Indonesia Looks Promising
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Indonesia has been one the best spots on the globe for investors to put their money the past three years. Its stock market outperformed the regional index by a whopping 130%! But so far this year, it has been a far different story. So far in 2012 the MSCI Indonesia has risen a mere 1.4%, far short of the MSCI Asia ex-Japan index return of 15.8%.
Nevertheless, the Indonesian economy still looks fine. It grew at an annual growth rate last year of 6.5%, up from 6.1% in 2010. This was its best performance since the Asian financial crisis of the late 1990s. Inflation too was on the decline in 2011, to a 3.8% rate, having fallen since a spike in food prices in late-2010.
Investors have been drawn to Indonesia for two reasons. First, the country is rich in natural resources the world needs: coal (particularly thermal coal), copper and palm oil.
Secondly, there is the burgeoning of its middle class whose spending now accounts for more than two-thirds of Indonesia's economic activity. For those unaware of it, Indonesia has Asia's third largest population – 240 million people. More than half the population is under the age of 30, meaning that demographics will be a tailwind for the economy for years to come. In the coming decade, more than 60 million low-income workers are expected to join the middle class, making Indonesia the fastest growing market behind only China and India.
Most economists say that annual disposable income is a rough gauge for what is considered middle class. Market research firm Euromonitor expects the number of Indonesian households with $5,000-$15,000 in annual disposable income to grow from under 40% of the population to nearly 60% by the end of this decade.
This domestic spending is forecast to support corporate earnings. Morgan Stanley predicts that Indonesian corporate earnings per share will rise 15.5% this year, or 4 percentage points higher than corporations in the rest of southeast Asia.
Additionally, in sharp contrast to developed markets, the sovereign debt of Indonesia was recently upgraded by both Moody's and Fitch Ratings to investment grade. This change in rating has pushed down the yield on Indonesia's benchmark 10-year bond by about 100 basis points to nearly an all-time low of 5.3%. The upgrade should lower borrowing costs for Indonesian corporates as well.
All of this should bode well for holders of exchange traded funds that invest in Indonesia. Currently there are two such ETFs – the iShares MSCI Indonesia Investable Market Index Fund (AMEX: EIDO) and the Market Vectors Indonesia Index ETF (AMEX: IDX).
But as mentioned earlier, Indonesian stocks have lagged this year. Why?
Credit Suisse believes it is due to the fact that Indonesian stocks trade at nearly a 50% premium to their emerging market peers. Some investors say the premium is justified since the return on equity for Indonesian companies is far above their southeast Asian counterparts – nearly 25% versus below 15%.
The most likely reason for Indonesia's lagging stock market performance so far in 2012 is investor psychology. Indonesia's stock market dynamics is driven largely by domestic consumption. However, global investors right now are buying the story that the global economic growth has re-awakened. This has led them to focus on stock markets and economies which are driven more by exports to countries like the United States rather than domestic growth.
If the outlook on global economic growth changes for the worse, however, Indonesia will once again come back into favor and outperform other global stock markets.
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