Tong Kooi Ong blogs: Anxious period of uncertainties

From The Edge Malaysia
6th Feb 2014

THIS week, The Edge Malaysia carried a special report, The State of The Nation. It addresses the various issues of what you need to know about the economy, stock market and politics today.

Here are a few highlights:

1. There is no imminent or immediate economic crisis. However, the risk bandwidth has widened substantially.

2. Malaysia has a grace period of up to two years to successfully reform, rejuvenate and implement its transformation policies. These include widening its tax base, reducing subsidies, cutting wastages and leakages in government spending, instilling fiscal discipline, improving its current account surplus and increasing private sector competitiveness by eradicating rent-seeking and monopolistic practices.

3. Theoretically, the country could sustain its fiscal deficit by printing more ringgit. In reality, there are limits.

4. Foreign holdings of MGS (Malaysian Government Securities) are very high and the current account surplus is vulnerable. Too much of the government’s revenue is dependent on oil, and its operating expenditure is stubbornly rising.

5. In an environment where issues of politics, economics, race and religion are politicized, the bet is that politicians will likely resort to populist policies, or do nothing. They would be reluctant to push through painful and unpopular – but right – decisions.

6. Any sharp rise in US interest rates (the long-term yield is already steepening) or a major decline in oil and commodity prices will quickly reduce this two-year grace period we have to fix the problems.

7. Malaysian stock prices, based on fundamentals, are currently overvalued. Earnings growth will slow, interest rates will rise and capital outflows by foreign investors will likely continue.

8. Even if some foreign equity funds return to emerging markets should the US economic recovery be weaker than expected, the upside for Malaysian equities will be limited relative to the region. Since March 2013, the FBM KLCI has outperformed other benchmark indices in the region due to heavy buying by domestic institutional funds. If foreign appetite for equities in this region returns, the laggards and cheaper markets are likely to be re-rated upwards first.

9. Foreign holdings of MGS will fall further with the expected global rise in interest rates. The current level of almost 45% foreign ownership is one of the highest in the world, and creates a risk. When foreigners exit their holdings of MGS, the locals must replace them. This will require a re-balancing of the portfolios of major local funds such as the Employees Provident Fund (EPF) into MGS, leaving them less room to increase their equity investments.

10. The biggest risk going forward is that no amount of local institutional fund buying will be able to counter any accelerated and concurrent selling by both foreign and retail investors in the equities and bond markets.

11. At this stage, our view of the Malaysian stock market is that the potential risks overwhelm the potential rewards.

Using the horse as the analogy, given that this year is the year of the wooden horse in the lunar calendar, The Edge argues that for Malaysia, it is not a wooden but a WOUNDED HORSE.

The horse was overstretched the last few years, galloping strongly after being fed with financial steroids.

The fiscal indiscipline and consumption spree of the last few years were facilitated by the massive injection of cheap global liquidity and an enormous expansion in domestic bank loans to consumers.

The steroids are now being gradually withdrawn. Liquidity is moving out of emerging markets and interest rates are set to rise globally.

Below is the performance of major global stock markets since the start of the year of the horse:

	Index on 30 Jan	Index on 5 Feb	% Change
Dow Jones	15,848.61	15,440.23	Down 2.58%
NASDAQ	4,123.13	4,011.55	Down 2.71%
FTSE 1000	6,538.45	6,457.89	Down 1.23%
DAX	9,373.48	9,116.32	Down 2.74%
Nikkei 225	15,007.06	14,180.38	Down 5.51%
Hang Seng	22,035.42	21,269.38	Down 3.48%
STI	3,027.22	2,960.09	Down 2.22%
FBM KLCI	1,804.03	1,785.88	Down 1.00%

Looking at the performance of the global stock markets so far, this horse is certainly not galloping. Whether this was due to the poorer than expected US and Chinese manufacturing data or the strengthening Yen, is really quite secondary.

The point is that the world is in an anxious period of uncertainties.

These stock markets not only fell over the last few trading days, but more significantly, it was universal with major single-day plunges in stock prices.

Japan’s Nikkei 225 plunged 4.18% and Hong Kong’s Hang Seng fell 2.89% on 4 February, while the Dow Jones Industrials Average fell 2.61% on 3 February.

Over the course of the coming months, The Edge will discuss these issues and attempt to provide essential insights, analysis and understanding.

And on every issue of The Edge for 2014, there will be a The State of The Nation Update, highlighting recent developments in the form of updating and analyzing further the charts used in the original report. This will help you track the key variables to assist you in making informed business and investment decisions.

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