Ever since our call on the local small cap early last year, it posted respectable performance in 2017, with the FBMSC Index delivering more than 18%, outperforming the FBMKLCI Index. During the previous small-cap write-up, we mentioned that one of the drivers for the small cap companies was the improving economic growth where the performance of small cap stock has a positive correlation with the economic condition. However, moving into 2018, despite the expectation of continuing synchronized global economic growth, we foresee a dimmer outlook for the Malaysia small cap companies in comparison with their larger counterparts. As such, in this article, we would like to discuss what are the factors that could potentially hinder the growth of the local smaller companies in 2018.
After being the second best performing currency in Asia last year, strengthening more than 10% against US Dollar, Ringgit has emerged as one of the strongest currencies in Asia on year-to-date basis as of 9th February 2018 (see figure 1). For most of the Malaysians, the appreciation of Ringgit is something worth celebrating. However, as the old saying goes, “every coin has two sides”, when one is celebrating on the appreciation of Ringgit, the others would have been hurting by the strong Ringgit – exporters. Within the mid to small cap space, we saw plenty of the companies fall under the exporting category especially for best performing sector in 2017 – Technology and Semiconductor sector as well as some other sectors like the rubber glove and furniture sector.
|Figure 1: YTD Currency Performance
Even if we assume that the Ringgit to stabilize at the current level (RM3.90 against USD), we would see an appreciation of close to 10% for the Malaysia Ringgit on year-on-year basis in 2018. In fact, the stronger Ringgit poises to contribute to the decline in profits for the exporters and hinder the earnings growth of these players.
Escalating Foreign Fund Flow
As of 2nd February 2018, Malaysia equity market posted 5 consecutive weeks of foreign fund inflow, with the foreign investors buying up to US $911.2 million on year-to-date basis. In comparison with the same period a year ago, the YTD foreign fund inflow has grown by close to 12 times of the amount registered in 2017.
In fact, the rapidly rising foreign fund inflow is a reflection of the improving fundamental for the local economy and the recovering corporate earnings. Another factor that would boost the foreign fund inflow is the undervaluation of the Ringgit. Reason being, if Ringgit were to further appreciate moving forward, it would translate into higher total return for the foreign investors due to the currency translation gain. Hence, the better economic fundamental coupled with the potential upside for Ringgit would be a strong catalyst for the inflow of foreign fund.
The return of foreign fund into the local equity market has renewed the buying interest in big-caps stocks which subsequently led to the outperformance of the big caps against the small caps on year-to-date basis (see figure 2). We foresee the continuing foreign fund inflow to lift the performance of the big-cap segment as the foreign investors will usually focus on those big-cap companies that they are more familiar with.
|Figure 2: FBMKLCI vs FBMSC Index
Increasing Volatility in 2018
Unlike last year, where we experienced a year of low volatility in the global equity market, this year, we might be seeing increasing volatility due to the reducing excess liquidity in the financial market as we expect more central banks to follow the footstep of Fed to move toward normalization of monetary policy.
As such, investors might find it even tougher to handpick small cap companies during this rising volatility environment especially after 3 years of outperformance against the big-cap segment which lifted the valuation of small cap companies to a relatively higher level.
All in all, after moving into 2018, we believe the prospect for the big-cap companies looks brighter than the small cap companies given the abovementioned factors. For investors who shared the same view with us, they can consider our all-time favorite local equity fund – Kenanga Growth Fund.
However, despite being positive on the big-cap segment, we believe that the strong macroeconomic outlook is likely to support the earnings growth for small cap stocks. Hence, investors should not completely ignore the small cap companies which are able to provide investors with the growth element. For growth seeking investors, they can look into
Eastspring Investment Small-Cap Fund or
Eastspring Investment Islamic Small-Cap Fund.