Most global equity markets in 2011 ended lower with the exception of the U.S. and a small number of Asian countries such as Indonesia. The U.S. economy continued to show signs of stabilization, evident from better employment and confidence numbers. We believe this momentum will continue as we move into 2012. On the other hand, concerns continued to mount in the Eurozone, where the PIIGS’ debt issues and lagging competitiveness of countries in Southern Europe have not been addressed convincingly yet.
Most Asian equity markets saw negative returns in 2011 due to broad-based global risk aversion. North Asian markets performed relatively poorer compared to ASEAN markets. The former are more exposed to the global cyclical sectors in general, and to the Chinese economy in particular, which also showed signs of slowdown in the second half of 2011. The Indonesian equity market was amongst the best performing markets, with the JCI returning +3.2%.
Indonesia concluded the year with the announcement of two important events. First, the country’s credit rating was upgraded to investment grade by Fitch, a long awaited event since the country lost that rating in 1997. The fixed-income market reacted positively, with the 10-year local government bond yield falling to 6%, two percentage points lower than that at the beginning of the year. Second, the Indonesia Parliament passed the new land acquisition bill, a critical milestone for the development of infrastructure projects in the country.
The outlook for Indonesia in 2012 remains bright, with GDP growth expected to be more than 6%, strong consumer confidence and FDI. We are hopeful that the passing of the land acquisition bill will spark a new investment and infrastructure spending cycle over the medium term. This is something sorely needed given the congested roads and high cost of doing business in the country. President Susilo Bambang Yudhoyono understands the importance of infrastructure spending and has put the implementation regulation for the land acquisition bill on an accelerated program. Continued success in this area would help to safeguard the sound Indonesian economy from less benign developments in the rest of the world.
Bank Indonesia has started to ease monetary policy through cutting of benchmark rates twice since November 2011. We believe the central bank is prepared to reduce rates further should the macro environment deteriorate significantly. On inflation, we are watchful of a re-acceleration in consumer prices in 2H 2012, as the government is expected to remove fuel subsidy for private vehicles by April 2012. The implication of such policy action is that it may raise inflation rates indirectly through higher logistics and transportation costs.
On investment opportunities for equities in 2012, we believe construction and toll road companies are a good way to benefit from higher infrastructure investments. Other sectors that we favour include domestic consumption stories, media companies, auto-related companies, industrial estates and companies that will benefit from lower funding costs. But we are mindful that the macro environment remains uncertain and that the Indonesia market valuation is no longer as attractive as before given the spectacular performance over the last 3.5 years. As such, our emphasis will be on stocks that are laggards and with good risk/reward trade-offs.
We are cautious on the energy and coal sector over the short-term given the slower growth in China and the developed economies. We also expect to see greater competition amongst banks, which will affect their net interest margins and operating income. Large banks, with their strong branch franchise and correspondingly large deposit base and lower cost of funds, will fare better than smaller ones.
As to interest bearing instruments, local currency yields have already dropped significantly and the room for further decreases in our view is small. However, given the relatively high yields in government bonds in Indonesia and active purchases by authorities, it is also difficult to believe in sharp price corrections, in particular for longer maturities.
The Rupiah could come under pressure should foreign investors again become more risk conscious. Foreign ownership in equity and fixed income is high, compared to historic experience. Bond yields could then rise for the same reason. We continue to remain slightly underweight duration at current yields and would opportunistically accumulate government bonds with longer maturities in case of price corrections.. We have a positive view on quasi-sovereign and high quality corporate bonds as they still offer attractive spreads compared to government bonds.