EIDO: Positive economic outlook to support equity market sentiment

Overview of opportunities

Indonesia’s economy has outperformed the emerging market space and appears to have a favorable outlook in the coming years. Despite its lower weighting in the MSCI Emerging Markets index, this country is likely to be very difficult that investors should ignore due to its demographic makeup and favorable long-term economic performance.

Recent signals look very positive as Indonesia looks set to generate stronger growth this year, especially if the Central Bank starts cutting rates later this year. Inflation is under control, which should support consumer sentiment in the second half of this year.

Indonesian stocks significantly outperformed emerging markets in the first half of this year, but that trend could reverse as growth in Indonesia begins to return to decade highs. Shares remain attractively priced, which could contribute to a short-term market rebound in the second half of this year.

Since we last covered this ETF in 2022, iShares MSCI Indonesia ETF, inflation has declined and the country’s growth prospects have improved substantially. Based on these changes, I think now is a good time to increase exposure to Indonesia as it looks poised to outperform other emerging markets in 2024 and 2025. Indonesia’s growth should return to its historical average and remain above 5% over the next years, which bodes well for equity markets.

Economic Bright Spot: Economic sentiment to support the stock market

Indonesia’s economy has been a relatively bright spot amid the slowdown in other economies, as Indonesia’s GDP grew by 5-5.3% in 2022 and 2023. The outlook for 2024 also looks very favorable as Indonesia targets growth of 5.4% this year. In comparison, growth in other emerging and developing countries is likely to be lower, according to IMF projections.

Despite its favorable economic profile, the MSCI Indonesia index has only slightly outperformed the MSCI Emerging Markets over the past decade. However, Indonesia has a history of massive overshoot in certain cycles, as seen in 2009-2013.

Despite its strong economic outlook, the Indonesian stock market underperformed the MSCI Emerging Markets in 2023, following its performance of around 25 percentage points in 2022, when emerging markets fell nearly 20%. Indonesian stocks have also underperformed slightly in 2024, but could be poised to break out later this year as the economy continues to improve.

This current setup has created an attractive valuation for the Indonesian stock market, which trades at only a slight premium to MSCI Emerging Markets and offers a considerably higher dividend yield of 4.7%. Indonesia also trades at a slight discount to other regional peers such as Thailand, Vietnam and India.

One of the major factors holding back the country’s economy, rising inflation in 2022, has resolved significantly in 2024. Inflation peaked at around 6% in September 2022, but has since fallen below 3%, more in line with the historical average.

Inflation Indonesia

Lower inflation helped boost consumer sentiment in Indonesia as household consumption rose 4.9 percent from a year ago in the last quarter. This rebound in consumer growth, along with government spending, has helped Indonesia’s growth return to its pre-covid highs.

Another potential catalyst, which could start to have an impact in 2025, is the potential for the country’s Central Bank to start cutting rates now that inflation has remained stable in recent months. Inflation recently eased to 2.1% last month and has remained below 3% since May, which should give the country’s Central Bank plenty of room to cut rates in the second half of 2024.

The country’s benchmark interest rate has been around 6% since the start of 2023, well below the lows of 2022. If inflation continues to remain below 3%, the country’s Central Bank may be able to cut rates in its next meetings.

Bank Indonesia recently decided to keep interest rates steady despite positive inflation readings during its last meeting. A recent Reuters poll of analysts predicts it will cut rates by 25 basis points at its next meeting. These announcements could help boost stock sentiment in 2024 and consequently lead to stronger growth in 2025.

Looking at the iShares MSCI Indonesia ETF

With only a small amount of liquid ADR options, ETFs are generally the easiest way to access markets like Indonesia. The iShares Indonesia ETF (NYSEARCA:EIDO) is one of the easiest ways to get market exposure at a reasonable valuation. While the broader market trades at around 17x earnings and over 2x book value, this ETF trades at a lower valuation. This ETF also has a relatively low expense ratio of 0.59%, in line with other emerging market regional ETFs.

One factor to note is that this ETF has a very strong exposure to Indonesian financial companies, much more than most emerging market ETFs.

This ETF also makes a relatively concentrated bet on individual names such as Bank Central Asia, although not as much as the MSCI Indonesia Index. In comparison, this index invests about 56% of its assets in these three top holdings, while the iShares MSCI Indonesia ETF only invests about 46% of its assets in these three companies.

Banks may be a good way to play this economic recovery, as banks may be able to boost credit growth and maintain asset quality as economic conditions normalize. Fitch Ratings recently upgraded Indonesian banks from BBB- to BB+ due to the improved outlook for Indonesia’s economy. Moreover, this approach also allows you to access the market at around 12 times earnings with reasonable growth prospects.

Final thoughts

Indonesia’s economy looks poised to outperform other emerging markets in the coming years, but equity markets have had a lackluster performance this year. This trend is likely to reverse in the second half of this year, allowing Indonesia to begin to outperform other emerging markets.

Financial companies make up nearly 60% of the MSCI Indonesia index, so it’s hard to avoid exposure to this theme. There are several alternatives to avoid heavy exposure to Indonesian banks, although these options are limited as many of the Indonesian OTC companies have low liquidity.

1) Alternative ETF: The VanEck Indonesia ETF (IDX) invests only about 30% of its assets in financial companies. The main factors to note are lower AUM (around $28 million) and lower liquidity (around 12,000 shares/day). In comparison, the iShares MSCI Indonesia ETF has an AUM of over USD 300 million and an average daily trading volume of approximately 554,000.

2. Telecommunications company: Telkom Indonesia (TLK) is a highly liquid ADR that provides exposure to Indonesia’s telecommunications industry. We covered this company a few months ago and think it looks attractively positioned following the pullback after Q1 2024.

Overall, I think the iShares MSCI Indonesia ETF and Telkom Indonesia are two excellent vehicles to gain exposure to the Indonesian stock market. Indonesia’s stock market has several catalysts ahead, thanks to its economic outlook and lower valuation, and looks poised to outperform emerging markets and regional peers.