It has been a while since the beginning of 2014. This is a year of surprises. Despite the muted outlook that we had in the beginning of the year, IHSG actually turned out quite well.

Jokowi and the Other Guy

 

There were two big rallies that marked the first half of the year. The first one happened when Jokowi announced that he would run for presidency. The second one happened when Jokowi was expected to win the election. So much euphoria that the market seemed not to care about the true fundamental of the reality. Was this euphoria warranted?

 

We will try to provide our coarse opinion (which might actually turn out to be dead wrong). One of the hallmark of the other guy’s plan is to increase the country debt load. We are unable to find the original source of this statement, but you can read it here and here. The plan sounds very simple. To increase the economy growth, you increase the leverage. This is actually very good idea when the economy is expanding. If you are a company, when times are good, you will use the availability of credit (especially cheap ones) to fuel your expansion. The company will do very well because the return of investment will be better than the cost of your fund.

 

However, this route might not be as good as it sounds. First of all, economy growth is not everything. Increasing economy growth from 5% to 10% alone is not enough. How you achieve the number also matters. Introducing more debt in the system would ramp up the number but it would also introduce a lot of waste and inefficiency. When liquidity is good and money is not tight, people do not spend time on improving efficiency. That is why sometimes you need a economic cycle to ensure the expansion is done in the up market and cost cutting is done in the down market.

 

Second, the other guy’s plan needs to be seen in the larger context. Our economy has grown explosively since 1998 crisis. This could be attributed to the rise of export (especially coal and palm oil), the increase of leverage (external debt grew from 140bio in 2004 to 260bio in 2014), and the global cheap credit. For 2014, the situation might be different. Coal and Palm oil do not contribute to the export as strong as they were in the earlier years. Price has been tough, even though the volume might increase. At the same time, as seen in the graph below, the country has been quite relaxed in term of importing goods. Beginning 2004, armed with the cash obtained few years earlier, the country started to increase its import. This is very good if the country is importing capital goods such as machinery and building materials. Apparently we are importing quite a number of cars, phone, and oil. In 2013, we exported $11.5 bio of palm oil and $26.4 bio (based on 330MT x $80/MT, please correct me if I am wrong), we imported around $3 bio of cellphone and $29 bio of oil. We exported tonnes of raw materials and imported a lot of processed goods. With the weakening of the price of coal and palm oil, the trade deficit might cause some hiccups if it is not caused by the right capital allocation (phones instead of road, infrastructure).

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Indonesia Balance of Trade

Another important background is since 2004, our debt has almost doubled. However, interestingly, the ratio government debt to GDP has been steadily decreasing. The consumer credit and loan to private sector have also been increased in a huge amount. This might partly explain the so-called “economic boom” that we feel after 2004. That also explain why a lot of our friends who were working in the credit sector got promoted so fast (no hard feelings please). I don’t think it is a coincidence that Indonesian GDP’s explosive growth coincide with the increasing of the leverage level. I am not saying that this is the bad thing; as long as you reap more than the cost of funding, then it is good. In fact if you see Indonesia’s situation, you could see that the GDP rose almost four times. However, the growth started to peak end of 2012. This means if you seek to increase debt just to get more growth, you will get much less return compared to what happened in the 2000s era. Extra leverage will just make the deleveraging process much harder and painful in the future. It is just delaying the inevitable.
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Lastly, the global landscape is much different today. During the last 10 years, global credit supply was abundant. People were scared to put money in US and Europe, as the result, the capital moved someone else. Arguably, Asia was one of the biggest beneficiary. Post 2000, Indonesia’s Foreign Direct Investment (FDI) surged. In today context, we are seeing that the capital is beginning to flow back to the US/EU market. Their stock markets are recovering, and soon enough the Feds will start to increase the interest rate, making leverage more expensive. The graph below is Indonesian FDI chart.

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Our view is that increasing leverage is unwise and reckless. Instead of trying to push economy even further, we should accept that contraction is due. This is just part of economic cycle. Any effort to force the market to go up further will strain it. This is true for both Jokowi and the other candidate’s policies. We viewed that Jokowi’s policy was less aggressive and more cautious. It is more realistic. After all, this is the economic situation that both candidates are inheriting. There are constraints in term of what they can do or cannot do. We think it would be good to control the import and pay attention to the infrastructure spending. However, in reality, it is unwise to expect that in the next decades, the IHSG, or even Indonesia’s economy as a whole would perform at the same level with the previous decade.

 

In conclusion, when we look at the market reaction, it should be happy when the other candidate wins because short term, you will see the market pushed even further. However, in Jokowi’s plan, whatever he is going to do, the result will not be seen at least in another 5-10 years. That is why in our opinion, the market euphoria over Jokowi’s election is just a fads. If the interest rate goes up further (Historically, 7% is very low), liquidity dries up, inflation creeps in, and reality kicks in, valuation will need to be adjusted. In the face of this facts, as Van Den Berg said, “You’re going to have to start adjusting your stock market multiples, because if you don’t the market is going to do it for you.” We don’t think paying a multiple of 40 will be wise, at most it is just a sign of courage and boldness.

 

Going forward, we think the IHSG book value might be able to grow 10% steadily. However, we think the valuation is on the high side. Early, we said that we expect the valuation to be around 3500, right now we revised it to 4000.

 

Mistakes

 

As usual, no year is free from mistakes, this year included. Our biggest mistake the last six months was to liquidate our position in one of the highest conviction company. We liquidated our position in BBRI when there is a big rally. We gain 20% from the trade. If we still hang on the company, today we will have 50% gain. This is a wake up call for us. We need to adhere to our philosophy stronger, instead of being shaken by the short term view.

 

Our Result

 

Our result this half year is marked by the rallying on our biggest holding. There is also notable investment idea, which can be categorized by special situation. We have taken position in CPGT, which has been hit hard by the case. We believe that the media has been incorrectly portrayed the situation, and the public has been irrationally understanding the situation. This is what makes special situation possible. We might be writing about it once we have closed our position.
Anyway, our current unaudited result is 30% vs IHSG’s 15% as of June 30th. We will talk about this at next year update.

 

Reading Material:

 

Disclaimer: Most forecast, analysis, and opinion are bound to be wrong. This piece of opinion is not exempt. Please put your thinking hat on.