J.P. Morgan Securities Indonesia Equity Strategy - Should we keep drinking the Indonesia Kool-Aid?

As the JCI Index pushes past 3,000 to an all-time high level this week, we ask whether what we see as unbridled bullishness on Indonesian equities needs to be tempered. At the same time we present what we see as the main counter arguments to our opinions, aiming to foster debate on the issue.

5 reasons to lay off the Kool-Aid
• Earnings revisions have turned negative: EPS forecasts have moved lower in the last month and, for the first time since March 2009, more analysts have revised earnings lower rather than higher.
• Inflation is going up – pipeline inflation is above comfort levels: J.P. Morgan forecasts inflation of 6.3% at year end, higher than BI’s comfort zone. We see pipeline inflation risks, and are concerned that current discount rates could be exposed to risks as inflation rises.
• Liquidity has tightened, interest rates have started moving higher:
The JIBOR has started moving higher and money supply growth is lagging nominal GDP.
• Market breadth narrowed significantly in 2Q: Five stocks (UNVR, ASII, GGRM, BBRI, BMRI) accounted for 100% of the JCI’s move in 2Q. Exclude these and investors would have lost money in Indonesia.
• Where are the reforms? Growth is being driven by cyclical momentum;
we have struggled to list reforms carried out over the last year.

5 arguments in favor of taking another sip
• Equities have de-rated since 4Q09, despite bond yields sliding:
Declining long bond yields have not translated into higher multiples.
• Portfolio inflows could drive the cost of capital even lower: Fixed income flows remain strong, and could drive yields even lower.
• FDI has started to pick up: 1Q FY10 FDI was up 35% y/y, and signs are that investments into manufacturing are picking up.
• Tapping into new pools of capital: We continue to note new investors in the country seeking growth opportunities elusive elsewhere.
• An appreciation of the Rupiah could be a game-changer: A one-time shift higher in the currency could challenge our opinions on inflation/domestic liquidity and may drive asset prices higher.