A Follow-up of My Previous Post: "Indonesia's Economic Outlook 2007"

As the title suggests... (see below)

The good fortune for domestic and International investors

Frank van Lerven

These were the returns on stocks for the year 2006 as recorded by Dow Jones and MSCI on Dec. 12, 2006:
World (in US$): +17.4 percent
Europe (in Euros): 14.4 percent
Asia Pacific : + 8.4 percent
U.S. (broad market): +12.3 percent
Asia Pacific excl. Japan: + 21.9 percent
Indonesia: +48.9 percent

These fine returns were preceded by similar, positive returns for every single year, going back to 2003. So, global and domestic investors are now looking at four years of positive returns, most of them in double digits! The JSX (the Jakarta Stock Exchange) has been going from one high to another (now 1,755), but the Dow Jones (now at 12,310) has also reached an all time high. To put this in perspective, the S&P 500 at 1,412 is still off its high, reached in 2000 (1,553), and the Nasdaq 2000 (currently trading at 2,437) is still far off its 2000 peak (5,049)

"Will investors be able to find investments providing similar returns in 2007, and if so, where?" is certainly a question on many investors' minds. By the same token, a prudent investor would be justified in asking another question: "After four years of sun, is there any chance of rain in 2007?" And when the possibility of "rain" is a realistic perspective, investors in the JSX need to be aware that: when it rains here, it pours!

In speaking with Indonesian friends in these last weeks, I definitely pick up that the "chase for high returns" is alive and well. Bankers advise Indonesian investors to consider investing in the JSX, China, Emerging markets and any other markets that have recorded 30 percent plus annual returns in recent years. Also, most analysts in the U.S. have become increasingly positive and confident about the markets, projecting returns in the 8-12 percent range. One of them is Abbey Cohen of Goldman Sachs, who earned some reputation as a bullish analyst in the late '90s.

The economy moves in cycles, and over time, will show phases of: Expansion, contraction (recession) and recovery. Generally speaking, stock prices go up in the phase of expansion, as the world has been experiencing for a couple of years now, but fall in the phase of contraction (recession).

Many studies have been done on the actual returns that private investors make, compared to the funds they invest in. And study after study shows that there is a big difference: Where funds make money, private investors often do not. The reason is: The majority of private investors join the bull market at the end of its run, and then sell when the bear market is about to end.

There are reasons for caution and one of them is the length of the current bull run. According to some commentators, the current bull run in the U.S. equity markets is almost unprecedented, as it is the second lengthiest since World War II and has lasted 89 percent longer than average (according to Ned Davis Research Inc.)!

This "fact" may carry a bias, depending on how one defines bull market, but it is indicative of a notion all investors should be aware of: We had a good run, lasting four years, and these runs do end! The indices presented here, the Dow Jones, FT World Index (both in U.S. dollar and Euros) and the JSX, all clearly show the good run investors have had. The Dow Jones index, going back to 1920, provides a truly long-term perspective.

Indonesian investors have had the best of all worlds for the last couple of years: Excellent returns in the JSX, excellent returns when investing overseas, and excellent returns in investing in property at home!

So, could we be at the end or in the latter phase of a bull run? Or, put in more economic terms: Are we getting close to the Peak of the phase of expansion? And is there a chance that the U.S. economy is heading for recession after a couple of years of strong growth rather than the "soft landing" that most analysts are expecting?

If a true recession scenario in the U.S. materializes, it will be bad for equity investors, wherever in the world you invest! Less than expected earnings will be the news of the day, and the U.S. market will head south. Recession in the U.S. will mean that the U.S. consumers have no money to spend, and this will immediately affect the global economy.

Economists are notoriously bad at predicting markets and psychologists-financial planners, such as myself, do not do better. So, trying to read the newspaper of 2007 does not make sense. However, what does make sense is to identify trends and topics that constitute the key factors influencing where the markets are heading in 2007, and developments in the U.S. will lead the way!

Right now, (time of writing, mid-December) the indicators do seem to point to the "soft landing" scenario and a continuation of the bull market for stocks. Some of the bullish indicators are:

o An unprecedented amount of take-over activity in both Europe and the U.S.

o Lots of cash ("liquidity") around.

