inflation target range of 1-4%. Without inflationary pressure, there is no need for the central bank to hurry raising its policy rate.
There could be some bubbles forming in some assets, as the central bank often worries about "yield searching" behaviour that could lead to instability in the future. However, if there was an equity market bubble, the recent correction deflated it.
When the SET index reached a new high of around 1,850 points in February, nearly achieving our 2018 year-end target just two months into the year, it pushed the SET index PE ratio to around 2.5 standard deviations (SD) above its three-year moving average, almost forming a bubble. (Any move above 2SD tends to be seen only around 5% of the time for most stocks.)
External headwinds including trade tensions and emerging market currency declines have cooled the SET rally we saw in the first quarter of this year. While these external factors have not had a severe direct impact on the Thai economy, they have helped bring market valuations to a more reasonable level.
During the past two months, the SET index dropped below 1,600 before recovering to around 1,700. The swing helps to remind local investors that equities can be very volatile and should be priced accordingly. A market that has cautious investors is unlikely to overheat.
The good news is that during the recent market consolidation, corporate results for the first two quarters showed strong earnings growth of nearly 8% year-on-year. As prices drop and earnings rise, the PE ratio comes down, bringing down the risk of an overheating market.
HEALTHY DEMAND
Meanwhile, the central bank's most recently updated monthly economic indicators for July point to continuing growth in domestic demand, driven by improving farm income, and strong consumer confidence. This is a good start for third-quarter numbers.
The external balance remains strong with a year-to-date current account surplus of around $22 billion. This should help shield the country from the impact of currency crises in other countries, mostly caused by unsustainable external balance deficits.
We expect the SET Index to perform reasonably well during the last four months of the year. Earnings are on track to achieve our full-year growth target of 8-10% year-on-year, while the SET index is down 2% year-to-date.
There is a good chance that the index will soon catch up with its fundamental earnings growth. We maintain our year-end target of 1,900, up 10% from the current level.
Our top picks for September are based on: a new investment cycle that should benefit industrial estates (AMATA, WHA); improving consumption and domestic demand helping out-of-home media players (PLANB); and the chicken price cycle bottoming out, which will lead to a turnaround in broiler profitability (CPF, GFPT).
Pornthep Jubandhu is the senior vice-president for the Investment Strategy Department at SCB Securities Co Ltd.