Note: One of the trends of 2006 was "Private Equity funds" and "Hedge funds" flexing their muscles

o reasonable P/E ratios, e.g. for the U.S. at 15, Europe at 14 and Asian markets (excl. Japan) at 16.

o Continuing high growth in China, which may positively affect the Japanese economy

The indicators, which point to, at least, slower growth are:

o Lower economic growth figures for 2007 for most developing countries

o Slowing housing market in the U.S.

o Longer term U.S. bonds return less interest than short term bonds (the so called "inverted" yield curve), indicating that investors expect that interest rates will come down, and this would happen when growth slows.

Another factor is the U.S dollar! In the latter part of 2006, the U.S dollar started to drop further against the Euro and the Yen. Few analysts truly understand the specific timing of this downfall, as the U.S dollar has for a long time been seen as "overvalued". However, a further sharp decline would render the financial markets unstable.

So, investors who want to keep some kind of control over their investments should pay attention to:

o how the "slower growth" scenario in the U.S. unfolds. Interest rates staying at current levels in the U.S. (5.25 percent), or coming down slightly, inflation declining from 2.4 percent now to under 2 percent, probably mean that "the soft landing" is in place. A sharp decline in interest rates and inflation can cause turbulence in the stock markets.

o how the U.S dollar fares; if e.g. the Euro-U.S dollar conversion rate stays close to where it now stands (1.33), there would not be any negative effect, but if the rate moves beyond 1.4, this benign picture would alter.

If the "soft landing" in the U.S. materializes, there is, indeed, little to stop the Indonesian stock market from going further, and making new highs in uncharted territory. Interest rates in Indonesia will most likely continue to come down, and this will continue to make stocks attractive

The writer is CFP and FPC qualified financial planning professional.

INVESTMENT STRATEGIES FOR 2007:

Step 1: Assess your base currency

Is it the U.S. dollar, the Euro, the GBP or perhaps the IDR? As currency fluctuations are highly unpredictable, it is a sound advice to:

o Invest at least 50 percent of the stock section in your base currency (example: U.S. dollar holders investing in the U.S. stock market)

o Invest 90-100 percent of the fixed interest section in your base currency (example: Euro holders investing in Euro denominated bonds)

Step 2: Asses your tolerance for risk and diversify between asset classes

Stock markets are volatile and can experience downturns of 40-50 percent. Can you tolerate this kind of volatility and how much time do you have to recover from losses?

A guideline for allocating between the asset classes, considering your risk profile is:

Low risk : 80 percent fixed interest-20 percent stocks

Medium risk : 40 percent fixed interest-60 percent stocks

High risk : 20 percent fixed interest-80 percent stocks

Step 3 for U.S dollar, Euro, GBP investors:

o Invest 70-80 percent of your stock section in the U.S. and Europe (and most of it in the market of your base currency) and 20-30 percent in Asian markets and/or Emerging Markets;

o "Spread" the maturities in your fixed interest section by investing in bonds with short-, medium and long-term maturities. Alternatively, invest in well managed bond funds and/or inflation indexed bonds consider low risk "fund-of-fund" hedge funds", to replace part of the fixed interest section.

Step 3 for rupiah investors:

o Invest 50 percent of your stock section in the Indonesian market and 50 percent "overseas", predominantly in the U.S., Europe, and then Asian markets

o Invest at least 80 percent in Indonesian bonds with medium and long maturities and up to 20 percent in US$/Euro fixed interest funds (to diversify)

Step 4: Assess your appetite for truly high-risk investments (speculation)

If you have a desire to speculate, to get truly high returns, give this part of your financial assets a name: "the gambling envelope". Then consider:

* High growth markets such as India, China, entering these markets using mutual funds

* Playing stock index and currency futures

* Trading in options

* Investing in one stock

Be realistic with your expectations about returns in the Chinese stock market; this market may be overbought at current levels. Consider the Japanese stock market, as this has been the one market that did not perform in 2006, and so may be well positioned to catch up with the other global markets in 2007!